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Chapter 4

Chapter 4. Extensions of Demand and Supply Analysis. Shipping companies have found in recent years that there has been a shortage of available space at U.S. seaports. What market condition would give rise to a persistent shortage?. Introduction. Learning Objectives.

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Chapter 4

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  1. Chapter 4 Extensions of Demandand Supply Analysis

  2. Shipping companies have found in recent years that there has been a shortage of available space at U.S. seaports. What market condition would give rise to a persistent shortage? Introduction

  3. Learning Objectives • Discuss the essential features of the price system • Evaluate the effects on the market price and equilibrium quantity of changes in demand and supply • Understand the rationing function of prices

  4. Learning Objectives • Explain the effects of price ceilings • Explain the effects of price floors • Describe various types of government-imposed quantity restrictions on markets

  5. Chapter Outline • The Price System • Exchange and Markets • Changes in Demand and Supply • Price Flexibility and Adjustment Speed • The Rationing Function of Prices

  6. Chapter Outline • The Policy of Government-Imposed Price Controls • The Policy of Controlling Rents • Price Floors in Agriculture • Price Floors in the Labor Market • Quantity Restrictions

  7. Did You Know That... • A shortage of flu vaccine arose in 2003? • Persistent shortages and surpluses may be observed in various markets? • The model of supply and demand can explain many of these instances of a gap between quantity supplied and quantity demanded?

  8. The Price System • Price System (market system) • An economic system that allocates resources based on relative prices determined by supply and demand • Prices signal what is relatively scarce and relatively abundant

  9. Exchange and Markets • Markets • Emphasize voluntary exchange • Determine the terms of exchange • Facilitate exchange

  10. Exchange and Markets • Voluntary Exchange • Acts of trading between individuals that make both parties to the trade subjectively better off • Terms of Exchange • The prices we pay for the desired items

  11. Exchange and Markets • Transaction Cost • The costs associated with exchange • Examples • Price shopping • Determining quality • Determining reliability • Service availability • Cost of contracting

  12. Exchange and Markets • The role of middlemen • Middlemen (intermediaries) or brokers reduce transaction cost by providing information to buyers and sellers. • Examples • Real estate brokers • Stock brokers • Consignment shops • Car dealerships

  13. Exchange and Markets • Observation • Consumers on the Internet rely on intelligent shopping agents to act as middlemen • Question • How has the increase in the number of web pages affected the potential market for shopbot services?

  14. Changes in Demand and Supply • Changes in supply and demand create a disequilibrium • The market price and quantity adjust to a new equilibrium

  15. E1 D1 Shifts in Demand and Supply: Determinate Results Increase Demand with Supply Constant S P1 Q1 Figure 4-1

  16. D2 Shifts in Demand and Supply: Determinate Results Increase Demand with Supply Constant S At price P1 quantity demanded exceeds quantity supplied— a shortage exists E1 P1 D1 Q1 Q2 Figure 4-1

  17. E2 P2 D2 Q2 Shifts in Demand and Supply: Determinate Results Increase Demand with Supply Constant S Equilibrium price and quantity increase to P2and Q2 E1 P1 D1 Q1 Figure 4-1

  18. D2 Shifts in Demand and Supply: Determinate Results Decrease Demand with Supply Constant S E1 At price P1 quantity supplied exceeds quantity demanded— a surplus exists. P1 D1 Q2 Q1 Figure 4-1

  19. E3 P3 Q3 Shifts in Demand and Supply: Determinate Results Decrease Demand with Supply Constant S E1 Equilibrium price and quantity decrease to P3and Q3 P1 D1 D3 Q1 Figure 4-1

  20. S1 E1 D Shifts in Demand and Supply: Determinate Results Increase Supply with Demand Constant P1 Q1 Figure 4-1

  21. Shifts in Demand and Supply: Determinate Results Increase Supply with Demand Constant At price P1 quantity supplied exceeds quantity demanded— a surplus exists S1 S2 E1 P1 D Q1 Q3 Figure 4-1

  22. E2 P2 Q2 Shifts in Demand and Supply: Determinate Results Increase Supply with Demand Constant Equilibrium price decreases and quantity increases to P2and Q2 S1 S2 E1 P1 D Q1 Figure 4-1

  23. S3 S1 E1 P1 D Q1 Q2 Shifts in Demand and Supply: Determinate Results Decrease Supply with Demand Constant At price P1 quantity demanded exceeds quantity supplied— a shortage exists Figure 4-1

  24. S3 E3 P3 P1 Q1 Shifts in Demand and Supply: Determinate Results Decrease Supply with Demand Constant Equilibrium price decreases and quantity increases to P3and Q3 S1 E1 D Q3 Figure 4-1

  25. Changes in Demand and Supply • Summary • Increases in demand increase equilibrium price and quantity. • Decreases in demand decrease equilibrium price and quantity.

  26. Changes in Demand and Supply • Summary • Increases in supply decrease equilibrium price and increase equilibrium quantity. • Decreases in supply increase equilibrium price and decrease equilibrium quantity.

  27. Changes in Demand and Supply • When both demand and supply shift • Simultaneous changes in demand and supply put conflicting pressure on price or quantity • The resulting effect depends upon how much each curve shifts • Either equilibrium price or quantity will be indeterminate

  28. Changes in Demand and Supply • When both demand and supply increase • Change in price is indeterminate • Quantity will increase • When both demand and supply decrease • Change in price is indeterminate • Quantity will decrease

  29. Changes in Demand and Supply • When supply decreases and demand increases • Price will increase • Change in quantity is indeterminate • When supply increases and demand decreases • Price will decrease • Change in quantity is indeterminate

  30. Price Flexibilityand Adjustment Speed • Flexibility and indirect adjustment • Quality • Service • Rebates

  31. Price Flexibilityand Adjustment Speed • Adjustment speed • Market characteristics influence adjustment speed • Markets may overshoot in the adjustment process

  32. Example:Why Plywood Prices Have Soared • The supply has decreased, due to some lumber sellers going out of business and to delays in timber harvesting as a result of wet weather. • Demand has increased both from the private sector and from government purchases for the military.

  33. Example:Why Plywood Prices Have Soared Figure 4-2

  34. The Rationing Function of Prices • When surpluses and shortages exist, the price adjusts to clear the market. • This adjustment is the rationing function of price.

  35. The Rationing Function of Prices • When prices cannot adjust non-price rationing occurs • Rationing by queues • Rationing by lotteries • Rationing by coupons

  36. The Rationing Function of Prices • The essential role of rationing • With scarcity rationing must occur • We must choose the rationing mechanism: price or non-price • Price rationing is the most efficient • Further trades could not occur without making somebody worse-off

  37. The Rationing Function of Prices • Question • If price rationing is the most efficient is it the best way to ration?

  38. The Policy of Government-Imposed Price Controls • Price Controls • Government-mandated minimum or maximum prices • PriceCeiling • A legal maximum price • PriceFloor • A legal minimum price

  39. The Policy of Government-Imposed Price Controls • Price ceiling and black markets • Price ceilings may prevent the equilibrium price from being achieved if it is above the ceiling price.

  40. The Policy of Government-Imposed Price Controls • Non-Price Rationing Devices • All methods used to ration scarce goods that are price-controlled • BlackMarket • A market in which price-controlled goods are sold at an illegally high price

  41. S’ Implicit supply schedule at P1 < Pe P2 Pe P1 Shortage D Qd Qe Qs Black Markets Price Quantity per Unit Time Period Figure 4-3

  42. Example:Vaccine Shortages • Government mandates have resulted in a substantial portion of childhood vaccines being sold at prices below the market price. • As a consequence, pharmaceutical companies are cutting back on the production of vaccines.

  43. The Policy of Controlling Rents • The functions of rental prices • Promote the efficient maintenance and construction of housing • Allocate existing housing • Ration the use of housing

  44. The Policy of Controlling Rents • Rent controls and construction • Controls discourage construction • With a 16% vacancy rate and no controls, Dallas recently built 11,000 new rental units. • With a 1.6% vacancy rate and controls, San Francisco recently built 2,000 new rental units.

  45. The Policy of Controlling Rents • Effects on the existing supply of housing • Property owners cannot recover costs

  46. The Policy of Controlling Rents • Rationing the current use of housing • Reduces mobility • New York’s “housing gridlock”

  47. The Policy of Controlling Rents • Attempts at evading rent controls • Forcing tenants to leave • Tenants subletting apartments • Housing courts

  48. The Policy of Controlling Rents • Who gains and who loses from rent controls? • Losers • Property owners • Low-income individuals • Benefits • Upper-income professionals

  49. Price Floors in Agriculture • Support Price • the governmentally established minimum price farmers are to receive for a particular agricultural product.

  50. Excess quantity supplied S Ps Pe E D Qs Qe Qd Agricultural Price Supports Dollars per Unit Quantity of Peanuts per Time Period Figure 4-4

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