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Using Supply and Demand

Chapter 5

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Laugher Curve

Q. How many conservative economists

does it take to screw in a lightbulb?

A. None.

If the government would just leave it

alone, it would screw itself in.

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The Power of Supply and

Demand Changes in supply and demand will

change equilibrium price and quantity.

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Demand A shift in demand that moves the

demand curve to the right causes

equilibrium price and quantity to rise.

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Demand A shift in supply that moves the supply

curve to the left causes equilibrium price

to rise and equilibrium quantity to fall.

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A Shift in Demand

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A Shift in Supply

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Six Real World Examples of

Supply and Demand Supply and demand can shed light on a

variety of real-world events:

Florida freeze.

Financial assets and the baby boomers.

Ten percent excise tax.

Rice in Indonesia.

Farm laborers.

Christmas toys.

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Florida Freeze

The crop-damaging freeze shifted the

supply curve to the left.

At the original price, quantity demandedexceeded quantity supplied.

Price rose until the quantity demanded

equaled the quantity supplied.

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Florida Freeze

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Financial Assets and the

Baby Boomers Demographic changes among baby

boomers moved the demand curve for

financial assets to the right. At the original price, quantity demanded

exceeded quantity supplied.

Price rose until the quantity demandedequaled the quantity supplied.

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Baby Boomers

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Baby Boomers The same phenomenon occurred in the

surging demand for housing among this

group during the 1980s.

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Excise Taxes

Congress imposed a 10 percent surtax

on luxury boats.

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Excise Taxes

A 10 percent surtax on luxury boats

levied on suppliers shifts the supply

curve to the left.

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Excise Taxes

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Rice in Indonesia

Drought, pestilence, and the financial

crisis shifted the supply curve to the left.

The steep demand curve means thatthe quantity demanded does not change

much with changes in price.

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Rice in Indonesia

Responding to high prices, the

government imported rice and

distributed it to the market, causing thesupply curve to shift to the right.

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Rice in Indonesia

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Farm Laborers

The compressed harvesting season

increased the demand and increased

INS patrols decreased supply. Demand shifted to the right and supply

shifted to the left.

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Farm Laborers

At the original price, the quantity of

workers demanded exceeded the

quantity supplied.

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Farm Laborers

Price rises until the quantity demanded

equaled the quantity supplied.

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Farm Laborers

The effect on the number of laborers

hired depended on the relative size of

the supply shift.

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Farm Laborers

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Christmas Toys

A Christmas craze for Furbies shifts

demand to the right.

A shortage ensued along with a blackmarket.

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Christmas Toys

Finally the supplier produced more,

shifting the supply curve to the right,

causing the price to drop.

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Christmas Toys

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A Review

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Government Interferences

Buyers look to government for ways to

hold prices down.

Sellers look to government for ways tohold prices up.

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Price Ceilings

A pr ice ceil ingis a government-

imposed limit on how high a price can

be charged.

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Rent Controls

Rent contro lis a price ceiling on rents

set by government.

An example is rent control in Parisfollowing World War I and World War II.

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Rent Controls

The following were the consequences of

rent control in Paris:

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Rent Controls

The following were the consequences of

rent control in Paris:

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Rent Controls

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Rent Controls

A similar situation occurred in New York

City.

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Price Floors

A pr ice f loo ris a government-imposed

limit on how low a price can be charged.

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Minimum Wage

The minimum wage is an example of a

price floor.

A min imum wageis set by governmentspecifying the lowest wage a firm can

legally pay an employee.

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Minimum Wage

The minimum wage creates winners

and losers:

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Minimum Wage

Economists disagree about the effects

of the minimum wage.

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Taxes, Tariffs, and Quotas

An exc ise taxis a tax that is levied on a

specific good.

A tari f fis an excise tax on an importedgood.

Taxes and tariffs raise prices and

reduce quantity.

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The Effect of an Excise Tax

on Price and Quantity A 10 percent luxury tax on expensive

boats was imposed in 1990.

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on Price and Quantity Because the luxury tax was imposed on

the boat builders, the supply curve

moved up by the amount of the tax.

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on Price and Quantity At a price equal to the original price plus

the tax there was excess supply.

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on Price and Quantity

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on Price and Quantity The tax was repealed in 1993 because

of tax revenue shortfalls.

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Quantity Restrictions: Quotas

A quotais a quantitative restriction on

the amount that one nation can export

to another.

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The U.S. government restricted imports

of Japanese cars.

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The Relationship Between a

Quota and a Tariff Tariffs and quotas can both be used to

reduce quantity and raise prices.

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Quota and a Tariff There is a difference between imposing

a tariff and imposing a quota.

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Quota and a Tariff As a consequence, once quotas are

instituted, Japanese firms competed

intensely to get them.

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Quota and a Tariff

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The Limitations Of Supply

And Demand Analysis It is not enough to be able to explain

what happens when supply or demand

curves shift. It is necessary to understand the

assumptions underlying the analysis.

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And Demand Analysis Other things don't remain constant.

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And Demand Analysis Deciding whether the effects are

significant to consider requires a

knowledge of the structure of theeconomy because all actions have

ripple or feedback effects.

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And Demand Analysis The other-things-constant assumption is

likely not to hold true when one the

goods represent a large percentage ofthe entire economy.

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The Fallacy of Composition

The fal lacy o f composi t ionis the false

assumption that what is true for a part

will also be true for the whole.

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Thousands of small effects taken

together add up to a large effect.

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When analyzing the aggregate, small

effects that can be put aside in micro,

can add up, and hence cannot beforgotten.

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Small effects comprise microeconomics

while large effects comprise

macroeconomics.

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The Roles of Government

Provide a stable institutional framework.

Promote effective and workable

competition. Correct for externalities.

Ensure economic stability and growth.

Provide for public goods.

Adjust for undesired market results.

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Provide a Stable Set of

Institutions and Rules Only the government can create a

stable environment and enforce

contracts through its legal system.

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Provide a Stable Set of

Institutions and Rules When governments do not provide a

stable environment, as is now

happening in Russia, economic growthis difficult - usually such economies are

stagnant.

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Promote Effective and

Workable Competition Government promotes competition and

protect against monopolies.

Monopoly poweris the ability ofindividuals or firms currently in businessto prevent other individuals or firms fromentering the same kind of business

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Workable Competition Monopoly power gives existing firms or

individuals the power to raise prices.

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Workable Competition Many players in the market insist on

open competition except when it comes

to themselves:

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Correct for Externalities

Unless they are required to do so,

parties to any exchange are unlikely to

take into account any externality.

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An external i tyis the effect that an

action may have on a third party that the

person who undertook that action didnot take into account.

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The externality may be positive in which

case society benefits even more than

the two parties

an example iseducation.

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The externality may be negative in

which case society as a whole benefits

less than the two parties

an exampleis pollution.

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When there are externalities,

government has the potential role to

change the rules so that the partiesmust take into account the effect of their

actions on others.

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Ensure Economic Stability

and Growth Most Americans agree that government

should:

Prevent large fluctuations in economicactivity.

Maintain a relatively constant price level.

Provide an economic environmentconducive to economic growth.

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Ensure Economic Stability

and Growth Most economists support these goals

since they involve macroeconomic

externalities.

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Provide for Public Goods

Pub l ic goodsare those whose

consumption by one individual does not

prevent their consumption by otherindividuals an example is a public

park.

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In contrast, a pr ivate goodis one that,

when consumed by one individual,

cannot be consumed by otherindividuals an example is an apple.

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A free rideris a person who

participates in something without having

to pay for it.

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Since most everyone would enjoy

having public parks without having to

pay for them, government requires thatthe public be taxed to pay for public

parks, thereby eliminating free riders.

Adj f U d i d M k

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Adjust for Undesired Market

Results In an attempt to make the market fairer,

the government, through taxes and

expenditures, redistributes incomeamong households.

The result is controversy.

Adj f U d i d M k

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Results For example, in trying to be fair, which

type of tax should the government use?

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Results A progress ive tax, such as the U.S.

income tax is one whose rates increase

as a person's income increases.

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Results A regressive taxsuch as a sales tax is

one whose effect decrease as income

rises.

Adj t f U d i d M k t

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Results A propo rt ional tax, such as the Social

Security tax, is one whose rates are

constant at all income levels, regardlessof the taxpayer's total annual income.


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Results Another controversial role for

government involves deciding what is

best for people independently of theirdesires.


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Results Should government prohibit demerit

goods and activities?


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Results Demeri t goods and act iv i t iesare

things government believes are bad for

you, although you may like them.


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Results Meri t goods and act iv i t iesare things

the government believes are good for

you, although you may not like them.

M k t F il d

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Market Failures and

Government Failures Market failures are the reason why

government intervenes.

M k t F il d

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Market Failures and

Government Failures Market fai luresare situations where

the market does not lead to a desired

result.

M k t F il d

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Market Failures and

Government Failures Government intervention, however, may

make matters worse.

M k t F il d

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Market Failures and

Government Failures Governm ent fai luresare situations

where the government intervenes and

makes the situation worse

government is always failing in one way

or another.

M k t F il d

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Market Failures and

Government Failures Real-world policy makers are left with

the choice of selecting that which is

least bad -- market failure orgovernment failure.

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Using Supply and Demand

End of Chapter 5

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Chap005x