KAPLAN BU204-4 CHAPTERS 3 & 4 Nicholas Bergan

Supply and Demand Model The demand curve The supply curve The set of factors that cause the demand curve to shift, and the set of factors that cause the supply curve to shift. The equilibrium price The way the equilibrium price changes when the supply or demand curves shift To understand the supply and demand model, we will examine each of these elements.

Demand A demand schedule is a table showing how much of a good or service consumers will want to buy at different prices. The curve that connects these points is a demand curve. A demand curve is a graphical representation of the demand schedule, another way of showing how much of a good or service consumers want to buy at any given price. Generally, the proposition that a higher price for a good, other things equal, leads people to demand a smaller quantity of that good is so reliable that economists are willing to call it a “law”—the law of demand.

Factors that cause a shift in the Demand Curve Economists believe that there are four principal factors that shift the demand curve for a good: Changes in the prices of related goods Changes in income Changes in tastes Changes in expectations Two goods are substitutes if a fall in the price of one of the goods makes consumers less willing to buy the other good.

Supply The quantity supplied is the actual amount of a good or service people are willing to sell at some specific price. A supply schedule shows how much of a good or service would be supplied at different prices. A supply curve shows graphically how much of a good or service people are willing to sell at any given price.

Factors that cause a shift in the Supply Curve  Economists believe that shifts of supply curves are mainly the result of three factors (though, as in the case of demand, there are other possible causes): Changes in input prices Changes in technology Changes in expectations

Equilibrium, Shortage, Surplus  Equilibrium;  A competitive market is in equilibrium when price has moved to a level at which the quantity demanded of a good equals the quantity supplied of that good. The price at which this takes place is the equilibrium price, also referred to as the market-clearing price. The quantity of the good bought and sold at that price is the equilibrium quantity.  Surplus  ; There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level.  Shortage;  There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level.

Summary of Market  To summarize how a market responds to a change in demand: An increase in demand leads to a rise in both the equilibrium price and the equilibrium quantity. A decrease in demand leads to a fall in both the equilibrium price and the equilibrium quantity.  To summarize how a market responds to a change in supply: An increase in supply leads to a fall in the equilibrium price and a rise in the equilibrium quantity. A decrease in supply leads to a rise in the equilibrium price and a fall in the equilibrium quantity.

Price Controls  Price controls are legal restrictions on how high or low a market price may go.  They can take two forms: a price ceiling is a maximum price sellers are allowed to charge for a good, or a price floor, a minimum price buyers are required to pay for a good.  A market or an economy is inefficient if there are missed opportunities: some people could be made better off without making other people worse off.

Price Ceilings  Price ceilings often lead to inefficiency in the form of inefficient allocation to consumers: people who want the good badly and are willing to pay a high price don’t get it, and those who care relatively little about the good and are only willing to pay a low price do get it.  Price ceilings typically lead to inefficiency in the form of wasted resources: people spend money and expend effort in order to deal with the shortages caused by the price ceiling.  Price ceilings often lead to inefficiency in that the goods being offered are of inefficiently low quality: sellers offer low-quality goods at a low price even though buyers would prefer a higher quality at a higher price.

So Why Are There Price Ceilings?  We have seen three common results of price ceilings:  A persistent shortage of the good  Inefficiency arising from this persistent shortage in the form of inefficient allocation of the good to consumers, resources wasted in searching for the good, and the inefficiently low quality of the good offered for sale  The emergence of illegal, black market activity

Price Floors  The minimum wage is a legal floor on the wage rate, which is the market price of labor.  Price floors lead to inefficient allocation of sales among sellers: those who would be willing to sell the good at the lowest price are not always those who actually manage to sell it.  Price floors often lead to inefficiency in that goods of inefficiently high quality are offered: sellers offer high- quality goods at a high price, even though buyers would prefer a lower quality at a lower price.

So Why Are There Price Floors?  To sum up, a price floor creates various negative side effects:  A persistent surplus of the good  Inefficiency arising from the persistent surplus in the form of inefficient allocation of sales among sellers, wasted resources, and an inefficiently high level of quality offered by suppliers  The temptation to engage in illegal activity, particularly bribery and corruption of government officials

Quota’s  A quantity control, or quota, is an upper limit on the quantity of some good that can be bought or sold. The total amount of the good that can be legally transacted is the quota limit.  A license gives its owner the right to supply a good.  The demand price of a given quantity is the price at which consumers will demand that quantity.  The supply price of a given quantity is the price at which producers will supply that quantity.  A quantity control, or quota, drives a wedge between the demand price and the supply price of a good; that is, the price paid by buyers ends up being higher than that received by sellers.  The difference between the demand and supply price at the quota limit is the quota rent, the earnings that accrue to the license-holder from ownership of the right to sell the good. It is equal to the market price of the license when the licenses are traded.

Taxation  An excise tax is a tax on sales of a good or service.  The incidence of a tax is a measure of who really pays it.  The excess burden, or deadweight loss, from a tax is the extra cost in the form of inefficiency that results because the tax discourages mutually beneficial transactions.

Review Questions Which of the following will NOT cause an increase in demand for good X? A good is inferior if ______. A technological advance in the production of automobiles will _______.

Review Questions Cont. A recent news story reported that OPEC is expected to decrease the supply of oil next summer. Summer is traditionally a time of increased demand for oil because of the many families driving and flying to vacation sites. What would be the combined effect of these two events on the summer market for gasoline? You notice that the price of DVD players falls and the quantity of DVD players sold increases. This set of observations can be the result of the ______. Rent controls in New York City cause all of the following except ______.

Review Questions Cont. A binding price floor causes ______. Although most economists agree that price floors and ceilings lead to inefficiency, governments continue to impose such price controls. A possible reason for this is ______. The “quota rent” refers to ______. If an excise tax is imposed on automobiles and collected from consumers ______.

Questions for Chapters 3 & 4  Questions?