Chapter 4: Bring Supply and Demand Together

By the end of this chapter, you will … 1. see how both the supply and demand determine the price of a good and the quantity sold; 2. be able to identify the areas of shortage and surplus; 3. know the laws of demand and supply; and 4. examine the effects of government intervention that introduce price controls into competitive markets.

4.1 Market Equilibrium Price and Quantity Market Equilibrium: The intersection of the market demand curve and the market supply Q d = Q s Determines the equilibrium price and equilibrium quantity of the market. At the equilibrium market price, the amount that buyers are willing and able to buy is exactly equal to the amount that sellers are willing and able to produce.

4.1 Market Equilibrium Price and Quantity Surplus Price greater than equilibrium price. Sellers willing to sell more than demanders willing to buy. Market price will fall (self regulating market) Shortage Price less than equilibrium price. Buyers willing to buy more than sellers willing to sell. Market price will rise (self regulating market)

Determine the State of the Market in our hypothetical market for apples. PriceQuantity Demanded Quantity Supplied State of Market $51,0008,000 $43,0007,000 $35,000 $28,0003,000 $112,0001,000

A Hypothetical Market Supply and Demand Schedule for Apples Price of Apples (per kilogram) Quantity Demanded and Supplied of Apples (thousands of kilograms/year) $6 Demand Supply

4.2 Changes in Equilibrium Price and Quantity Three Steps to Analyzing Changes in Equilibrium 1. Decide whether the event shifts the supply or demand curve (or both). 2. Decide whether the curve(s) shift(s) to the left or to the right. 3. Use the supply-and-demand diagram to see how the shift affects equilibrium price and quantity.

How an Increase in Demand Affects the Equilibrium Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones Supply Initial equilibrium D D 3....and a higher quantity sold resulting in a higher price Hot weather increases the demand for ice cream New equilibrium $

How a Decrease in Supply Affects the Equilibrium Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones Demand New equilibrium Initial equilibrium S1S1 S2S resulting in a higher price of ice cream An increase in the price of sugar reduces the supply of ice cream and a lower quantity sold $2.50 4

Why is gasoline more expensive in the summer? Copyright©2003 Southwestern/Thomson Learning Price of Gasoline (per liter) 0 Quantity of Gasoline (millions of liters) Supply Initial equilibrium D

Why are strawberries cheaper in the summer? Copyright©2003 Southwestern/Thomson Learning Price of Strawberries (pint) 0 Quantity of Strawberries (pint) Demand Initial equilibrium S1S

Simultaneous changes in demand and supply: Very often, supply and demand will both shift in the same time period. (simultaneously) When this happens, we can predict the change in one variable (price or quantity), but we are unable to predict the direction of effect on the other variable. The change in the second variable is said to be indeterminate. 4.2 Changes in Equilibrium Price and Quantity

P1P1 Q1Q1 Shifts in Supply and Demand Price S0S0 D0D0 D1D1 Quantity S1S1 0 Q0Q0 P0P0 E1E1 E0E0 a. A Little Increase in Supply and a Big Decrease in Demand

Shifts in Supply and Demand S1S1 S0S0 D0D0 D1D1 Price P1P1 Q1Q1 Q0Q0 P0P0 Quantity 0 E0E0 E1E1 b. A Big Increase in Supply and a Little Decrease in Demand

The Effect of Changing Demand and/or Supply

4.3 Price Controls While non-equilibrium prices occur naturally in the private sector, reflecting uncertainty, they seldom last for long. Governments, however, may impose non-equilibrium prices for significant time periods. Price controls involve the use of the power of the government to establish prices different from the equilibrium prices that would otherwise prevail.

4.3 Price Controls Price Ceiling: A legal maximum price ‘Binding’ price ceiling are set below equilibrium price Example: rent control Price Floor: A legal minimum price ‘Binding’ price floors are set above equilibrium price Example: minimum wage

Show the impact of a price ceiling in the rental housing market. Price of Apartments (Rent) Quantity of Apartments Demand Supply 0 Q* P*

Some results of rent controls: Reluctance of tenants to move from rent control Reduced the incentives to construct new rental housing. Shortage of apartments that persists and grows over time. Little incentive to improve or upgrade rental apartments in order to get more rent. Some incentive to avoid routine maintenance. 4.3 Price Controls

Show the impact of a price floor in the labour market. Wage (price of labour) Quantity of Labour D LABOUR S LABOUR 0 QEQE WEWE

Some results of the minimum wage: Creates additional unemployment for low skill, least experienced workers. Workers that lose their jobs or are unable to get them in the first place suffer a decline in earnings. Workers that hold jobs with the same hours and working conditions after the minimum wage is increased gain substantially. 4.3 Price Controls

There is no impact of a price floor on the market for skilled and experienced workers. In this market the price floor (minimum wage) is not binding