Chapter 4 Markets in Action

Demand and Supply Changes in Demand and Supply Three steps to analyzing changes in equilibrium Decide if the event shifts the supply curve, the demand curve, or both curves Decide if curve shifts to right or to left Use supply-and-demand diagram Compare initial and new equilibrium How the shift affects equilibrium price and quantity

Supply and Demand Example: A change in market equilibrium due to a shift in demand A warm summer effect on the coffee market Warm weather - demand curve (tastes) Demand curve shifts to the left (down) Lower equilibrium price; lower equilibrium quantity

Supply and Demand Price Of Coffee D1 Supply 2.00 $2.50 New equilibrium D1 1. Warm weather decreases the demand for coffee . . . Supply 2. resulting in a lower price . . . 2.00 $2.50 New equilibrium 10 7 3. …and a lower quantity sold. D0 Quantity of Coffee An abnormally warm summer causes buyers to demand less coffee. The demand curve shifts from D0 to D1, which causes the equilibrium price to lower from $2.50 to $2.00 and the equilibrium quantity to lower from 10 cups to 7 cups.

Supply and Demand Example: A change in market equilibrium due to a shift in supply Technology improves the coffee making process Change in technology impacts the supply curve Supply curve shifts to the right Lower equilibrium price; higher equilibrium quantity

Supply and Demand Price of Coffee S1 S0 2.00 $2.50 7 New equilibrium 1. an improvement in technology S0 2.00 2. results in a lower price $2.50 7 3. and a higher quantity sold New equilibrium Demand 4 Quantity of Coffee A technology improvement causes sellers to supply more coffee. The supply curve shifts from S0 to S1, which causes the equilibrium price of coffee to lower from $2.50 to $2.00 and the equilibrium quantity to increase from 4 to 7 cups

Supply and Demand Example: A change in market equilibrium due to a shift in supply Labor wages increase Effect on the market for coffee? Change in input price impacts the supply curve Supply curve - shifts to the left Higher equilibrium price; lower equilibrium quantity

Supply and Demand Price of Coffee S1 $2.50 Demand S0 New equilibrium 4 1. an increase in labor wages S1 $2.50 2. results in a higher price Demand S0 New equilibrium 4 3. a smaller quantity sold 2.00 7 Quantity of Coffee An increase in labor wages (an input price) causes sellers to supply less coffee. The supply curve shifts from S0 to S1, which causes the equilibrium price of coffee to rise from $2.00 to $2.50 per cup and the equilibrium quantity to fall from 7 to 4 cups.

Price Controls Price ceilings – a legally established maximum price a seller can charge Price floors – a legally established minimum price a seller can be paid

Rent Market S 1,600 1,200 Rent ceiling 800 D 400 Month Rent per Unit (dollars) Rent ceiling 800 Shortage of 4 millions rental units D 400 2 4 6 8 Quantity of Rental Units (millions per month)

Rent Controls Shortages Illegal markets Less maintenance Discrimination

Examples of price floors Price Controls Examples of price floors Minimum wage law Agricultural price supports

Labor Market S Wm We D QD QE QS Wage Rate (dollars per hour) Unemployment Wage Rate (dollars per hour) Wm Minimum wage We D QD QE QS Quantity of Unskilled Labor (workers per year)

Market Failure Market Failure – a situation in which the price system results in too few or too many resources used in the production of a good or service. This inefficiency may justify government intervention. Lack of Competition Externalities Public Goods Income Inequality

Lack of Competition Lack of Competition Adam Smith – The father of modern economics who wrote The Wealth of Nations, published in 1776 There must be competition for markets to function properly

Rigging the Computer Market Price Inefficient equilibrium S2 S1 2,000 1,500 1,000 Efficient equilibrium D 500 50 100 150 200 Quantity

Externality Externality – A cost or benefit imposed on people other than the consumers and producers of a good or service (third parties). Negative Externality – an externality that is detrimental to third parties Pollution Positive Externality – an externality that is beneficial to third parties Vaccinations Regulation – remove or control the externality

External Costs of Pollution Includes external costs of pollution Efficient equilibrium S2 Excludes external costs of pollution S1 P2 Price of Steel P1 Inefficient equilibrium D Q2 Q1 Quantity of Steel

External Benefits of Education Price of education (tuition) Efficient equilibrium P2 Q2 P1 Includes social benefits D2 Inefficient equilibrium D1 Excludes social education benefits Q1 Quantity (number of students)

Externality Conclusion When the supply curve fails to include external costs, the equilibrium price is artificially low, and the equilibrium quantity is artificially high When externalities are present, market failure gives incorrect price and quantity signals, and resources are misallocated External costs cause the market to over allocate resources, and external benefits cause the market to under allocate resources

Public Goods Public Good – a good that, once produced, has two properties: users collectively consume benefits no one can be excluded (free rider) Examples National defense Public education Highways If public goods are available only in the marketplace, people wait for someone else to pay, and the result is an underproduction or zero production of public goods

Income Inequality Income inequality Government transfer programs such as social security, unemployment compensation, food stamps, and minimum wage are examples of programs that redistribute income.