Chapter 4 Markets in Action Key Concepts Summary Practice Quiz Internet Exercises ©2002 South-Western College Publishing

What can cause a shift in a demand curve? Number of buyers in the market Tastes and preferences Income Expectations of consumers Prices of related goods

The Effects of Shift in Demand on Market Equilibrium P The Effects of Shift in Demand on Market Equilibrium $1200 S $900 Shortage $600 D2 $300 D1 Q 4 8 12 16

The Effects of Shift in Demand on Market Equilibrium $40 S $30 Surplus $20 D1 $10 D2 10 20 30 40

Increase in Quantity Supplied Increase in Equilibrium Price Increase in Demand

Decrease in Quantity Supplied Decrease in Equilibrium Price Decrease in Demand

What can cause a shift in a supply curve? Technology Number of sellers in the market Resource prices Taxes and subsidies Expectations of producers

The Effects of Shift in Supply on Market Equilibrium $4 S1 S2 $3 Surplus $2 $1 D 20 40 60 80

The Effects of Shift in Supply on Market Equilibrium $800 S2 S1 $600 Shortage $400 $200 D 2 4 6 8

Increase in Quantity Demanded Decrease in Equilibrium Price Increase in Supply

Decrease in Quantity Demanded Increase in Equilibrium Price Decrease in Supply

Can the laws of demand and supply be repealed? In some markets, the objective of politicians is to prevent prices from reaching the equilibrium price

What are the two types of price controls? Price ceilings Price floors

What is a price ceiling? A legally established maximum price a seller can charge

Rent Control Results in a Shortage of Rental Units P Rent Control Results in a Shortage of Rental Units S $800 $600 Rent ceiling Shortage $400 D $200 Q 2 4 6 8

Quantity Demanded exceeds the quantity supplied Shortage Quantity Demanded exceeds the quantity supplied Rent Ceiling

What is the purpose of price ceilings on rent? So needy people will pay lower rent than the equilibrium rent

Why may rent controls be counterproductive? Shortages Illegal markets Less maintenance Discrimination

What are other examples of price ceilings? Wage and price controls Usury laws

What is a price floor? A legally established minimum price a seller can be paid

A Minimum Wage Results in a Surplus of Labor Wm Minimum wage Unemployment We D QD QE QS

Unemployment Minimum wage

What are examples of price floors? Minimum wage law Agricultural price supports

Why do we have price ceilings and floors? Because of failures in the free market

What is market failure? A situation in which the price system creates a problem for society or fails to achieve society’s goals

Who was Adam Smith? The father of modern economics who wrote The Wealth of Nations, published in 1776

What did Adam Smith say about competition? There must be competition for markets to function properly

What happens when competition is lacking? Market failure results

S1 S2 D 50 100 150 200 250 300 Inefficient equilibrium $2500 $2000 Rigging the Personal Computer Market Inefficient equilibrium $2500 S1 S2 $2000 $1500 $1000 D Efficient equilibrium $500 50 100 150 200 250 300

What is an example of another market failure? Externalities

What is an externality? A cost or benefit imposed on people other than the consumers and producers of a good or service

What is a negative externality? An externality that is detrimental to third parties

What is an example of a negative externality? Pollution

S2 S1 D P2 P1 Q2 Q1 Includes external costs of pollution External Cost of Pollution Includes external costs of pollution S2 S1 P2 P1 D Excludes external costs of pollution Q2 Q1

What is a positive externality? An externality that is beneficial to third parties

What is an example of a positive externality? Vaccinations

S D2 D1 P2 P1 Q1 Q2 $10 Includes Vaccination benefits External Benefits of AIDS Vaccinations Includes Vaccination benefits S P2 P1 D2 $10 Excludes Vaccination benefits D1 Q1 Q2

Inefficient equilibrium External costs

Inefficient equilibrium External benefits

What is another example of a positive externality? Public goods

What is a public good? A good that, once produced, has two properties: (1) users collectively consume benefits (2) no one can be excluded

What are examples of public goods? National defense Public education Roads

What is another example of market failure? Income inequality

Key Concepts

Key Concepts What can cause a shift in a demand curve? What can cause a shift in a supply curve? What are the two types of price controls? What is a price ceiling? What is a price floor? Why do we have price ceilings and floors? What is market failure?

Key Concepts cont. What happens when competition is lacking? What is an externality? What is a negative externality? What is a positive externality? What is a public good? What is another example of market failure?

Summary

Price ceilings and price floors are maximum and minimum prices enacted by law, rather than allowing the forces of supply and demand to determine prices. A price ceiling is a maximum price mandated by government, and a price floor is a minimum legal price.

P Q S D $800 $600 $400 $200 2 4 6 8 Rent ceiling Shortage If a price ceiling is set below the equilibrium price, a shortage will persist P S $800 $600 Rent ceiling Shortage $400 D $200 Q 2 4 6 8

If a price floor is set above the equilibrium price, a surplus will persist Wm Minimum wage Unemployment We D QD QE QS

Market failure means that the market mechanism does not achieve desirable results. Sources of market failure include lack of competition, externalities, public goods, and income inequality. Although controversial, government intervention is a possible way to correct market failure.

An externality is a cost or benefit of a good imposed on people who are not buyers or sellers of that good. Pollution is an example of an external cost, which means too many resources are used to produce the product responsible for the pollution. Two basic approaches to solve this market failure are taxes (like in pollution taxes) and regulation (like in vaccinations).

S2 S1 D P2 P1 Q2 Q1 Includes external costs of pollution External Cost of Pollution Includes external costs of pollution S2 S1 P2 P1 D Excludes external costs of pollution Q2 Q1

S D2 D1 P2 P1 Q1 Q2 Includes Vaccination benefits External Benefits of AIDS Vaccinations Includes Vaccination benefits S P2 P1 D2 Excludes Vaccination benefits D1 Q1 Q2

Public goods are goods that are consumed by everyone regardless of whether they pay or not. National defense, air traffic control, and other public goods can benefit many individuals simultaneously and are provided by the government.

©2002 South-Western College Publishing Chapter 4 Quiz ©2002 South-Western College Publishing

1. Suppose prices for new homes have risen, yet sales of new homes have also risen. We can conclude that a. the demand for new homes has risen. b. the law of demand has been violated. c. new firms have entered the construction industry. d. construction firms must be facing higher costs. A. The demand for new homes has risen causing the price to increase and the quantity of new homes to increase as illustrated on the next page.

An increase in demand for new homes P2 P1 D2 D1 Q1 Q2

2. Which of the following statements if true of a market? a. An increase in demand, with no change in supply, will increase the equilibrium price and quantity. b. An increase in supply, with no change in demand, will decrease the equilibrium price and the equilibrium quantity. c. A decrease in supply, with no change in demand, will decrease the equilibrium price and increase the equilibrium quantity. d. all of the above are true. A. See previous graph.

3. Consider the market for chicken 3. Consider the market for chicken. An increase in the price of beef will a. decrease the demand for chicken, creating a lower price and a smaller amount of chicken purchased in the market. b. decrease the supply of chicken, creating a higher price a and a smaller amount of chicken purchased in the market. c. increase the demand for chicken, creating a higher price and a greater amount of chicken purchased in the market. C. An increase in the price of beef will cause an increase in the demand for chicken because beef and chicken are substitutes.

4. An increase in consumer income increases the demand for oranges 4. An increase in consumer income increases the demand for oranges. As a result of the adjustment to a new equilibrium, there is a (an) a. leftward shift of the supply curve. b. downward movement along the supply curve. c. rightward shift of the supple curve. d. upward movement along the supply curve. D. As the demand curve shifts to the right along the upward sloping supply curve, there is a movement along the supply curve as illustrated on the next page.

The Effects of Shift in Demand on Market Equilibrium P The Effects of Shift in Demand on Market Equilibrium $1200 S $900 Shortage $600 D2 $300 D1 Q 4 8 12 16

5. An increase in the wage paid to grape pickers will cause the a. demand curve for grapes to shift to the right, resulting in higher prices for grapes. b. demand curve for grapes to shift to the left, resulting in lower prices for grapes.. c. supply curve for grapes to shift to the left, resulting in lower prices for grapes. d. supply curve for grapes to shift to the left, resulting in higher prices for grapes. D. An increase in costs is one factor that will cause the supply curve to shift to the left as production becomes more expensive as illustrated on the next page.

The Effects of Shift in Supply on Market Equilibrium $800 S2 S1 $600 Shortage $400 $200 D Q 2 4 6 8

6. If the federal government wants to raise the price of cheese, it will a. take cheese from government storage and sell it. b. encourage farmers to research ways to produce more cheese. c. subsidize purchases of farm equipment. d. encourage farmers to produce less cheese. D. As the supply curve for cheese shifts to the left and moves along a downward sloping demand curve, equilibrium price will increase as illustrated on the next page.

The Effects of Shift in Supply on Market Equilibrium $800 S2 S1 $600 Shortage $400 $200 D Q 2 4 6 8

7. Which of the following is least likely to result from rent controls set below the equilibrium price for rental housing? a. Shortages and black markets. b. Deterioration of existing rental housing. c. The supply of rental housing will increase rapidly. d. People will demand more apartments than are available. C. The supply curve will shift to the left, not to the right, as suppliers produce fewer rental units due to the lower price and lower profits.

8. Suppose the equilibrium price set by supply and demand is lower than the price ceiling set by the government. The result will be a. a shortage. b. that quantity demanded is equal to quantity supplied. c. a surplus. d. a black market. B. The purpose of price ceilings is to set a maximum price by law. If it is set lower than the equilibrium price, it will have no effect on the equilibrium price as illustrated on the next page.

Rent Control Results in a Shortage of Rental Units P Rent Control Results in a Shortage of Rental Units S $800 $600 Price ceiling Shortage $400 D $200 Q 2 4 6 8

9. A good that provides external benefits to society has a. too few resources devoted to production. b. too many resources devoted to its production. c. the optimal resources devoted to its production. d. not provided profits to producers of the good. A. An external benefit is an unintentional byproduct of the market.

10. Pollution from cars is an example of a (an) a. harmful opportunity cost. b. negative externality. c. production dislocation. d. none of the above. B. A negative externality imposes costs on third parties when drivers discharge pollution into the air, they erode the quality of life of others.

11. Which of the following is the best example of a public good? a. Pencils. b. Education. c. Defense. d. Trucks. C. None of the other answers fit the definition of a public good. A public good is something from which everyone benefits and no one can be excluded.

12. A public good may be defined as any good or service that a. allows users to collectively consume benefits. b. must be distributed equally to all citizens in equal shares. c. is never produced by government. d. answers a and c above. A. Once a public good is provided, for instance a road, everyone collectively benefits from it.

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