Supply and Demand Supply and Demand is the essential issue of economics. Economic agents: Households Economic agents: Business firms Markets for Outputs (products) Markets for Inputs (factors)

Market Equilibrium Q* S Q P 0 D P*

Mathematical form of The equilibrium state Equilibrium is the state where quantity demanded equals quantity supplied Equilibrium is the state where quantity demanded equals quantity supplied Q d = Q s Q d = Q s Demand and supply can be represented by equations Demand and supply can be represented by equations

Example Suppose the TV market is described as follows: The Demand Function The Demand Function Q d = P The Supply Function The Supply Function Q s = P Find equilibrium price and quantity Find equilibrium price and quantity

Equilibrium Math Form Q d = Q s By substitution, P = P 105 = 150 P P = 0.70 (Equilibrium price) Q = X 0.7 = 60 (Equilibrium quantity)

Comparative static analysis in the equation form Outside force change the equation. Outside force change the equation. Example, income changes causes the shift in the demand function to Example, income changes causes the shift in the demand function to Q d = P Q d = P Then we solve for the new equilibrium price and equilibrium quantity Then we solve for the new equilibrium price and equilibrium quantity Draw conclusions Draw conclusions

CONTROLS ON PRICES Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Result in government-created price ceilings and floors. Result in government-created price ceilings and floors.

CONTROLS ON PRICES Price Ceiling Price Ceiling –A legal maximum on the price at which a good can be sold. Price Floor Price Floor –A legal minimum on the price at which a good can be sold.

How Price Ceilings Affect Market Outcomes If the price ceiling is set set below the equilibrium price (called binding), leading to a shortage. If the price ceiling is set set below the equilibrium price (called binding), leading to a shortage.

A Market with a Price Ceiling Apartments available For rent 0 Rent of Apartment Demand Supply 800 Price ceiling Shortage 7500 Quantity supplied Quantity demanded Equilibrium price $2000

How Price Ceilings Affect Market Outcomes A (binding) price ceiling creates A (binding) price ceiling creates – Shortages because Q D > Q S. Example: Gasoline shortage of the 1970s Example: Gasoline shortage of the 1970s Example: Usury law and interest rate control Example: Usury law and interest rate control Shortage and repressed inflation in CPEs Shortage and repressed inflation in CPEs – Nonprice rationing Examples: Long lines, discrimination by sellers Examples: Long lines, discrimination by sellers

CASE STUDY: Lines at the Gas Pump Economists blame government regulations that limited the price oil companies could charge for gasoline. Economists blame government regulations that limited the price oil companies could charge for gasoline. In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so the higher oil prices reduced the supply of gasoline. In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so the higher oil prices reduced the supply of gasoline. What was responsible for the long gas lines? What was responsible for the long gas lines?

How Price Floors Affect Market Outcomes When the government imposes a price floor floor above the equilibrium price, leading to a surplus. When the government imposes a price floor floor above the equilibrium price, leading to a surplus.

A Market with a Price Floor Quantity of wheet Thousands of bushels 0 Price of Wheet Demand Supply $4 Price floor 80 Quantity demanded 120 Quantity supplied Equilibrium price Surplus 3

How Price Floors Affect Market Outcomes A binding price floor causes... A binding price floor causes... – a surplus because Q S > Q D. – nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria. Examples: The minimum wage, agricultural price supports Examples: The minimum wage, agricultural price supports Examples: Agricultural products Examples: Agricultural products

CASE STUDY: The Minimum Wage An important example of a price floor is the minimum wage. An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay. Minimum wage laws dictate the lowest price possible for labor that any employer may pay.

How the Minimum Wage Affects the Labor Market Quantity of Labor Wage 0 Labor Supply Labor surplus (unemployment) Labor demand Minimum wage Quantity demanded Quantity supplied Equilibrium wage

A Can of Worms Favoritism and corruption Favoritism and corruption Unenforceability Unenforceability Limit of volume of transactions Limit of volume of transactions Misallocation of resources and inefficiency Misallocation of resources and inefficiency