© 2003 McGraw-Hill Ryerson Limited Using Supply and Demand Chapter 5

© 2003 McGraw-Hill Ryerson Limited The Power of Supply and Demand u Changes in supply and demand will change equilibrium price and quantity.

© 2003 McGraw-Hill Ryerson Limited The Power of Supply and Demand u A shift in demand that moves the demand curve to the right causes equilibrium price and quantity to rise.

© 2003 McGraw-Hill Ryerson Limited The Power of Supply and Demand u A shift in supply that moves the supply curve to the left causes equilibrium price to rise and equilibrium quantity to fall.

© 2003 McGraw-Hill Ryerson Limited Price (per cassette) A S0S0 Quantity of cassettes (per week) $ Excess demand D1D1 A Shift in Demand Fig. 5-1a, p 105 D0D0 B (a)

© 2003 McGraw-Hill Ryerson Limited A A Shift in Supply Fig. 5-1b, p 105 Price (per cassette) Quantity of cassettes (per week) $ D0D0 S1S1 S0S0 C B Excess demand (b)

© 2003 McGraw-Hill Ryerson Limited Six Real World Examples of Supply and Demand changes u Supply and demand can shed light on a variety of real-world events: l Brazil freeze. l Financial assets and the baby boomers. l Twenty percent excise tax. l Rice in Indonesia. l Farm labourers. l Christmas toys.

© 2003 McGraw-Hill Ryerson Limited Sugar Shock in Brazil u The crop-damaging freeze shifted the supply curve to the left. u At the original price, quantity demanded exceeded quantity supplied. u Price rose until the quantity demanded equaled the quantity supplied.

© 2003 McGraw-Hill Ryerson Limited Brazil Freeze Fig. 5-2c, p 107 Demand S0S0 (c) P1P1 QeQe P0P0 QDQD QSQS S1S1

© 2003 McGraw-Hill Ryerson Limited Financial Assets and the Baby Boomers u Demographic changes among baby boomers moved the demand curve for financial assets to the right. u At the original price, quantity demanded exceeded quantity supplied. u Price rose until the quantity demanded equaled the quantity supplied.

© 2003 McGraw-Hill Ryerson Limited Financial Assets and the Baby Boomers Fig. 5-2f, p 107 S (f) D0D0 P1P1 Q1Q1 Q0Q0 P0P0 D1D1 QDQD

© 2003 McGraw-Hill Ryerson Limited Housing Market and the Baby Boomers u The same phenomenon occurred in the surging demand for housing among this group during the 1980s.

© 2003 McGraw-Hill Ryerson Limited Excise Taxes u Korean Government imposed a 20 percent luxury tax on imported golf clubs.

© 2003 McGraw-Hill Ryerson Limited Excise Taxes u A 20 percent tax levied on suppliers shifts the supply curve to the left. u After the tax is imposed, the quantity of imported clubs demanded drops.

© 2003 McGraw-Hill Ryerson Limited Excise Taxes Fig. 5-2e, p 107 S0S0 D0D0 P1P1 Q1Q1 P0P0 Q0Q0 S1S1 (e)

© 2003 McGraw-Hill Ryerson Limited Rice in Indonesia u Drought, pestilence, and the financial crisis shifted the supply curve to the left. u The steep demand curve means that the quantity demanded does not change much with changes in price.

© 2003 McGraw-Hill Ryerson Limited Rice in Indonesia u Responding to high prices, the government imported rice and distributed it to the market, causing the supply curve to shift to the right.

© 2003 McGraw-Hill Ryerson Limited Rice in Indonesia Fig. 5-2a, p 107 (a) S0S0 Demand P1P1 Q1Q1 P2P2 Q2Q2 P0P0 Q0Q0 S1S1 S2S2

© 2003 McGraw-Hill Ryerson Limited Farm Labourers u The compressed harvesting season increased the demand and increased authority border patrols decreased supply of labour. u Demand shifted to the right and supply shifted to the left.

© 2003 McGraw-Hill Ryerson Limited Farm Labourers u At the original price, the quantity of workers demanded exceeded the quantity supplied.

© 2003 McGraw-Hill Ryerson Limited Farm Labourers u Price rises until the quantity demanded equals the quantity supplied.

© 2003 McGraw-Hill Ryerson Limited Farm Labourers u The effect on the number of labourers hired depended on the relative size of the supply shift.

© 2003 McGraw-Hill Ryerson Limited Farm Labourers Fig. 5-2b, p 107 (b) S0S0 D0D0 P1P1 S1S1 D1D1 P0P0 QeQe

© 2003 McGraw-Hill Ryerson Limited Christmas Toys u A Christmas craze for Furbies shifts demand to the right. u A shortage ensued along with a black market.

© 2003 McGraw-Hill Ryerson Limited Christmas Toys u Finally the supplier produced more, shifting the supply curve to the right, causing the price to drop.

© 2003 McGraw-Hill Ryerson Limited Christmas Toys Fig. 5-2d, p 107 (d) P1P1 P0P0 Q S0 S0S0 D0D0 S1S1 D1D1 Q D0 Q D1

© 2003 McGraw-Hill Ryerson Limited Effects of Shifts of Demand and Supply on Price and Quantity, Table 5-1, p 110

© 2003 McGraw-Hill Ryerson Limited Government Interventions u Buyers look to government for ways to hold prices down. u Sellers look to government for ways to hold prices up.

© 2003 McGraw-Hill Ryerson Limited Price Ceilings u A price ceiling is a government- imposed limit on how high a price can be charged.

© 2003 McGraw-Hill Ryerson Limited Rent Controls u Rent control is a price ceiling on rents set by government. u An example is rent control in Paris following World War I and World War II.

© 2003 McGraw-Hill Ryerson Limited Rent Controls u The following were the consequences of rent control in Paris: l A huge shortage of living quarters. l New housing construction stopped. l Existing housing was allowed to deteriorate.

© 2003 McGraw-Hill Ryerson Limited Rent Controls u The following were the consequences of rent control in Paris: l For many, the only way to get living quarters was to offer a huge bribe to the landlord. l Many families had to double up with other family members.

© 2003 McGraw-Hill Ryerson Limited Rent Controls Fig. 5-3, p 111 QSQS QDQD Supply Demand Rental Price (per month) Quantity of apartments 2.50 $17.00 Shortage

© 2003 McGraw-Hill Ryerson Limited Rent Controls u With price ceilings, existing goods are no longer rationed entirely by price u Non-price rationing occurs

© 2003 McGraw-Hill Ryerson Limited Rent Controls Over Time u Short run supply for rental units is relatively fixed (inelastic). u In the long run supply is more elastic, indicating that landowners will increase the quantity of apartments supplied if rents rise, over time.

© 2003 McGraw-Hill Ryerson Limited Rent Controls Over Time u Rent controls will set the price below equilibrium and create shortages. u This will cause the short run supply to decrease. u If rent controls are removed, the short run supply will increase again.

© 2003 McGraw-Hill Ryerson Limited Rent Controls Over Time, Fig. 5- 4, p 113 SLSL D Rental Price ($ / month) Quantity of rental units S S’ S A B C

© 2003 McGraw-Hill Ryerson Limited When Rent Controls Work u If a temporary increase in the demand for housing is expected, rent controls may be effective. u This would create a temporary shortage of housing, but it would prevent high prices and a windfall to landlords.

© 2003 McGraw-Hill Ryerson Limited When Rent Controls Work, Fig. 5-5, p 114 Rental Price Quantity of rental units SLSL DS A B D’ R0R0 R1R1

© 2003 McGraw-Hill Ryerson Limited Price Floors u A price floor is a government-imposed limit on how low a price can be charged.

© 2003 McGraw-Hill Ryerson Limited Minimum Wage u The minimum wage is an example of a price floor. u A minimum wage is set by government specifying the lowest wage a firm can legally pay an employee.

© 2003 McGraw-Hill Ryerson Limited Minimum Wage u The minimum wage creates winners and losers: l Those who can find work earn a higher wage. l Others become unemployed. l Production costs increase. l Consumers pay higher prices.

© 2003 McGraw-Hill Ryerson Limited Minimum Wage u Economists disagree about the effects of the minimum wage.

© 2003 McGraw-Hill Ryerson Limited A Minimum Wage, Fig. 5-6, p 115 Wage (per hour) Quantity of workers S D WeWe W min QeQe Q2Q2 Q1Q1

© 2003 McGraw-Hill Ryerson Limited Taxes, Tariffs, and Quotas u An excise tax is a tax that is levied on a specific good. u A tariff is an excise tax on an imported good. u Taxes and tariffs raise prices and reduce quantity exchanged.

© 2003 McGraw-Hill Ryerson Limited The Effect of an Excise Tax on Price and Quantity u A luxury tax on jewellery manufactured in Canada is imposed.

© 2003 McGraw-Hill Ryerson Limited The Effect of an Excise Tax on Price and Quantity u Because the luxury tax was imposed on the jewellery manufacturers, the supply curve shifted up by the amount of the tax.

© 2003 McGraw-Hill Ryerson Limited The Effect of an Excise Tax on Price and Quantity u At a price equal to the original price plus the tax there was excess supply. u The price for rings rose by less than the tax, while quantity supplied and demanded fell.

© 2003 McGraw-Hill Ryerson Limited $ S1S1 420 $620 D S0S0 Quantity of rings 0 Price of rings The Effect of an Excise Tax Fig. 5-7, p 116 The supply curve shifts up by the $20 tax $

© 2003 McGraw-Hill Ryerson Limited Quantity Restrictions: Quotas u A quota is a quantitative restriction on the amount that can be bought or sold. u In international trade, it is a restriction on the amount one nation can export to another.

© 2003 McGraw-Hill Ryerson Limited Quantity Restrictions: Quotas u The Canadian government restricted imports of Japanese cars. u The effect was to raise the prices of Japanese automobiles in Canada.

© 2003 McGraw-Hill Ryerson Limited Supply Demand 20,000 8 $27,000 16,000 Japanese exports of cars (in millions) Quantity Restrictions: Quotas Fig. 5-8a, p 117 Quota

© 2003 McGraw-Hill Ryerson Limited The Relationship Between a Quota and a Tariff u Tariffs and quotas can both be used to reduce quantity and raise prices.

© 2003 McGraw-Hill Ryerson Limited The Relationship Between a Quota and a Tariff u There is a difference between imposing a tariff and imposing a quota. l In the case of a quota, the profits from a higher price goes to the manufacturer. l In the case of the tariff, the tax goes to the government.

© 2003 McGraw-Hill Ryerson Limited The Relationship Between a Quota and a Tariff u As a consequence, once quotas are instituted, Japanese firms competed intensely to get them.

© 2003 McGraw-Hill Ryerson Limited The Relationship Between a Quota and a Tariff Fig. 5-8b, p 117 Japanese exports of cars S1S1 Demand Price of Japanese cars S0S0 Tariff revenue 20,000 8 $11,000 16,000 $27,000 5

© 2003 McGraw-Hill Ryerson Limited The Limitations Of Supply And Demand Analysis u It is not enough to be able to explain what happens when supply or demand curves shift. u It is necessary to understand the assumptions underlying the analysis.

© 2003 McGraw-Hill Ryerson Limited The Limitations Of Supply And Demand Analysis u Other things don't remain constant. u Sometimes supply and demand are interconnected. u Supply/demand analysis is the first step to analysis, not the complete analysis.

© 2003 McGraw-Hill Ryerson Limited The Limitations Of Supply And Demand Analysis u Deciding whether the effects are significant to consider requires a knowledge of the structure of the economy because all actions have ripple or feedback effects.

© 2003 McGraw-Hill Ryerson Limited The Limitations Of Supply And Demand Analysis u The other-things-constant assumption will likely not hold true when one analyses the goods which represent a large percentage of the entire economy.

© 2003 McGraw-Hill Ryerson Limited Using Supply and Demand End of Chapter 5