Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 4 SUPPLY AND DEMAND

4-2 Learning Objectives In this chapter you’ll learn how to: 1. Define and explain demand in a product or service market. 2. Define and explain supply in a product or service market. 3. Determine the equilibrium point in the market for a specific good, given data on supply and demand at different price levels. 4. Explain what causes shifts in demand and supply. 5. Explain how price ceilings cause shortages. 6. Explain how price floors cause surpluses. 7. Apply supply and demand analysis to real-world problems.

4-3 Demand Demand is the schedule of quantities of a good or service that people are willing and able to buy at different prices. o Sometimes a schedule is also called a table. Shows how much quantity of a good or service can be sold at different prices. Illustrates that people pay for goods or services according to how many benefits those goods or services will yield.

4-4 Demand Schedule and Curve Table 1 Price QD $500 1, , , , , , , , ,000 Begin with P = $500 and Q = 1,000 To graph, plot one set of points at a time.

4-5 Supply Supply is the schedule of quantities of a good or service that people are willing to sell at different prices. Generally, the higher the price, the more of a good or service individuals are willing to supply. As price increases so does quantity provided. As the price increases or decreases, producing a good or service becomes more or less attractive to producers at the margin.

4-6 Supply Schedule and Curve To graph, plot one set of points at a time. Begin with P = $100 and Q = 2,000

4-7 Equilibrium Equilibrium price is the price at which quantity demanded equals quantity supplied or Q D = Q S. A surplus occurs when the market price is above equilibrium price. A shortage occurs when the market price is below equilibrium price.

4-8 A Picture of Equilibrium Equilibrium occurs at the point where supply crosses demand. If price were higher than equilibrium, more producers would want to produce goods or services than consumers would want to consume. Q S > Q D If the price were lower, more consumers would want to consume goods or services than producers would want to produce. Q D > Q S

4-9 Shifts in Demand A change in the price of a good or service causes movement along a given demand curve. o Movement up or down the same curve. A change in the demand schedule results in a shift of the demand curve to a completely different curve. o If consumer preferences change, that will shift the demand curve either outward or inward depending upon the nature of the change.

4-10 Demand Curve Shifts Outward When people are willing to buy more goods or services at every possible price. If preferences or income (ability to pay) increase. If perceived benefits increase, people will pay more. If more people want to fly to visit family at Thanksgiving than at other times, we expect an outward shift in demand for flights. D 1 shifts to the right to D 2.

4-11 Demand Curve Shifts Inward When people are willing to buy fewer goods at every previous price. If preferences or income (ability to pay) change. If there is a severe economic downturn and fewer people are taking trips, we would expect an inward shift of the demand curve.

4-12 Questions for Thought and Discussion What would happen to demand for the various services and products under the following scenarios? Will the curve shift and in which direction? o The President of the U.S. expresses concern about mad cow disease and beef. What happens to the demand for hamburgers? o The National Institutes of Health releases a study that shows Vitamin D reduces the probability of getting cancer. What happens to demand for Vitamin D? o The manufacturers of Frisbees discover a new, less expensive polymer to make Frisbees. What happens to the demand for Frisbees?

4-13 Shifts in Supply Changes in the cost of factors of production or increases in productivity shift the supply curve. Changes in technology or the number of sellers shift the supply curve. Changes in the expectation of the price shift the supply curve.

4-14 Supply Shift Outward (Increase) Businesses supply more at the same price as before. Improvements in technology, lower resource costs, or higher factor productivity can result in this sort of shift. If the price of jet fuel decreases, this would result in an outward shift in the supply curve of airline flights. S 1 shifts to the right to S 2.

4-15 Supply Curve Shift Inward (Decrease) Businesses supply less at the same price as before. As costs change for businesses, opportunity costs change. If the cost of jet fuel rises, that would shift the supply curve for airline flights inward to the left. On the graph, an increase in costs of grapes would lead to a lower supply of bottles of wine.

4-16 Shift in Demand and Equilibrium If there are shifts in demand or supply, a new equilibrium point will be found. In this instance, a demand- driven increase for the new iPhone pushes price up and the quantity of subscriptions sold up.

4-17 Shift in Supply and Equilibrium If there are shifts in demand or supply, a new equilibrium point will be found. In this instance, there is an increase in supply. What happens to equilibrium price and quantity when supply increases from S 1 to S 2 ?

4-18 Questions for Thought and Discussion Why is equilibrium thought to be efficient? What happens if price is not at an equilibrium point? What do prices represent to producers and consumers?

4-19 Governments and the Market The government may ensure the smooth operation of the markets by protecting property rights, guaranteeing enforcement of legal contracts, and issuing a supply of money that buyers and sellers readily accept. Governments sometimes change market outcomes by imposing prices floors and price ceilings. This may create shortages or surpluses. While governmental interference with the market system can have adverse affects, the government does have a substantial supportive role to play in a market economy.

4-20 Price Floors Sometimes producers believe the price they are getting for their product is too low. They may lobby the government to impose a price floor above equilibrium. This effective price floor results in a surplus being supplied at the higher price. Suppliers end up supplying more than consumers want to buy. Examples: wheat and corn prices and federal minimum wage How do you think price floors for agricultural commodities would impact the market for these commodities?

4-21 Price Ceilings Sometimes buyers believe they are paying too much for a good or service. Buyers may lobby the government to put a price cap on what sellers can charge. Classic example: rent - controlled apartments. When rent control is in place producers can not charge a price above the ceiling. This is an effective price ceiling because it is set below equilibrium.

4-22 Rent Control: The Institution People Love to Hate People who live in rent-controlled properties get their apartments at bargain prices. People looking for apartments will have a harder time finding them and will have to put up with more inconveniences in the housing market because rent control reduces the incentives of business people to provide quality housing options. Rent control can misallocate a scarce resource (housing) to people who value the resource less than market value. From a policy standpoint, who is helped or hurt by rent control? Why does local government have this policy in some U.S. cities?

4-23 Application of Supply and Demand: Interest Rate Determination Interest rates are set by supply and demand. It is the market for loanable funds. Suppliers are banks, mortgage companies, credit unions, etc. Demanders are homeowners and businesses. On the graph, what is the equilibrium interest rate? How much money is lent/borrowed?

4-24 Application of Supply and Demand: Shifts in Interest Rates What would happen to the interest rate and funds lent/borrowed when supply or demand increases?

4-25 Further Applications of Supply and Demand: Questions for Thought and Discussion Should parking be free at your school? Would a parking fee eliminate the shortage? If the price of gasoline increased to $8 a gallon, would you cut back on your driving? Explain how prices are a signal to producers about consumer preferences.

4-26 Gasoline Markets and Price: Hurricane Katrina Case Study On Labor Day weekend of 2005, Hurricane Katrina: o Temporarily shut down off-shore wells in the Gulf of Mexico. o Briefly put 10% of our refineries out of commission. o Caused a sudden drop in oil supply. The result was: o The government took a “hands off” approach. o Gasoline prices rose sharply. o People could buy all they wanted but at sharply increased prices.

4-27 Questions for Thought and Discussion How is equilibrium price affected by changes in demand and supply? If you were a landlord, would you be against rent control? Do corporations have incentives to lobby the government for price floors or ceilings? Practical Application: Urban highways are usually congested during morning and evening commuting times. Using supply and demand analysis, what simple step could be taken to greatly reduce congestion?