Economic Examples 1. Cyclone Larry in Australia Destroyed 80% of the banana crop. Prices went from $1.00 to $2.00 per pound Supply or Demand problem?? Banana Market Quantity $2.00 DRDR S1S1 Price Q1Q1 Q2Q2 S2S2 $1.00

Sales of SUVs in the U.S. P0P0 Q1Q1 P1P1 Increasing gas costs causes the demand curve to shift left Average price fell 10% Price for SUVs fell from P 0 to P 1 where Q demanded = Q supplied S0S0 D0D0 P Q Q0Q0 SUVs D1D1 Supply or Demand problem?

Coffee Beans fell from $2.00/pound in 1997 to $.50 in 2002 Supply or Demand problem? Price Coffee Bean Market Q1Q1 DcDc Q2Q2 S1S1 Quantity S2S2 $2.00 $0.50 New growing techniques and the entry of new growers shifted the supply curve.

2. Increase in the Demand for Loanable Funds r2r2 Q1Q1 r1r1 Q2Q2 Interest rate Quantity of loanable funds At the interest rate r the quantity of loanable funds demanded by borrowers into equals quantity supplied by lenders. An increase in demand will move D 1 to D 2 Higher interest rates encourage additional savings, making it possible to fund more borrowing. the interest rises to r 2 and increasing borrowing to Q 2 S D 1 D 2 Lending Borrowing

Foreign exchange market is where currency of one country is traded for another. The exchange rate is measured as the dollar price of foreign currency. The Price of Foreign Currency Changes in exchange rates will alter the prices of internationally traded goods/services and assets A lower dollar price of foreign currency will have two effects: It will lower the price of foreign goods to U.S. residents and raise imports. It will raise the price of U.S. goods to foreigners and lower exports.

Examples of exchange rates Country currencyIn US$Per US$ US$ vs. YTD change (%) Mexico peso China yuan United Kingdom pound Poland zloty Israel shekel Kuwait dinar

Increase in the Demand for Foreign Exchange 0.20 Q1Q1 Q2Q2 Exchange rate ($ per quetzal) Quantity of quetzal exchange S D 1 U.S. sales to Guatemala U.S. purchases from Guatemala D Beginning equilibrium exchange rate: (10 cents = 1quetzal). An increase in American demand for Guatemalan coffee will also increase the demand for quetzals Equilibrium occurs where the new demand for quetzals D 2 just equals the supply S – at $.20 per quetzal with Q 2 > Q 1 quetzals clearing the market.

Government Intervention in the Market

It stops the price from rising to the equilibrium level. Example: rent control The direct effect of a price ceiling is a shortage: quantity demanded exceeds quantity supplied. 1. Price Ceilings Price ceiling is a legally established maximum price that sellers may charge.

In the rental housing market the price (rent) P 0 would bring the quantity of rental units demanded into balance with the quantity supplied. A price ceiling like P 1 sets a price below equilibrium … quantity demanded Q D … exceeds quantity supplied Q S … resulting in a shortage. The Impact of a Price Ceiling Price (rent) Quantity of housing units Price ceiling D QSQS QDQD P0P0 S P1P1 Shortage Rental housing market

The future supply of housing will decline. The quality of housing will deteriorate. Non-price methods of rationing will increase in importance. Effects of Rent Control Long-term renters will benefit at the expense of newcomers.

Price floor is a legally established minimum price that buyers must pay. It stops the price from dropping down to equilibrium level. Example: minimum wage The direct effect of a price floor above the equilibrium price is a surplus: quantity supplied exceeds quantity demanded. 2. Price Floors

A price floor like P 1 sets a price above market equilibrium causing quantity supplied Q D … Non-price factors will become more important than prices in determining where scarce goods go. to exceed quantity demanded Q S … resulting in a surplus. The Impact of a Price Floor Price Quantity Price floor D QDQD QSQS P0P0 S P1P1 Surplus

Direct effect: Reduces employment of low-skilled labor. Indirect effects: Reduction in non-wage component of compensation. Less on-the-job training. May encourage students to drop out of school A higher minimum wage does little to help the poor. Minimum Wage Effects

Employment and the Minimum Wage Price (wage) Quantity (employment) Minimum wage level D E1E1 E0E0 S $ 5.15 Excess supply $ 4.00 If a price (wage) of $4.00 could bring equilibrium. A minimum wage (price floor) of $5.15 would increase the earnings of those who stayed employed (E 1 ), but would reduce the employment of others. Those who lose their job (E 0 to E 1 ) would be pushed into either unemployment or some other less preferred form of employment.

Excise Taxes An excise tax is a tax that is levied on a specific good A tariff is an excise tax on an imported good The result of taxes and tariffs is an increase in equilibrium prices and reduce equilibrium quantities Government impacts markets through taxation 5-16

The price of boats rises by less than the tax to $70,000 The Effect of an Excise Tax S0S0 D0D0 P Q $65, The supply curve shifts up by the amount of the tax Government imposes a $10,000 luxury tax on the suppliers of boats S1S1 Tax = $10,000 Luxury Boats $60,000 $70,000

Quantity Restrictions Government regulates markets with licenses, which limit entry into a market Many professions require licenses, such as doctors, financial planners, cosmetologists, electricians, or taxi cab drivers The results of limited number of licenses in a market are increases in wages and an increases in the price of obtaining the license 5-18

The Effect of a Quantity Restriction QRQR D0D0 12,0 00 When the demand for taxi services increased, because the number of taxi licenses was limited, wages increased Successful lobbying by taxi cab drivers in NYC resulted in quantity restrictions (medallions) NYC Taxi Drivers $1 5 P (wage) Q (of drivers) D1D1

Application: The Effect of a Quantity Restriction QRQR D0D0 12,0 00 The demand for taxi medallions also increased because wages were increasing. But because the number of taxi licenses was limited, the price of a medallion also increased NYC Taxis Medallions $400,00 0 P Q (of medallions) D1D1 Initial Fee

Third-Party-Payer Markets In third-party-payer markets, the person who receives the good differs from the person paying for the good Equilibrium quantity and total spending can be much higher in third-party-payer markets Under a third-party-payer system, the person who chooses how much to purchase doesn’t pay the entire cost Goods from a third-party-payer system will be rationed through social and political means 5-21

Third-Party-Payer Markets D0D0 10 Health Care $2 5 P Q $4 5 $5 S0S0 18 The consumer pays the entire cost Total expenditures for 18 units of health care With a co-payment of $5, consumers demand 18 units Sellers require $45 per unit for that quantity …are greater than when…