1. Chapter 4 Markets in Action

2. Demand and Supply Changes in Demand and Supply
Three steps to analyzing changes in equilibrium
Decide if the event shifts the supply curve, the demand curve, or both curves
Decide if curve shifts to right or to left
Use supply-and-demand diagram
Compare initial and new equilibrium
How the shift affects equilibrium price and quantity

3. Supply and Demand
Example: A change in market equilibrium due to a shift in demand
A warm summer effect on the coffee market
Warm weather - demand curve (tastes)
Demand curve shifts to the left (down)
Lower equilibrium price; lower equilibrium quantity

4. Supply and Demand Price Of Coffee D1 Supply 2.00 $2.50 New equilibriumD1
1. Warm weather
decreases the demand
for coffee . . .
Supply
2. resulting in
a lower price . . .
2.00
$2.50
New equilibrium 10 7
3. …and a lower quantity sold. D0
Quantity of Coffee
An abnormally warm summer causes buyers to demand less coffee. The demand curve shifts from D0 to D1, which causes the equilibrium price to lower from $2.50 to $2.00 and the equilibrium quantity to lower from 10 cups to 7 cups.

5. Supply and Demand
Example: A change in market equilibrium due to a shift in supply
Technology improves the coffee making process
Change in technology impacts the supply curve
Supply curve shifts to the right
Lower equilibrium price; higher equilibrium quantity

6. Supply and Demand Price of Coffee S1 S0 2.00 $2.50 7 New equilibrium
1. an improvement in technology S0
2.00
2. results in
a lower price
$2.50 7
3. and a higher quantity sold
New equilibrium
Demand 4
Quantity of Coffee
A technology improvement causes sellers to supply more coffee. The supply curve shifts from S0 to S1, which causes the equilibrium price of coffee to lower from $2.50 to $2.00 and the equilibrium quantity to increase from 4 to 7 cups

7. Supply and Demand
Example: A change in market equilibrium due to a shift in supply
Labor wages increase
Effect on the market for coffee?
Change in input price impacts the supply curve
Supply curve - shifts to the left
Higher equilibrium price; lower equilibrium quantity

8. Supply and Demand Price of Coffee S1 $2.50 Demand S0 New equilibrium 4
1. an increase in labor wages S1
$2.50
2. results in
a higher price
Demand S0
New equilibrium 4
3. a smaller quantity sold
2.00 7
Quantity of Coffee
An increase in labor wages (an input price) causes sellers to supply less coffee. The supply curve shifts from S0 to S1, which causes the equilibrium price of coffee to rise from $2.00 to $2.50 per cup and the equilibrium quantity to fall from 7 to 4 cups.

9. Price Controls
Price ceilings – a legally established maximum price a seller can charge
Price floors – a legally established minimum price a seller can be paid

10. Rent Market S 1,600 1,200 Rent ceiling 800 D 400
Month Rent per Unit (dollars)
Rent ceiling
800
Shortage of 4 millions rental units D
400 2 4 6 8
Quantity of Rental Units (millions per month)

11. Rent Controls Shortages Illegal markets Less maintenance
Discrimination

12. Examples of price floors
Price Controls
Examples of price floors
Minimum wage law
Agricultural price supports

13. Labor Market S Wm We D QD QE QS Wage Rate (dollars per hour)
Unemployment
Wage Rate (dollars per hour) Wm
Minimum wage We D QD QE QS
Quantity of Unskilled Labor (workers per year)

14. Market Failure
Market Failure – a situation in which the price system results in too few or too many resources used in the production of a good or service. This inefficiency may justify government intervention.
Lack of Competition
Externalities
Public Goods
Income Inequality

15. Lack of Competition Lack of Competition
Adam Smith – The father of modern economics who wrote The Wealth of Nations, published in 1776
There must be competition for markets to function properly

16. Rigging the Computer Market
Price
Inefficient equilibrium S2 S1
2,000
1,500
1,000
Efficient equilibrium D
500 50
100
150
200
Quantity

17. Externality
Externality – A cost or benefit imposed on people other than the consumers and producers of a good or service (third parties).
Negative Externality – an externality that is detrimental to third parties
Pollution
Positive Externality – an externality that is beneficial to third parties
Vaccinations
Regulation – remove or control the externality

18. External Costs of Pollution
Includes external costs of pollution
Efficient equilibrium S2
Excludes external costs of pollution S1 P2
Price of Steel P1
Inefficient equilibrium D Q2 Q1
Quantity of Steel

19. External Benefits of Education
Price of education (tuition)
Efficient equilibrium P2 Q2 P1
Includes social benefits D2
Inefficient equilibrium D1
Excludes social education benefits Q1
Quantity (number of students)

20. Externality Conclusion
When the supply curve fails to include external costs, the equilibrium price is artificially low, and the equilibrium quantity is artificially high
When externalities are present, market failure gives incorrect price and quantity signals, and resources are misallocated
External costs cause the market to over allocate resources, and external benefits cause the market to under allocate resources

21. Public Goods
Public Good – a good that, once produced, has two properties:
users collectively consume benefits
no one can be excluded (free rider)
Examples
National defense
Public education
Highways
If public goods are available only in the marketplace, people wait for someone else to pay, and the result is an underproduction or zero production of public goods

22. Income Inequality Income inequality
Government transfer programs such as social security, unemployment compensation, food stamps, and minimum wage are examples of programs that redistribute income.