1. 1 Ch. 4: Supply and Demand: Practice James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts University ©2005 Thomson Business & Professional Publishing, A Division of Thomson Learning

2. 2 Application 1: Why Do Colleges Use GPAs, ACTs, and SATs for Purposes of Admission? The tuition that students pay to attend college is usually less than the equilibrium tuition. The tuition that students pay to attend college is usually less than the equilibrium tuition. The college is likely to ration its available space by a combination of money price and some other non-price rationing device, such as GPA, SAT, TASP, and ACT. The college is likely to ration its available space by a combination of money price and some other non-price rationing device, such as GPA, SAT, TASP, and ACT.

3. 3 Exhibit 1: College and University Admissions

4. 4 Self-Test Suppose the demand rises for admission to a university but both the tuition and the number of openings in the entering class remain the same. Will this affect the admission standards of the university? Explain. Suppose the demand rises for admission to a university but both the tuition and the number of openings in the entering class remain the same. Will this affect the admission standards of the university? Explain. Administrators and faculty at state colleges and universities often say that their standards of admission are independent of whether there is a shortage or surplus of openings at the university. Do you think this is true? Explain. Administrators and faculty at state colleges and universities often say that their standards of admission are independent of whether there is a shortage or surplus of openings at the university. Do you think this is true? Explain.

5. 5 Application 2: What Would Happen If Marijuana Were Legalized? What would happen to equilibrium price? What would happen to the equilibrium quantity? What would happen to equilibrium price? What would happen to the equilibrium quantity? Supply would increase, as farmers began to grow marijuana instead of corn or other products. Supply would increase, as farmers began to grow marijuana instead of corn or other products. Demand would increase, as the number of people who want to buy and consume marijuana increases. Demand would increase, as the number of people who want to buy and consume marijuana increases. Equilibrium price is dependent on whether supply or demand increases the most. Equilibrium price is dependent on whether supply or demand increases the most. Equilibrium quantity would increase. Equilibrium quantity would increase.

6. 6 Application 3: Where Did You Get That Music? Too many people are downloading music from the internet instead of purchasing CDs. Possible solutions: 1. Higher Price: Recording industry threatened to sue scores of people who download music. 2. Lower Demand: Recording industry aired television commercials to lower demand. 3. Lower Supply: Recording industry sued certain companies such as Napster.

7. 7 Self-Test On January 21, 2004 the recording industry filed lawsuits against 532 people it accused of illegally swapping copyrighted music on the internet. What does this have to do with supply, demand, or price? On January 21, 2004 the recording industry filed lawsuits against 532 people it accused of illegally swapping copyrighted music on the internet. What does this have to do with supply, demand, or price? If the recording industry puts few TV commercials trying to lower demand for downloading music, but instead continues to sue, what does this say? If the recording industry puts few TV commercials trying to lower demand for downloading music, but instead continues to sue, what does this say?

8. 8 Application 4: The Minimum Wage Law At a higher minimum wage, more unskilled workers want to work, but only a few are hired. At a higher minimum wage, more unskilled workers want to work, but only a few are hired. Additionally, fewer workers are paid at the higher minimum wage than at the previous equilibrium wage. Additionally, fewer workers are paid at the higher minimum wage than at the previous equilibrium wage. In a competitive market setting, the forces of supply and demand determine equilibrium wages. In a competitive market setting, the forces of supply and demand determine equilibrium wages.

9. 9 The Minimum Wage Law If labor markets are competitive and the demand for labor is downward-sloping, a minimum wage (above equilibrium wage) will reduce employment. If labor markets are competitive and the demand for labor is downward-sloping, a minimum wage (above equilibrium wage) will reduce employment. The important question is: How much will it reduce employment? A $1 raise at the expense of 1 labor hour is different than a $1 raise at the expense of 1,000,000 labor hours. The important question is: How much will it reduce employment? A $1 raise at the expense of 1 labor hour is different than a $1 raise at the expense of 1,000,000 labor hours.

10. 10 Exhibit 2: Effects of the Minimum Wage

11. 11 Self-Test When the labor supply is upward- sloping, an effective minimum wage law creates a surplus of labor. If the labor supply is vertical, does a surplus of labor still occur? Explain. When the labor supply is upward- sloping, an effective minimum wage law creates a surplus of labor. If the labor supply is vertical, does a surplus of labor still occur? Explain. Someone says that an increase in the minimum wage will not cause firms to hire fewer workers. What is this person assuming? Someone says that an increase in the minimum wage will not cause firms to hire fewer workers. What is this person assuming?

12. 12 Application 5: Price Ceiling In The Kidney Market Kidneys are currently donated as there is no free market for kidneys. Kidneys are currently donated as there is no free market for kidneys. Assuming that some people are unwilling to donate a kidney for $0 but would for some other amount of money, the kidney market could be analyzed using a standard supply and demand curve. Assuming that some people are unwilling to donate a kidney for $0 but would for some other amount of money, the kidney market could be analyzed using a standard supply and demand curve. At $0 compensation, there is a larger quantity demanded than supplied, exactly the case we see today in the United States. At $0 compensation, there is a larger quantity demanded than supplied, exactly the case we see today in the United States.

13. 13 Exhibit 3: The Market for Kidneys

14. 14 Self-Test A shortage of kidneys is a consequence of the price of a kidney being below equilibrium price. Do you agree or disagree? Explain. A shortage of kidneys is a consequence of the price of a kidney being below equilibrium price. Do you agree or disagree? Explain. Suppose the price ceiling in the kidney market is $0. Will there be a shortage of kidneys? Explain. Suppose the price ceiling in the kidney market is $0. Will there be a shortage of kidneys? Explain.

15. 15 Application 6: Health Care and the Right to Sue Your HMO Some people argue you should be able to sue your HMO. Some people argue you should be able to sue your HMO. Consider two settings: one where you can sue your HMO, and one where you cannot. Consider two settings: one where you can sue your HMO, and one where you cannot. –An HMO’s liability costs are lower if patients cannot sue. These costs will be passed on to consumers, raising HMO rates for everyone.

16. 16 Exhibit 4: Apartment Rent and the Law

17. 17 Self-Test Economists often say, “There is no such thing as a free lunch.” How is this saying related to patients moving from a system when they cannot sue their HMOs to one where they can. Economists often say, “There is no such thing as a free lunch.” How is this saying related to patients moving from a system when they cannot sue their HMOs to one where they can. A professor tells her students that they can have an extra week to complete their research papers. Under what conditions are the students made better off? Can you think of a case where the students would actually be made worse off. A professor tells her students that they can have an extra week to complete their research papers. Under what conditions are the students made better off? Can you think of a case where the students would actually be made worse off.

18. 18 Application 7: If Gold Prices Are The Same Everywhere, Then Why Aren’t House Prices? If gold prices were different, sellers would buy in one area, and sell in another. If gold prices were different, sellers would buy in one area, and sell in another. As time went on, the lack of gold would drive up prices in some areas, while the deluge of gold would drive down prices in other areas until the prices of gold is fixed across the world. As time went on, the lack of gold would drive up prices in some areas, while the deluge of gold would drive down prices in other areas until the prices of gold is fixed across the world. However, since we can not pick up a house and land and transplant them in a new area, house prices vary across the country. However, since we can not pick up a house and land and transplant them in a new area, house prices vary across the country.

19. 19 Self-Test What causes the price of gold to be the same in New York and London? What causes the price of gold to be the same in New York and London? The price of a Honda Pilot is nearly the same in Miami as it is in Dallas. Why? The price of a Honda Pilot is nearly the same in Miami as it is in Dallas. Why?

20. 20 Application 8: Do You Pay For Good Weather? There is no weather market. There is no weather market. But to enjoy the weather in San Diego, CA, you must be there, either living there or visiting. But to enjoy the weather in San Diego, CA, you must be there, either living there or visiting. If there were only bad weather in San Diego, the demand to live there would be lower and the cost of living would be lower. If there were only bad weather in San Diego, the demand to live there would be lower and the cost of living would be lower.

21. 21 Self-Test Give an example to illustrate that someone may “pay” for clean air in much the same way that she “pays” for good weather. Give an example to illustrate that someone may “pay” for clean air in much the same way that she “pays” for good weather. If people pay for good weather, who ultimately receives the “good-weather payment” ? If people pay for good weather, who ultimately receives the “good-weather payment” ?

22. 22 Application 9: Paying All Professors The Same Salary Professors have different salaries. Should they all have the same salary? Professors have different salaries. Should they all have the same salary? Market conditions are different for history and accounting professors. Market conditions are different for history and accounting professors. Same salary would create surpluses and shortages. Same salary would create surpluses and shortages.

23. 23 Exhibit 5: Paying Professors the Same Salary

24. 24 Self-Test Suppose the supply of biology and computer science professors is the same but the demand for computer scientists is greater. If a shortage exists in both fields, in which field is the shortage greater? Explain. Suppose the supply of biology and computer science professors is the same but the demand for computer scientists is greater. If a shortage exists in both fields, in which field is the shortage greater? Explain. Under what condition might an economist propose that all college professors be paid the same? Under what condition might an economist propose that all college professors be paid the same?

25. 25 Application 10: Price Floors and Winners and Losers Suppose an agricultural foodstuff receives a price floor. Who gains and who loses? Consumers lose. Consumers lose. Producers gain. Producers gain. Society loses (consumers lose more than producers gain). Society loses (consumers lose more than producers gain).

26. 26 Exhibit 6: Agricultural Price Floors

27. 27 Self-Test Look at the area equal to areas 3 + 5 in Exhibit 6. If there is a price floor, this area ends up being a deadweight loss. It is the loss to society of not producing Q1. Are there mutually beneficial trades that exist between Q2 and Q1, and if so, how do you know this? Look at the area equal to areas 3 + 5 in Exhibit 6. If there is a price floor, this area ends up being a deadweight loss. It is the loss to society of not producing Q1. Are there mutually beneficial trades that exist between Q2 and Q1, and if so, how do you know this? Why might producers argue for a price floor if it ends up making society worse off? Why might producers argue for a price floor if it ends up making society worse off?

28. 28 Application 11: College Super-Athletes Assume a super-athlete receives a full ride scholarship at a university. NCAA rules limit payment to the athlete to the amount of the scholarship even if the athlete is worth more to the university. Assume a super-athlete receives a full ride scholarship at a university. NCAA rules limit payment to the athlete to the amount of the scholarship even if the athlete is worth more to the university. Because of a perfectly inelastic supply curve, NCAA rules result in a transfer from the athlete to the university. Because of a perfectly inelastic supply curve, NCAA rules result in a transfer from the athlete to the university.

29. 29 Exhibit 7: The College Athlete

30. 30 Self-Test University X is a large university with a major football team. A new field house and track was just added to the university. What might this have to do with our discussion? University X is a large university with a major football team. A new field house and track was just added to the university. What might this have to do with our discussion? Sometimes it is argued that if colleges paid student athletes, the demand for college sports would decline. How would this change the analysis? Sometimes it is argued that if colleges paid student athletes, the demand for college sports would decline. How would this change the analysis?

31. 31 Application 12: Supply and Demand on the Freeway The supply of freeway space remains the same, but the demand for space fluctuates. The supply of freeway space remains the same, but the demand for space fluctuates. Some people have proposed tolls to control the demand for freeway space. Some people have proposed tolls to control the demand for freeway space. If the driving population increases in an area, and the supply of freeway space remains the same, what will happen to freeway congestion? If the driving population increases in an area, and the supply of freeway space remains the same, what will happen to freeway congestion?

32. 32 Exhibit 8: Freeway Congestion and Supply and Demand

33. 33 Self-Test In Exhibit 9, at what price is there a surplus of freeway space at 8 A.M.? In Exhibit 9, at what price is there a surplus of freeway space at 8 A.M.? If the driving population increases in an area and the supply of freeway space remains constant, what will happen to freeway congestion? Explain. If the driving population increases in an area and the supply of freeway space remains constant, what will happen to freeway congestion? Explain.

34. 34 Application 13: What Does Price Have to do with Getting to Class on Time? Price and parking places conspire to delay students. Price and parking places conspire to delay students. Students pay money or time to get to classes. Students pay money or time to get to classes. Some suggest auctioning off parking spaces on a yearly basis. Some suggest auctioning off parking spaces on a yearly basis. Just because someone doesn’t pay the price doesn’t mean there isn’t a price to pay. Just because someone doesn’t pay the price doesn’t mean there isn’t a price to pay.

35. 35 Self-Test If a person pays for something in terms of time, he or she is really paying in terms of money. Do you agree or disagree? Explain. If a person pays for something in terms of time, he or she is really paying in terms of money. Do you agree or disagree? Explain. Suppose a price of $1/day is the equilibrium price. What happens if demand rises more than supply and the price is kept at $1? Suppose a price of $1/day is the equilibrium price. What happens if demand rises more than supply and the price is kept at $1?

36. 36 Application 14: Aisle Seats on Commercial Airlines The supply curve for aisle seats and middle seats are equal straight lines, while the demand is anything but equal. The supply curve for aisle seats and middle seats are equal straight lines, while the demand is anything but equal. Airlines charge the same price for middle and aisle seats. Airlines charge the same price for middle and aisle seats. Late comers get the middle seats. Late comers get the middle seats.

37. 37 Application 15: 10 O’Clock Classes in College Supply for classes is fixed, but are offered at different times. Supply for classes is fixed, but are offered at different times. Demand varies based an times. Demand varies based an times. There is a set of prices that will make the quantity demanded of each class the same. There is a set of prices that will make the quantity demanded of each class the same.

38. 38 Exhibit 9: The Supply and Demand for College Classes at Different Times

39. 39 Application 16: What is the price of an “A”? Assume Professor Lawson is a slightly better teacher that Professor Brown. Assume Professor Lawson is a slightly better teacher that Professor Brown. Will Professor Brown have fewer students? Will Professor Brown have fewer students? Not necessarily. Professor Brown may lower the cost to students. Not necessarily. Professor Brown may lower the cost to students. –Less work. –Easier tests. –Higher GPA. –Etc.

40. 40 Exhibit 10: The Price of an A

41. 41 Self-Test If more people want to read romance novels than classic novels, it holds that the demand for romance novels is greater than the demand for classic novels. Agree or disagree? Explain. If more people want to read romance novels than classic novels, it holds that the demand for romance novels is greater than the demand for classic novels. Agree or disagree? Explain. Popularity is a function of demand, not price. Agree or disagree? Explain. Popularity is a function of demand, not price. Agree or disagree? Explain.

42. 42 Coming Up (Ch. 5): Macroeconomic Measurements, Part I: Prices & Unemployment