1. 2 2 Supply and Demand

2. ●Demand –consumer side of the market ●Supply –seller side of the market ●Equilibrium –how prices and quantities are determined by the market ●Changes in equilibrium –shifts in D and S ●Price ceilings and price floors –government’s attempt to restraint or bolster prices ●Demand –consumer side of the market ●Supply –seller side of the market ●Equilibrium –how prices and quantities are determined by the market ●Changes in equilibrium –shifts in D and S ●Price ceilings and price floors –government’s attempt to restraint or bolster prices Outline Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

3. Demand and Quantity Demanded ●Quantity of demand = the amount that buyers wish to purchase at each price ●Qd depends on P, population size, consumer incomes, tastes, and P of other products ●D  focus only on relationship between P and Qd ●Consider D schedule for milk –table showing the Qd at each P ●Quantity of demand = the amount that buyers wish to purchase at each price ●Qd depends on P, population size, consumer incomes, tastes, and P of other products ●D  focus only on relationship between P and Qd ●Consider D schedule for milk –table showing the Qd at each P

4. TABLE 1. Demand Schedule for Milk Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

5. ●The Demand Curve ♦Graph of a demand schedule ♦Negative slope ■As ↑P milk  ↓Qd milk because: 1.People consume less milk. 2.Some people drop out of the market for milk and drink tea or orange juice instead. ●The Demand Curve ♦Graph of a demand schedule ♦Negative slope ■As ↑P milk  ↓Qd milk because: 1.People consume less milk. 2.Some people drop out of the market for milk and drink tea or orange juice instead. Demand and Quantity Demanded

6. FIGURE 1. Demand Curve for Milk Price per Quart H G F E C D D B A Quantity Demanded in Billions of Quarts per Year 757065605550450.90 1.00 1.10 1.20 1.30 1.40 $1.50 Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

7. Demand and Quantity Demanded ●Along D curve all other determinants of Qd for milk (e.g., consumer incomes, P orange juice, or P cereal) are held constant. P of milk is the only determinant of D for milk that is allowed to . ●Law of Demand  the lower P of the good, the larger Q consumers wish to purchase. In general, D curves have a (-) slope. ●Along D curve all other determinants of Qd for milk (e.g., consumer incomes, P orange juice, or P cereal) are held constant. P of milk is the only determinant of D for milk that is allowed to . ●Law of Demand  the lower P of the good, the larger Q consumers wish to purchase. In general, D curves have a (-) slope.

8. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Demand and Quantity Demanded ●Shifts of the Demand Curve ♦Movement along a fixed demand curve: ■  Price ♦Shift in the entire demand curve: ■  Incomes ■  Population ■  Preferences ■  Prices and availability of related goods ●Shifts of the Demand Curve ♦Movement along a fixed demand curve: ■  Price ♦Shift in the entire demand curve: ■  Incomes ■  Population ■  Preferences ■  Prices and availability of related goods

9. FIGURE 2. Movement along vs. a shift in the Demand Curve Price per Quart Quantity Demanded in Billions of Quarts per year B 1.10 $1.30 D 0 D 0 A D 1 D 1 Copyright© 2006 South-Western/Thomson Learning. All rights reserved. C D 55657080 Movement along: A to B (or C to D) Outward shift: A to C (and B to D)

10. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Factors that shift demand 1.∆ income: ●Normal goods: ↑ income  shifts D out ●Inferior goods: ↑ income  shifts D in  What are some examples of inferior goods? 1.∆ income: ●Normal goods: ↑ income  shifts D out ●Inferior goods: ↑ income  shifts D in  What are some examples of inferior goods?

11. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Factors that shift demand 2.∆ P of related products: a)Two goods are compliments if they are consumed together. ●↓P of a compliment  shifts D out ●E.g., ↓P cereal  shifts D milk out What will happen to D for milk if ↑ P oreos? 2.∆ P of related products: a)Two goods are compliments if they are consumed together. ●↓P of a compliment  shifts D out ●E.g., ↓P cereal  shifts D milk out What will happen to D for milk if ↑ P oreos?

12. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Factors that shift demand 2.∆ P of related products: b)Two goods are substitutes if one can replace the other in consumption. ●↓P of a substitute  shifts D in ●E.g., ↓P orange juice  shifts D milk in What will happen to D for milk if ↑ P tea? 2.∆ P of related products: b)Two goods are substitutes if one can replace the other in consumption. ●↓P of a substitute  shifts D in ●E.g., ↓P orange juice  shifts D milk in What will happen to D for milk if ↑ P tea?

13. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Factors that shift demand 3)∆ tastes: ♦If consumers worry about their daily calcium intake  D milk shifts out ♦As population ages  D milk shifts in Why have we seen a rise in the number of milk ads? 4)∆ population: ♦If the size of the population increases  D milk shifts out. 3)∆ tastes: ♦If consumers worry about their daily calcium intake  D milk shifts out ♦As population ages  D milk shifts in Why have we seen a rise in the number of milk ads? 4)∆ population: ♦If the size of the population increases  D milk shifts out.

14. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Supply and Quantity Supplied ●Quantity of supply = amount that producers wish to sell at each price ●Qs depends on P, size of the industry, P of inputs, and technology. ●S  focus only on relationship between P and Qs ●Consider S schedule for milk –table showing the Qs at each P ●Quantity of supply = amount that producers wish to sell at each price ●Qs depends on P, size of the industry, P of inputs, and technology. ●S  focus only on relationship between P and Qs ●Consider S schedule for milk –table showing the Qs at each P

15. TABLE 2. Supply Schedule for Milk Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

16. Supply and Quantity Supplied ●The Supply Curve ♦Graph of a supply schedule ♦Positive slope ■Farmers require ↑P milk to ↑Qs because ↑costs as they produce more ●Higher milk prod. requires more cows, feed, milking equipment, dairy workers, etc. Suppliers want to make profits, so they raise P to cover their costs. ●The Supply Curve ♦Graph of a supply schedule ♦Positive slope ■Farmers require ↑P milk to ↑Qs because ↑costs as they produce more ●Higher milk prod. requires more cows, feed, milking equipment, dairy workers, etc. Suppliers want to make profits, so they raise P to cover their costs.

17. FIGURE 3. Supply Curve for Milk S S a b c e f g h 908070605040 $1.50 1.40 1.30 1.20 1.10 1.00 Price per Quart Quantity Supplied in Billions of Quarts per Year 300.90 Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

18. Supply and Quantity Supplied ●Along S curve all other determinants of Qs of milk (e.g., P feed, weather, wages of dairy workers) are held constant. P of milk is the only determinant of S of milk that is allowed to . ●Law of Supply  the higher P of the good, the larger Q firms want to produce. In general, S curves have a (+) slope. ●Along S curve all other determinants of Qs of milk (e.g., P feed, weather, wages of dairy workers) are held constant. P of milk is the only determinant of S of milk that is allowed to . ●Law of Supply  the higher P of the good, the larger Q firms want to produce. In general, S curves have a (+) slope.

19. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Supply and Quantity Supplied ●Shifts of the Supply Curve ♦Movement along a fixed supply curve: ■  Price ♦Shift in the entire supply curve: ■  Size of the industry ■  Technological progress ■  Prices of inputs ■  Prices of related outputs ●Shifts of the Supply Curve ♦Movement along a fixed supply curve: ■  Price ♦Shift in the entire supply curve: ■  Size of the industry ■  Technological progress ■  Prices of inputs ■  Prices of related outputs

20. FIGURE 4. Movement along vs. a shift in the Supply Curve S 0 S 0 Price per Quart Quantity Supplied in Billions of Quarts per Year B A S 1 S 1 1.10 $1.30 Copyright© 2006 South-Western/Thomson Learning. All rights reserved. C D 50707595 Movement along: A to B (or C to D) Outward shift: A to C (and B to D)

21. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Factors that shift supply 1.  Size of the industry: ●↑number of firms  shifts S out What happens to the S milk if the number of dairy farms decreases? 2.  Price of inputs: ●↓price of an input  shifts S out What happens to the S milk if dairy workers unionize and negotiate higher wages? 1.  Size of the industry: ●↑number of firms  shifts S out What happens to the S milk if the number of dairy farms decreases? 2.  Price of inputs: ●↓price of an input  shifts S out What happens to the S milk if dairy workers unionize and negotiate higher wages?

22. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Factors that shift supply 3.Technological progress: ●Improvements in technology  shifts S out ●Example: many dairy farmers use BGH to ↑output of milk per cow. 4.∆ Prices of related products: ●∆ P of 1 good produce a multi-product industry can shift S curve of other goods produced by that industry. ♦E.g., if ↑P cheese  shifts S milk in 3.Technological progress: ●Improvements in technology  shifts S out ●Example: many dairy farmers use BGH to ↑output of milk per cow. 4.∆ Prices of related products: ●∆ P of 1 good produce a multi-product industry can shift S curve of other goods produced by that industry. ♦E.g., if ↑P cheese  shifts S milk in

23. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Supply and Demand Equilibrium ●In a free market, Q of goods and services is determined by the intersection of S and D. ●E  consumers are willing to buy exactly what producers are willing to sell ●In a free market, Q of goods and services is determined by the intersection of S and D. ●E  consumers are willing to buy exactly what producers are willing to sell

24. TABLE 3. Equilibrium Price & Quantity of Milk Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

25. Supply and Demand Equilibrium ●E occurs where Qs = Qd = 60 at P = $1.20 ●If P > P E  surplus (with Qs > Qd). Surplus ends with frustrated sellers ↓P to reduce inventories. ●If P Qs). Shortage ends with frustrated consumers offering ↑P to obtain the good. ●E occurs where Qs = Qd = 60 at P = $1.20 ●If P > P E  surplus (with Qs > Qd). Surplus ends with frustrated sellers ↓P to reduce inventories. ●If P Qs). Shortage ends with frustrated consumers offering ↑P to obtain the good.

26. FIGURE 5. Supply-Demand Equilibrium D D G A S S 908070605040 $1.50 1.40 1.30 1.20 1.10 1.00 Price per Quart Quantity in Billions of Quarts per Year 300.90 E g a Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

27. Adjustment to Shifts in Demand ●Any shift in S or D   E ●Shifts in Demand ♦Shifts in D   equilibrium P and Q in the same direction ■Example: any inward shift in D lowers equilibrium P and Q. ●Any shift in S or D   E ●Shifts in Demand ♦Shifts in D   equilibrium P and Q in the same direction ■Example: any inward shift in D lowers equilibrium P and Q.

28. FIGURE 6. Inward shift in the Demand Curve Copyright© 2006 South-Western/Thomson Learning. All rights reserved. 604550 1.10 Quantity $1.20 Price per Quart D 2 D 2 D 0 D 0 S S 3 1 2 1 to 2: D shifts in. Point 2: surplus of 15 as Qd < Qs. Surplus ends as ↓P. ↓P  encourages ↑Qd (2 to 3) and ↓ Qs (1 to 3) which ends the surplus. Point 3: new E.

29. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Adjustment to Shifts in Supply ●Shifts in Supply ♦Shifts in S   equilibrium P and Q in opposite directions ■Example: any inward shift in S lowers equilibrium Q and raises equilibrium P. ●Shifts in Supply ♦Shifts in S   equilibrium P and Q in opposite directions ■Example: any inward shift in S lowers equilibrium Q and raises equilibrium P.

30. FIGURE 7. Inward shift in the Supply Curve D D S 2 S 2 S 0 S 0 37.55060 $1.40 Quantity 1.20 Price per Quart 3 2 1 Copyright© 2006 South-Western/Thomson Learning. All rights reserved. 1 to 2: S shifts in. Point 2: shortage of 22.5 as Qs < Qd. Shortage ends as ↑P. ↑ P  encourages ↓ Qd (1 to 3) and ↑ Qs (2 to 3) which ends the shortage. Point 3: new E.

31. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Government Intervention in Markets: Price Ceilings ●A price ceiling is a legal maximum on the price that may be charged for a good. ■Example: Rent control in NY City 1.Persistent shortage develops as Qd > Qs ♦Low vacancy rate (1/2 national average) 2.“Black” markets arise with higher prices ♦“Key money” to move up on wait lists or forced to buy wretched furniture at high P ●A price ceiling is a legal maximum on the price that may be charged for a good. ■Example: Rent control in NY City 1.Persistent shortage develops as Qd > Qs ♦Low vacancy rate (1/2 national average) 2.“Black” markets arise with higher prices ♦“Key money” to move up on wait lists or forced to buy wretched furniture at high P

32. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Price Ceilings 3.Illicit suppliers get substantial portion of P ♦E.g., theater ticket P controls in NY City 4.Investment in the industry dries up ♦Convert apartments to office space or condos ♦Inadequately maintained apartments ♦Abandoned buildings With all of these problems, why have rent controls in NY City continued since WWII? 3.Illicit suppliers get substantial portion of P ♦E.g., theater ticket P controls in NY City 4.Investment in the industry dries up ♦Convert apartments to office space or condos ♦Inadequately maintained apartments ♦Abandoned buildings With all of these problems, why have rent controls in NY City continued since WWII?

33. FIGURE 8. Rent Control S S D D 03.5 1,200 2.53 Rent per Month Millions of Dwellings Rented per Month $2,000 B Market rent E Rent ceiling C Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

34. Government Intervention in Markets: Price Floors ●A price floor is a legal minimum on the price that may be charged for a good. ■Examples: min. wage and agricultural P supports 1.Persistent surplus develops ♦E.g., EU with CAP. Europeans export surplus; lowers world food Ps and fuels trade disputes with U.S. 2.Disposal problems ♦E.g., Gov. has to purchase, store, and dispose of the agricultural surplus. ●A price floor is a legal minimum on the price that may be charged for a good. ■Examples: min. wage and agricultural P supports 1.Persistent surplus develops ♦E.g., EU with CAP. Europeans export surplus; lowers world food Ps and fuels trade disputes with U.S. 2.Disposal problems ♦E.g., Gov. has to purchase, store, and dispose of the agricultural surplus.

35. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Price Floors 3.Sellers offer inefficient discounts ♦E.g., In 1980s, regulated airlines competed in food quality and attractiveness of flight attendants. 4.Overinvestment in the industry ♦Inefficient businesses can survive with a high P floor. Trucking and airline industries faced massive layoffs after deregulation in 1980s. 5.Vested interests that resist change ♦P supports began in 1933. Still exist today, even though farmers are only 2% of the U.S. workforce. 3.Sellers offer inefficient discounts ♦E.g., In 1980s, regulated airlines competed in food quality and attractiveness of flight attendants. 4.Overinvestment in the industry ♦Inefficient businesses can survive with a high P floor. Trucking and airline industries faced massive layoffs after deregulation in 1980s. 5.Vested interests that resist change ♦P supports began in 1933. Still exist today, even though farmers are only 2% of the U.S. workforce.

36. FIGURE 9. Milk Price Supports S S D D Price Quantity $1.20 $1.40 Copyright© 2006 South-Western/Thomson Learning. All rights reserved. E 605080 AB Surplus = 30 (A to B) Gov Cost = $1.40 x 30 = $ 42 billion

37. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. More problems with price ceilings or floors ●Favoritism and corruption ♦E.g., Discriminate against renters with children or Soviet officials who purchased goods that others could not get. ●Auxiliary restrictions ♦E.g., NY City has laws banning the conversion of rent- controlled apartments to condos. ●Misallocation of resources ♦E.g., Russian farmers fed their animals bread because the P ceiling was below the P of grain. U.S. imported cereal from Canada to remove the sugar when P was extremely high. ●Favoritism and corruption ♦E.g., Discriminate against renters with children or Soviet officials who purchased goods that others could not get. ●Auxiliary restrictions ♦E.g., NY City has laws banning the conversion of rent- controlled apartments to condos. ●Misallocation of resources ♦E.g., Russian farmers fed their animals bread because the P ceiling was below the P of grain. U.S. imported cereal from Canada to remove the sugar when P was extremely high.