ECONOMICS 200 BASIC ECONOMIC ISSUESchrystie/econ200/2_goods market.pdf · Decide whether the event shifts the supply or demand curve (or both). Decide whether the curve(s) shift(s)

ECONOMICS 200

BASIC ECONOMIC ISSUES

Dec. 21 2010 Chrystie Burr

*Picture modified from David Klein’s NY Times publication

1

Topics To be Covered2

How Economists Think

The Division of Labor

Supply and Demand

Price Floor and Price Ceiling

Elasticity

Unit 3: Supply and Demand3

Circular flow diagram

What is Price?4

In the Goods Market-

Price: outcome of supply and demand

Example: Adam Smith’s diamond-water paradox

Value in exchange vs. value in use

Economists care about value in exchange which

depends on the scarcity of the good

Economists knows the prices of everything

and the intrinsic value of nothing

Demand Definition5

Demand

Demand is a relationship between quantity

demanded and any given price (a line\curve)

Quantity demanded is a specific amount

demanded at a certain price (a point)

Demand curve is a graph of this relationship

Demand curve slopes down

Substitution effect

Income effect

6

Catherine’s Demand Schedule

Catherine’s Demand Schedule and

Demand Curve7

Price of

Ice-Cream Cone

0

2.50

2.00

1.50

1.00

0.50

1 2 3 4 5 6 7 8 9 10 11 Quantity of

Ice-Cream Cones

$3.00

12

1. A decrease

in price ...

2. ... increases quantity

of cones demanded.

Change in Quantity Demanded8

0

D

Price of Ice-Cream Cones

Quantity of Ice-Cream Cones

A tax that raises the price of ice-

cream cones results in a movement

along the demand curve.

A

B

8

1.00

$2.00

4

Shifts in the Demand Curve9

Consumer income

Normal good

Inferior good

Prices of related goods

Complements

Substitutes

Tastes

Expectations

Weather

Number of buyers

Shifts in the Demand Curve10

Price of

Ice-Cream

Cone

Quantity ofIce-Cream Cones

Increase

in demand

Decrease

in demand

Demand curve, D3

Demand

curve, D1

Demand

curve, D2

0

Demand Summary11

Change in demand: Change in income

Number of Buyers

Tastes/Expectation

Price of complement or substitute goods

Change in quantity demanded: Change in prices

Supply12

Supply

Supply is a relationship between quantity supplied

and any given price

Quantity supplied is the quantity supplied at a

given price

Supply curve slopes up

Existing firm wants to produce more

New entrants

Kevin’s Supply Schedule13

Kevin’s Supply Curve and Supply Schedule

14

Price of

Ice-Cream

Cone

0

2.50

2.00

1.50

1.00

1 2 3 4 5 6 7 8 9 10 11 Quantity of

Ice-Cream Cones

$3.00

12

0.50

1. An

increase

in price ...

Changes in Quantity Supplied15

1 5

Price of Ice-

Cream

Cone

Quantity of

Ice-Cream

Cones0

S

1.00A

C$3.00

A rise in the price

of ice cream

cones results in a

movement along

the supply curve.

Shifts in the Supply Curve16

Change in technology

Change in input prices

Change in expectation

Change in the number of sellers

Weather

Shifts in the Supply Curve17

Price of

Ice-Cream

Cone

Quantity of0

Increase

in supply

Decrease

in supply

Supply curve, S3

curve,

Supply

S1Supply

curve, S2

Supply Summary18

Change in supply: Change in technology

Weather

Prices of key input

Expectation

Number of sellers

Change in quantity demanded: Change in Price

Supply and Demand Together

19 Price of

Ice-Cream

Cone

0 1 2 3 4 5 6 7 8 9 10 11 12

Quantity of Ice-Cream Cones

13

Equilibrium

quantity

Equilibrium price Equilibrium

Supply

Demand

$2.00

Supply and Demand Together20

Equilibrium price: Quantity demanded = Quantity supplied

At $2.00, the quantity demanded

is equal to the quantity supplied!

Demand Schedule Supply Schedule

Market not in Equilibrium21

Price of

Ice-Cream

Cone

0

Supply

Demand

(a) Excess Supply

Quantity

demanded

Quantity

supplied

Surplus

Quantity of

Ice-Cream

Cones

4

$2.50

10

2.00

7


Surplus

When market price > equilibrium price,

quantity demanded < quantity supplied

This is called excess supply or surplus

Supplier will lower the price to increase sales

thereby moving towards equilibrium


Price of

Ice-Cream

Cone

0 Quantity of

Ice-Cream

Cones

Supply

Demand

(b) Excess Demand

Quantity

supplied

Quantity

demanded

1.50

10

$2.00

74

Shortage


Shortage

When market price < equilibrium price,

quantity demanded > quantity supplied

This is called excess demand or shortage

Supplier will raise the due to too many buyers

chasing too few goods, thereby moving toward

equilibrium

Equilibrium25

What does equilibrium mean?

A balancing point that the economy tends to go

Equilibrium prices and quantities are efficient.

Three Steps to Analyzing Changes in Equilibrium

26

Decide whether the event shifts the supply or

demand curve (or both).

Decide whether the curve(s) shift(s) to the left

or to the right.

Use the supply-and-demand diagram to see

how the shift affects equilibrium price and

quantity.

How an Increase in Demand

Affects the Equilibrium27

Price of

Ice-Cream

Cone

0 Quantity of

Ice-Cream Cones

Supply

Initial

equilibrium

D

D

2. . . . resulting

in a higher

price . . .

1. Hot weather increases

the demand for ice cream . . .

2.00

7

New equilibrium$2.50

10

How a Decrease in Supply Affects

the Equilibrium28

Price of

Ice-Cream

Cone

0 Quantity of

Ice-Cream Cones

Demand

New

equilibrium

Initial equilibrium

S1

S2

2. . . . resulting

in a higher

price of ice

cream . . .

1. An increase in the

price of sugar reduces

the supply of ice cream. . .

3. . . . and a lower

quantity sold.

2.00

7

$2.50

4

Supply and Demand Model29

As a framework for discussing how prices and

quantities are determined in markets and why

they change.

Not everyone will be happy at the equilibrium.

Real people don’t think in terms of the model.

It worked well in markets all over the world and

at all different times.




Supply and Demand


Elasticity

Unit 4: Price Floors and Price Ceilings31

Inevitability vs. desirability

The inevitable market outcome not necessarily

desirable

Will the method used by the society and

government achieve the desired goal?

Disagreements over the market outcome is

unavoidable.

Definition of Price Ceiling32

Price ceiling: the government sets the price

above which more cannot be charged.

The goal of rent control policy is to help the

poor by making housing more affordable

Example: rent control laws. Shortage of apartments

Depends on who you know but what you pay

Grey market trade

People who really need a apartment couldn’t get more

One economist called rent control “the best way to destroy

a city, other than bombing.”

Price Ceiling33 (a) Rent Control in the Short Run

Quantity of

Apartments

0

Supply

Controlled rent

Rental

Price of

Apartment

Demand

Shortage

Price Ceiling(b) Rent Control in the Long Run

0

Rental

Price of

Apartment

Quantity of

Apartments

Demand

Supply

Controlled rent

Shortage

Price Ceiling: 1973 Gasoline Crisis35

Price Ceiling: 1973 Gasoline Crisis36

In 1973, OPEC raised the price of crude oil in

world markets. Crude oil is the major input in

gasoline, so the higher oil prices reduced the

supply of gasoline.

What was responsible for the long gas lines?

Economists blame government regulations

that limited the price oil companies could

charge for gasoline.

Definition of Price Floor37

Price floor: the government sets a minimum

price that you are not allow to pay less than

that price

Example: Laws guarantee farmer certain price

for their crops, or the minimum wage High income country spend 1 billion dollar a day on

subsidy agriculture product

Surplus

Farmland rent goes up

Intensive farming

Food aid to poorer countries

Price Floor: Minimum Wage Example

Quantity of

Labor

Wage

0

Labor

demand

Labor

Supply

Equilibrium

employment

Equilibrium

wage

Price Floor: Minimum Wage Example

39

Quantity of

Labor

Wage

0

Labor

SupplyLabor surplus

(unemployment)

Labor

demand

Minimum

wage

Quantity

demanded

Quantity

supplied

Price Control Summary40

Price floor and price ceiling inevitably affect

everyone in the market.

In a few historical cases such as Old Soviet

Russia, government tried to do both which

leads to deficit and chaos.

The market is too powerful to ignore.

Price Control Summary41

There are better ways to provide assistance.

Politicians prefer price ceilings and price floor No direct budgetary cost

Not clear who is paying and who we are helping

Economists believe in taking all costs into

account including the hidden opportunity cost.




Supply and Demand


Elasticity

Unit 5: Elasticity43

Question: How much does the change in price

causes the change in quantity demanded or

supply?

Definition:

=

Categories of Elasticity44

If… Then… It’s Called

% change > % change

in quantity in price elastic

% change = % change

In quantity in price

unitary

elasticity

% change < % change

In quantity in price inelastic

Three Categories of Elasticity45

Elastic demand: Quantity demanded responds strongly to changes in price.

Inelastic demand: Quantity demanded does not respond strongly to price changes.

Unitary elasticity of demand: Quantity demanded changes by the same percentage as the price.

Elastic supply:

Inelastic supply:

Unitary elasticity of supply

Computing the Price Elasticity of Demand

46

Example: If the price of an ice cream cone

increases from $2.00 to $2.20 and the amount

you buy falls from 10 to 8 cones, then your

elasticity of demand would be calculated as:

( )

( . . )

.

10 8

10100

2 20 2 00

2 00100

20%

10%2

The Variety of Demand Curves47

Because the price elasticity of demand

measures how much quantity demanded

responds to the price, it is closely related to

the slope of the demand curve.


(a) Perfectly Inelastic Demand: Elasticity Equals 0

$5

4

Quantity

Demand

1000

1. An

increase

in price . . .

2. . . . leaves the quantity demanded unchanged.

Price


(b) Inelastic Demand: Elasticity Is Less Than 1

Quantity0

$5

90

Demand1. A 22%

increase

in price . . .

Price

2. . . . leads to an 11% decrease in quantity demanded.

4

100


2. . . . leads to a 22% decrease in quantity demanded.

(c) Unit Elastic Demand: Elasticity Equals 1

Quantity

4

1000

Price

$5

80

1. A 22%

increase

in price . . .

Demand


(d) Elastic Demand: Elasticity Is Greater Than 1

Demand

Quantity

4

1000

Price

$5

50

1. A 22%

increase

in price . . .

2. . . . leads to a 67% decrease in quantity demanded.


(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Quantity0

Price

$4 Demand

2. At exactly $4,

consumers will

buy any quantity.

1. At any price

above $4, quantity

demanded is zero.

3. At a price below $4,

quantity demanded is infinite.

The Price Elasticity of Demand and

Its Determinants53

Demand tends to be more elastic :

the larger the number of close substitutes.

if the good is a luxury.

the longer the time period.

Application of Elasticity54

Tells us how prices should be set and how

markets would react

Raising price will bring in more revenue if

demand is inelastic; however raising price will

bring in less revenue if demand is elastic.

Example: A band deciding on whether to sell

the tickets at a lot of tickets at a lower price or

to sell less tickets at a higher price.

Revenue = Price x Quantity

Application of Elasticity55

When demand is inelastic, increases in cost of production can be passed along to consumers. But not if the demand is elastic. The producer has to borne this additional cost.

Coffee

Tax on cigarettes

Applicable to situations in which behavior is changing in response to changes in a price

Quantity of labor response changes to income

Quantity of saving respond to changes in rate of return

Documents

ECONOMICS 200 BASIC ECONOMIC ISSUESchrystie/econ200/2_goods market.pdf · Decide whether the event shifts the supply or demand curve (or both). Decide whether the curve(s) shift(s)