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Introduction: Thinking Like an Economist
1CHAPTER
Using Supply and Demand
It is by invisible hands that we are bent and tortured worst.
— Nietzsche
CHAPTER
5
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
1Using Supply and Demand5
5-2
Application: Apples in the United States
D0
Quantity
The hurricane damage caused the supply curve
to shift left
Hurricane Irene destroyed a significant portion of the
apple crop in the northeastern U.S.
S1
Price rose from P0 to P1
where quantity demanded = quantity supplied
Q1
P1
S0
Price
P0
Q0
Apples
Excess demand
1Using Supply and Demand5
5-3
Application: Sales of SUVs in the U.S.
P0
Q1
P1
Increasing gas costs causes the demand curve
to shift left
Gasoline in the U.S. is increasingly expensive
Price for SUVs fell
from P0 to P1 where
Q demanded = Q supplied
S0
D0
Price
Quantity Q0
SUVs
Excess supply
D1
1Using Supply and Demand5
5-4
Application: Edible Oils in the World
S0
D0
Price
Quantity
Growing middle class in Asia has increased demand for oilsS1
At the same time, U.S. farmers are growing more
corn and less soy (less soy oil)
Edible Oils
P0
P1
D1The result is increased prices
for edible oils
1Using Supply and Demand5
5-5
A Review of Changes in Supply and Demand
No change in Supply
Supply increases Supply decreases
No change in Demand
P sameQ same
P downQ up
P up Q down
Demand increases
P upQ up
P ambiguous Q up
P upQ ambiguous
Demand decreases
P downQ down
P downQ ambiguous
P ambiguous Q down
1Using Supply and Demand5
5-6
Government Intervention
• Price ceilings and price floors
• Third-party-payer markets
• Excise taxes and tariffs
• Quantity restrictions
The invisible hand is not the only factor in determining prices; social and political forces also determine price.
Other factors include:
1Using Supply and Demand5
5-7
Government Intervention: Price Ceilings
When a government wants to hold prices down to favor buyers, it imposes a price ceiling
A price ceiling is a government-imposed limit on how high a price can be charged
With price ceilings, existing goods are no longer rationed entirely by price so other methods of rationing arise
Price ceilings create shortages
Price ceilings below equilibrium price will have an effect on the market
1Using Supply and Demand5
5-8
S0
D0
P(rental price per month)
Q (number of apartments)
$17
$2.50
QDQS
Shortage
Housing
The rent controls caused a housing shortage
After WWII, rent controls (a form of price ceiling)
were put in place
There would not be a shortage if rents had been allowed to increase to the equilibrium price of $17
Application: Rent Controls in Paris
1Using Supply and Demand5
5-9
Government Intervention: Price Floors
When a government wants to prevent a price from falling below a certain level to favor suppliers, it imposes a price floor
A price floor is a government-imposed limit on how low a price can be charged
Price floors above equilibrium price will have an effect on the market
Price floors create excess supply
1Using Supply and Demand5
5-10
Application: A Minimum Wage
S0
D0
P (wage per hour)
Q (quantity of workers)
W0
Wmin
QD QS
Excess supply = unemployment
Labor
Minimum wages cause unemployment
A minimum wage is a type of price floor, it is the lowest wage a firm can legally pay an employee
Q0
1Using Supply and Demand5
5-11
Government Intervention: 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
1Using Supply and Demand5
5-12
Application: The Effect of an Excise Tax
S0
D0
Price
Quantity
$60,000
600510
The supply curve shifts up by the amount of the tax
Government imposes a $10,000 luxury tax on the suppliers of boats
S1
The price of boats rises by less than the tax to $65,000
Tax = $10,000
Luxury Boats
$65,000
420
$10,000
$70,000
1Using Supply and Demand5
5-13
Government Intervention: 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
1Using Supply and Demand5
5-14
Application: The Effect of a Quantity Restriction
QR
D0
12,000
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
$15
P (wages per week )
Q (number of licensed taxis)
D1
1Using Supply and Demand5
5-15
Application: The Effect of a Quantity Restriction
QR
D0
12,000
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
$400,000
P (price of taxi medallion)
Q (number of taxi of medallions)
D1Initial Fee
1Using Supply and Demand5
5-16
Government Intervention: 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
1Using Supply and Demand5
5-17
Application: Third-Party-Payer Markets
Demand
10
Health Care
$25
Price
Quantity
$45
$5
Supply
18
The consumer pays the entire cost
Total expenditures for 18 units of health care
With a copayment of $5, consumers demand 18 units
Sellers require $45 per unit for that quantity
…are greater than when…