At price P3 quantitydemanded equalsquantity supplied--

Increase Demand With Supply Constant, Equilibrium Price and Quantity Both Increase.

S

D2

E1

E2

D1

P3

Q3

Shifts: Demand & Supply

People Decide to Have People Decide to Have More ChildrenMore Children

S

D1

P1

Q1

E1

Minivan Market

• Consider the Consider the market for market for minivans.minivans.

1.1. For each event For each event identify identify whether whether demand or demand or supply is supply is affected.affected.

2.2. Determine the Determine the direction of direction of change.change.

3.3. Draw a diagram Draw a diagram to illustrate to illustrate how how equilibrium is equilibrium is changed.changed.

D2

P2

Q2

E2

Steelworkers Strike Raises Steelworkers Strike Raises Steel PricesSteel Prices

D

S1

Q1

P1

E1

Minivan Market

S2

Q2

P2

E2

New Automated Machinery New Automated Machinery IntroducedIntroduced

S1

D

P1

Q1

E1

Minivan Market

S2

P2

Q2

E2

Price of Station Wagons Price of Station Wagons RisesRises

S

D1

P2

Q2

E2

Minivan Market

D2

P1

Q1

E1

D1

Stock Market Crash Stock Market Crash Lowers WealthLowers Wealth

S

P1

Q1

E1

Minivan Market

D2

P2

Q2

E2

Simultaneous ShiftsSimultaneous Shifts

– 2 events2 events•1.1. supply supply•2.2. demand demand

• only only supply supply P, P, Q.Q.• only only demand demand P, P, Q.Q.• Result: Result: Q guaranteedQ guaranteed

Example of a double shift.

D1

Shifts in Demand and in Shifts in Demand and in SupplySupply

S1

P1

Q1

E1

D2

S2

P2

Q2

E2

D1

Simultaneous ShiftsSimultaneous Shifts

S1

P1

Q1

E1

D2

S2

P2

Q2

E2

Simultaneous ShiftsSimultaneous Shifts

• second possibilitysecond possibility– 2 events2 events

•1.1. supply supply•2.2. demand demand

• only only supply supply P, P, Q.Q.• only only demand demand P, P, QQ• Result: Result: P guaranteed P guaranteed

Example of a double shift.

Shifts in Demand and in Shifts in Demand and in SupplySupply

S1

D1

P1

E1

Q1

S2

D2

P2

E2

Q2

D1

Shifts in Demand and in Shifts in Demand and in SupplySupply

S1

Q1

P1

E1

D2

S2

Q2

P2

E2

Markets and Markets and Government Policy Government Policy

• Supply and demand together Supply and demand together determine the prices of the determine the prices of the economy’s many different goods & economy’s many different goods & services.services.

• Prices guide the use of resources Prices guide the use of resources and the allocation of final goods and and the allocation of final goods and services.services.

Price ControlsPrice Controls

Price fixing is based on debatable Price fixing is based on debatable reasoning:reasoning:

• 1) Belief that one side of the market is 1) Belief that one side of the market is to “blame” for “undesirable” price to “blame” for “undesirable” price changes.changes.

• 2) Belief that governments can repeal 2) Belief that governments can repeal the laws of supply and demand. the laws of supply and demand.

• If you prevent prices from changing, you If you prevent prices from changing, you effectively suspend the mechanism for economic effectively suspend the mechanism for economic coordination.coordination.

Price ControlsPrice Controls

QdQsQuantity per Unit Time Period

Qd Qs

Equilibriumprice

D

Pric

e

S

Pe E1

Qe

P2

SurplusPrice FloorLegal Min. P.

P2

Shortage

P1

Price CeilingLegal Max. P.

P1

Price Price CeilingCeiling

QdQs

Quantity per Unit of Time

Q

d

Qs

Equilibriumprice

D

Pric

e

S

Pe E1

Qe

Shortage

P

1

Price CeilingLegal Max. P.

P1

• Def’n: places a legal maximum on the price at which the good can be sold.

– Below the equilibrium price, creates a shortage in the market.

– Alternative methods of rationing must then be found;

– E.G., First come, first served, personal biases, lottery, bribes...

A Market with a Price A Market with a Price CeilingCeiling

• eg. Rent Control: eg. Rent Control: goal, make housing goal, make housing more affordable.more affordable.

• Effects: Housing Effects: Housing shortage, reduces shortage, reduces quality of available quality of available housing, alternate housing, alternate methods of methods of rationing available rationing available apartmentsapartments

D

S

Price CeilingP1

P2

Q2Q1 Q3

P3

shortage

Quantity supplied

Quantity demanded

Market for OrgansMarket for Organs

• The Canadian government has The Canadian government has essentially placed a price ceiling of essentially placed a price ceiling of $0 on organs – to sell human $0 on organs – to sell human organs in this country is illegal.organs in this country is illegal.

• At the end of 2003, more than 3,700 At the end of 2003, more than 3,700 Canadians were waiting for an organ Canadians were waiting for an organ transplant and 147 died in 2003 transplant and 147 died in 2003 waiting.waiting.

Market for OrgansMarket for Organs

• All of us have two kidneys, but can All of us have two kidneys, but can survive (in fact live a normal life) with survive (in fact live a normal life) with just one.just one.

• It is therefore possible for anyone to It is therefore possible for anyone to decide to offer one of his or her own decide to offer one of his or her own kidneys, if the proper incentive exists.kidneys, if the proper incentive exists.

• For some this incentive would be a For some this incentive would be a financial one, and some people desperate financial one, and some people desperate for a kidney would be willing to payfor a kidney would be willing to pay Black Market in KidneysBlack Market in Kidneys

Black Market / Illegal Black Market / Illegal MarketMarket

QdQs

Shortage

Equilibriumprice

P2

PriceCeiling

Black Marketprice will bebetween P1 and P2.

Pric

e

Quantity per Unit Time Period

D

S

P1

Pe E1

Qe

Forces of demand and supply persists despite price controls

Price FloorPrice Floor• Def’n: legal minimum placed on the Def’n: legal minimum placed on the

price, above the equilibrium, price, above the equilibrium, resulting in a surplus. resulting in a surplus.

• E.g., minimum wage, agricultural price E.g., minimum wage, agricultural price supports.supports.

– Alternative methods of dealing with the Alternative methods of dealing with the surplus will emerge-surplus will emerge-

– Consequences include: waste, government Consequences include: waste, government purchase of surplus, subsidize consumer to purchase of surplus, subsidize consumer to purchase, production control.purchase, production control.

The Effect of Minimum The Effect of Minimum WagesWages

We E

Qe

Increase inquantity oflabour supplied

Excessquantitysupplied atwage Wm

Reductionin quantityof labourdemanded

D

S

Quantity of Labour per Time Period

Wag

e R

ate

per

Uni

t

Wm

Qd Qs

A B C

Qq

Sq

Agricultural Price Supports:Agricultural Price Supports:The Regulated Market for The Regulated Market for

EggsEggs

Quantity (dozens)

Pric

e pe

r do

zen

S

D

Pe

Qe

PqPrice will riseto Pq withimposition of a quota.

Price ControlsPrice Controls• Economists usually oppose price controls for Economists usually oppose price controls for

everyday kinds of commodities because everyday kinds of commodities because – They obscure the signals given by market They obscure the signals given by market

prices that normally guide the allocation of prices that normally guide the allocation of society’s scarce resources.society’s scarce resources.

Markets are prevented from performing Markets are prevented from performing their coordinating and rationing activities.their coordinating and rationing activities.

• However, if all things are not equal, and a However, if all things are not equal, and a market is not operating properly, price market is not operating properly, price controls can be usefulcontrols can be useful– Ie: controls placed upon a monopolyIe: controls placed upon a monopoly

The individual’s demand curve can be seen as the individual’s willingness to pay curve.

On the other hand, the individual must only actually pay the market price for (all) the units consumed.

For example, you may be willing to pay $40 for a haircut, but upon arriving at the stylist, discover that the price is only $20

The difference between willingness to pay and the amount you pay is the Consumer Surplus

Definition: The net economic benefit to the consumer due to a purchase (i.e. the willingness to pay of the consumer net of the actual expenditure on the good) is called consumer surplus.

The area under an ordinary demand curve and above the market price provides a measure of consumer surplus.

Note that a consumer will receive more surplus from the first good than from the last good.

Consumer SurplusConsumer Surplus

D

Q*

P*EquilibriumOr marketPrice

Quantity

Price

ConsumerSurplus

Consumer Surplus: The difference between what a consumer is willing to pay and what they pay for each item

Efficiency of the Equilibrium Efficiency of the Equilibrium QuantityQuantity

D

10

$8This calculationOnly works forA linear demandcurve

Quantity

Price

ConsumerSurplus

Consumer Surplus = area of triangle=1/2bh=1/2(16-8)(10)=40

$16

-a firm’s supply curve shows how much it is willing to sell a good for-the firm receives, however, the market price, which is often above their willingness to sell

Definition: Producer Surplus is the area above the supply curve and below the price. It is a monetary measure of the benefit that producers derive from producing a good at a particular price.

Producer SurplusProducer Surplus

S

Q*

P*EquilibriumOr marketPrice

Quantity

Price Producer Surplus: The difference between what a producer is willing to accept and what they receive for each item

Producer

Surplus

Producer SurplusProducer Surplus

S

10

$8EquilibriumOr marketPrice

Quantity

Price Producer Surplus = (1/2)BHPS=(1/2)10(5)PS=25

Producer

Surplus$3

When the government (or other agency, such as a union) imposes price floors and price ceilings, consumer and producer surplus is generally decreased (except in very rare and unique cases)

Generally, the consumers with the greatest willingness to pay or the producers with the greatest efficiency will consume and provide the good

The alternate situation is provided graphically for interest sake only

Without price controls, efficiency was maximized.

After the price control is imposed, some surplus is transferred between producers and consumers

BUT SOME SURPLUS IS LOST!

After the price control, production decreases, and a small triangle of producer and consumer surplus is lost – this triangle is the deadweight loss

Deadweight loss – reduction in net economic benefit due to inefficient allocation of resources

Price controls create inefficiencies!!

Price Ceiling

Demand

OldConsumer Surplus

Q

P

Q*

P*

A

B C

DOldProducer Surplus

Supply

Price Ceiling

The impact of a price ceiling depends on which consumer receive the available good. We will examine the 2 extreme cases:

•Consumers with greatest willingness to pay receive good (maximize consumer surplus)

•Consumers with least willingness to pay receive good (minimize consumer surplus)

Price Ceiling: Maximize Consumer Surplus

Demand

NewConsumer Surplus

Q

P

Qd

P*

A

B C

D

Qs

NewProducer Surplus

Supply

Price Ceiling

ExcessDemandQs

Deadweight Loss

Price Ceiling: Minimize Consumer Surplus

Demand

NewConsumer Surplus

Q

P

Qd

P*

A

B C

D

Qs

NewProducer Surplus

Supply

Price Ceiling

ExcessDemand

Qs

Price Ceiling: Minimize Consumer Surplus

Demand

Q

P

Qd

P*A

B

Qs

Supply

Price Ceiling

ExcessDemand

Qs

Deadweight Loss=A-B

•It is generally assumed that the consumers with the greatest willingness to pay receive the good, but this does not always occur

•Price ceilings are only effective if resale (black market) is prevented

•Price ceilings can also cause a reliance on imports to meet excess demand

A price floor always has the following effects:

• Excess supply will exist• The market will underconsume• Consumer surplus will decrease• Some consumer surplus is transferred to

the producer• Producer surplus may increase or

decrease• There will be a deadweight loss

Price Floor

Demand

OldConsumer Surplus

Q (L)

P (W)

Q*

P*

A

B C

DOldProducer Surplus

Supply

Price Ceiling(min. wage)

The impact of a price floor depends on which producer will sell the good (which worker works). We will examine the 2 extreme cases:

•Producers with greatest efficiency supply good (maximize producer surplus)

•Producers with least efficiency supply good (minimize producer surplus)

Price Floor: Maximize Producer Surplus

Demand

NewConsumer Surplus

Q (L)

P (W)

Qd

P*

A

B C

D

Qs

NewProducer Surplus

Supply

Price FloorIe: Min. Wage

ExcessSupplyQd

Deadweight Loss

Price Floor: Minimize Producer Surplus

Demand

NewConsumer Surplus

Q

P

Qd

P*

A

B C

D

Qs

NewProducer Surplus

Supply

Price FloorIe: Min. Wage

ExcessSupply

Qs

Price Floor: Minimize Producer Surplus

Demand

Q

P

Qd

P* YX

Qs

Supply

Price FloorIe: Min. Wage

ExcessSupply

Qs

Deadweight Loss=Y-X

• Therefore the attempt of a union to increase wages (create a price floor) has two effects:

1)Some workers receive a higher wage2)Some workers lose their jobs

• Note that there is a difference between negotiating a higher wage (a union’s publicized goal) and ensuring wages keep up with inflation (often a union’s achieved goal)

Midterm 1Midterm 1

• 1 hour1 hour• 50 multiple choice questions50 multiple choice questions• Includes all material previously coveredIncludes all material previously covered• Some questions will be quickly Some questions will be quickly

answered, others may take timeanswered, others may take time• Students should average 1 min per Students should average 1 min per

questionquestion• Feel free to skip over troublesome Feel free to skip over troublesome

questions until laterquestions until later