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Economics Today: Nineteenth Edition

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68 views65 pages

Economics Today: Nineteenth Edition

Uploaded by

Rimeh Bakir
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Economics Today

Nineteenth Edition

Chapter 4
Extensions of Demand and
Supply Analysis

Copyright © 2018, 2016, 2014 Pearson


CopyrightEducation, Inc. All
© 2018, 2016, 2014 Pearson Rights
Education, Inc. All Reserved
Rights Reserved
Introduction
Intermediaries, or go-between firms, specialize in
matching buyers and sellers.
In contrast to the argument that the Internet would
“liberate” consumers from relying on the services of
intermediaries, more companies have found niches
offering middlemen services on the Web.
In this chapter you will learn why market middlemen
often occupy key roles within a price system.

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
Learning Objectives (1of 2)
• 4.1 Discuss the essential features of the price
system
• 4.2 Evaluate the effects of changes in demand
and supply on the market price and equilibrium
quantity
• 4.3 Understand the rationing function of prices

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
Learning Objectives (2 of 2)
• 4.4 Explain the effects of price ceilings
• 4.5 Explain the effects of price floors and
government-imposed quantity restrictions

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
Chapter Outline
• 4.1 The Price System and Markets
• 4.2 Changes in Demand and Supply
• 4.3 The Rationing Function of Prices
• 4.4 Price Ceilings
• 4.5 Price Floors and Quantity Restrictions

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Did You Know That ...
• in every year since 2011, shortages have
persisted for about 300 pharmaceuticals
manufactured for diverse purposes?
• Various U.S. laws prevent prices from rising
sufficiently to eliminate shortages for numerous
pharmaceuticals for which government programs
such as Medicare and Medicare provide funding.
• Therefore, these laws effectively generate legally
binding price ceilings in some markets.

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4.1 The Price System and Markets (1 of 4)
• Price system, or market system
– An economic system in which relative prices are
constantly changing to reflect changes in supply and
demand:
 The prices are signals as to what is relatively scarce and
relatively abundant.
 Prices provide information to individuals and businesses.

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4.1 The Price System and Markets (2 of 4)
• Voluntary exchange
– An act of trading between individuals in the price
system
– Makes both parties to the trade subjectively better off

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4.1 The Price System and Markets (3 of 4)
• Transaction costs
– All the costs associated with exchange, including:
 The informational costs of finding out the price and quality,
service record, and durability of a product
 The cost of contracting and enforcing that contract

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4.1 The Price System and Markets (4 of 4)
• The role of middlemen
– Middlemen (intermediaries) or brokers reduce
transaction costs by providing information to buyers
and sellers.

• Platform firms
– Companies whose services link people to other
individuals who share their interests or who seek to buy
firms’ products, often via networks that the companies
operate.

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Behavioral Example: Online Dating
Sites and Virtual Roses
• Some online dating companies provide each
customer with a small number of virtual roses that
can be attached to invitations to date other
customers.
• The roses induce a 20 percent increase in the
date acceptance rate as recipients regard those
roses as indicators of the seriousness of senders’
interest.

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4.2 Changes in Demand and Supply
• Changes in supply and demand create a
disequilibrium.
• The market price and quantity adjust to a new
equilibrium.

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Figure 4-1 Shifts in Demand and in Supply:
Determinate Results, Panel (a)

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Figure 4-1 Shifts in Demand and in Supply:
Determinate Results, Panel (b)

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Figure 4-1 Shifts in Demand and in Supply:
Determinate Results, Panel (c)

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Figure 4-1 Shifts in Demand and in Supply:
Determinate Results, Panel (d)

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4.2 Changes in Demand and Supply (1 of 7)

• Summary:
– Increases in demand increase equilibrium price and
quantity.
– Decreases in demand decrease equilibrium price and
quantity.

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4.2 Changes in Demand and Supply (2 of 7)

• Summary:
– Increases in supply decrease equilibrium price and
increase equilibrium quantity.
– Decreases in supply increase equilibrium price and
decrease equilibrium quantity.

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4.2 Changes in Demand and Supply (3 of 7)

• When both demand and supply change:


– If both the supply and demand curves shift
simultaneously, the outcome is indeterminate for either
equilibrium price or equilibrium quantity.
– The resulting effect depends upon how much each
curve shifts.

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4.2 Changes in Demand and Supply (4 of 7)
• When both demand and supply increase:
– The change in equilibrium price is indeterminate.
– The equilibrium quantity increases unambiguously.

• When both demand and supply decrease:


– The change in equilibrium price is indeterminate.
– The equilibrium quantity decreases unambiguously.

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4.2 Changes in Demand and Supply (5 of 7)

• When supply decreases and demand increases:


– The equilibrium price increases.
– The change in the equilibrium quantity is uncertain
without more information.
• When supply increases and demand decreases:
– The equilibrium price decreases.
– The change in the equilibrium quantity is uncertain
without more information.

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4.2 Changes in Demand and Supply (6 of 7)
• Price flexibility:
– Prices that are quite flexible in some markets can be
less flexible in other market scenarios:
 May take the form of subtle adjustments such as hidden
payments and quality changes
 May not reach equilibrium right away

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4.2 Changes in Demand and Supply (7 of 7)
• Adjustment speed:
– Market characteristics influence adjustment speed.
– Markets may overshoot in the adjustment process.
– Markets are subject to energy shocks, labor strikes,
and severe weather.

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International Example: Why Are
Global Ship Rental Prices Dropping?
• Since 2010, the prices to rent ships that transport
goods across the world’s oceans have dropped by
more than 50 percent.
– One reason for this drop is the slow rebound of world
trade following the 2010 recession.
– Another reason is an increase in the supply of new
large freight ships.

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Figure 4-2 The Effects of a Simultaneous Increase
in the Supply of and Decrease in the Demand for
Ship Rentals

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4.3 The Rationing Function of Prices (1 of 3)
• Synchronization of decisions of buyers and sellers
that leads to equilibrium is called the rationing
function of prices.

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4.3 The Rationing Function of Prices (2 of 3)
• Methods of nonprice rationing:
– Rationing by queues (waiting in line)
– Rationing by random assignment or coupons

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Policy Example: Rationing Water
• In response to years of drought, the California
government announced a requirement for all cities
in the state to reduce their consumption of water
by 25 percent.
• The governments of many cities, such as San
Jose, effectively issue each household an
electronic coupon to ration water.

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4.3 The Rationing Function of Prices (3 of 3)

• The essential role of rationing:


– Implied by the presence of scarcity
– Price versus nonprice rationing mechanism:
 Price rationing leads to the most efficient use of available
resources.
 All gains from mutually beneficial trade are captured in a freely
rationing price system.

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4.4 Price Ceilings (1 of 8)
• Price controls
– Government-mandated minimum or maximum prices
• Price ceiling
– A legal maximum price
• Price floor
– A legal minimum price

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4.4 Price Ceilings (2 of 8)
• Price ceiling and black markets:
– A price ceilings may prevent the equilibrium price from
being achieved if it is above the ceiling price.
– A price ceiling that is set below the market clearing
price creates a shortage.

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4.4 Price Ceilings (3 of 8)
• Nonprice rationing devices
– All methods used to ration scarce goods that are price-
controlled

• Black market
– A market in which price-controlled goods are sold at an
illegally high price

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Figure 4-3 Black Markets for Portable Electric
Generators

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
International Example: Looking for Hard-to-
Find in Venezuela? Ask for the Bachaqueros
• The Venezuelan government has established
maximum allowed “fair prices” that sellers can
charge for a wide range of items from coffee to
toilet paper.
• As a consequence, bachaqueros work together
like hordes of ant-like insects to quickly purchase
all items, from store shelves at the government-
mandated prices as soon as they become
available and then resell them at considerably
higher prices on the black market.
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4.4 Price Ceilings (4 of 8)
• The functions of rental prices:
– Promote the efficient maintenance and construction of
housing
– Allocate existing housing
– Ration the use of housing

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
4.4 Price Ceilings (5 of 8)
• Rent controls and construction
– Controls discourage construction:
 With a 16 percent vacancy rate and no controls, Dallas
recently built 11,000 new rental units.
 With a 1.6 percent vacancy rate and controls, San Francisco
recently built 2,000 new rental units.

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
4.4 Price Ceilings (6 of 8)
• Effects on the existing supply of housing and
current use of housing:
– Property owners cannot recover costs:
 Maintenance, repairs, capital improvements

– Rations the current use of housing:


 Reduces mobility, e.g., New York’s “housing gridlock”

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4.4 Price Ceilings (7 of 8)
• Attempts to evade rent controls:
– Forcing tenants to leave
– Tenants subletting apartments
– Housing courts

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4.4 Price Ceilings (8 of 8)
• Who wins and who loses from rent controls?
– Losers:
 Property owners
 Low-income individuals

– Winners:
 Upper-income professionals

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
What If ... the government requires apartment
owners to set rents based on tenants’ incomes?
• More low-income households would seek those
rent-controlled apartments.
• As a consequence, shortages would occur in the
market for those apartments subject to price
ceilings.

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4.5 Price Floors and Quantity
Restrictions (1 of 5)
• Support price
– The government chooses a price floor for a product
and then acts to ensure that the price of the product
never falls below the support level:
 Price floors are associated with many agricultural products.
 A price floor that is set above the market clearing price results
in a surplus.

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Figure 4-4 Agricultural Price Supports

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4.5 Price Floors and Quantity
Restrictions (2 of 5)
• Questions:
– How could the government keep the price from falling?
– Who benefits from agricultural price supports?

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4.5 Price Floors and Quantity
Restrictions (3 of 5)
• Minimum wage
– A wage floor, legislated by government, that sets the
lowest hourly wage rate that firms may legally pay their
workers

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Figure 4-5 The Effect of Minimum Wages

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4.5 Price Floors and Quantity
Restrictions (4 of 5)
• Governments can impose quantity restrictions.
• The most obvious examples are banning
ownership or trading of goods:
– Human organs
– Drugs
– Hospital beds
– Gold from 1933 to 1973

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Example: Dramatic Responses to Cities’ Minimum
Wage Hikes: “Zeroing Out” Employment
• A number of cities, including Los Angeles, San
Francisco, and Seattle, have established a
minimum wage rate of $15 per hour, which is
higher than the $7.25-per-hour federal level.
• A number of firms and stores react to increased
minimum wage rates by shutting down, so their
quantity of labor demanded falls to zero.
• Such responses contribute to the upward
movement along a market labor demand curve.

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4.5 Price Floors and Quantity
Restrictions (5 of 5)
• Government prohibitions and licensing
requirements
– Some commodities cannot be purchased at all legally;
others require a license.
• Import quota
– Supply restriction that prohibits the importation of more
than a specified quantity of a particular good

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International Policy Example: The European Union
Decides That the Costs of Milk Quotas Outweigh the
Benefits
• In 1984, the European Union (EU) established
quotas for dairy farmers, resulting in an upward
movement along the market demand curve.
• Despite the higher price received by dairy farmers,
they were unable to implement fully new
techniques to boost milk production and reduce
their costs.
• In response, the EU now has completed a
phased-in elimination of its dairy quotas.

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You Are There: Price Rationing via Changes
in the Number of Items Sold in a Package
• In response to higher costs of inputs used to
produce pepper, McCormick & Company has
reduced the amount of pepper in each tin can, a
practice known as non-functional slack fill.
• This practice, also common among firms that sell
food items in packages, effectively increases the
price per ounce of pepper in the process which is
rationing via the price system.

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Issues & Applications: Online Middlemen:
Customer Sales Reps Move to the Web
• For many people, the time and effort required to find and
choose among all the possibilities available to them
represent transaction costs of exchange.
• Consumers’ desires to reduce these transaction costs
provide opportunities for middlemen.
• A firm called Operator offers a digital-device app that can
connect a consumer with a network of customer service
representatives.
• Amazon’s “Home Services” site also gives consumers a
network of providers of specialized services.

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
Summary Discussion of Learning
Objectives (1 of 6)
• 4.1 Discuss the essential features of the price
system
– A price system (market system) allows prices to
respond to changes in supply and demand for different
commodities.
– Prices are communicated in markets that tend to
minimize transaction costs.

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
Summary Discussion of Learning
Objectives (2 of 6)
• 4.2 Evaluate the effects of changes in demand
and supply on the market price and equilibrium
quantity
– Increases in demand increase equilibrium price and
quantity; decreases in demand decrease equilibrium
price and quantity.
– Increases in supply decrease market price and
increase equilibrium quantity; decreases in supply
increase market price and decrease equilibrium
quantity.

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Summary Discussion of Learning
Objectives (3 of 6)
• 4.2 Evaluate the effects of changes in demand
and supply on the market price and equilibrium
quantity
– When both demand and supply shift at the same time,
the outcome is indeterminate for either equilibrium
price or equilibrium quantity.

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
Summary Discussion of Learning
Objectives (4 of 6)
• 4.3 Understand the rationing function of prices
– In a market system, prices ration scarce goods and
services.
– Other ways of rationing include first come, first served;
political power; physical force; random assignment; and
coupons.

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
Summary Discussion of Learning
Objectives (5 of 6)
• 4.4 Explain the effects of price ceilings
– A price ceiling set below the market clearing price
results in a shortage:
 The resulting shortage can lead to nonprice rationing devices
and black markets.

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Summary Discussion of Learning
Objectives (6 of 6)
• 4.5 Explain the effects of price floors and
government-imposed quantity restrictions
– If the price floor is set above the market clearing price,
a surplus results:
 A price floor can take the form of a government-imposed price
support or minimum wage.
– Bans on sale or ownership
– Licensing restrictions
– Import quotas

Copyright © 2018, 2016, 2014 Pearson Education, Inc. All Rights Reserved
Appendix B: Consumer Surplus, Producer
Surplus, and Gains from Trade within a Price
System (1 of 4)
• Consumer surplus
– The difference between the total amount that
consumers would have been willing to pay for an item
and the total amount that they actually pay

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Figure B-1 Consumer Surplus

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Appendix B: Consumer Surplus, Producer
Surplus, and Gains from Trade within a Price
System (2 of 4)
• Producer surplus
– The difference between the total amount that producers
actually receive for an item and the total amount that
they would have been willing to accept for supplying
that item

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Figure B-2 Producer Surplus

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Appendix B: Consumer Surplus, Producer
Surplus, and Gains from Trade within a Price
System (3 of 4)
• Gains from trade
– The sum of consumer surplus and producer surplus

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Figure B-3 Consumer Surplus, Producer Surplus,
and Gains from Trade

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Appendix B: Consumer Surplus, Producer
Surplus, and Gains from Trade within a Price
System (4 of 4)
• How do price controls affect gains from trade?
– Consumer surplus and producer surplus are both
lower.
– Either a price ceiling or a price floor reduces gains from
trade.

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Copyright

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