Using Supply and Demand

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Using Supply and Demand

• Chapter 5

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Laugher Curve

• Q. How many conservative economists does it take
  to screw in a lightbulb?
• A. None.
• If the government would just leave it alone, it
  would screw itself in.

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The Power of Supply and Demand

• Changes in supply and demand will change
  equilibrium price and quantity.

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The Power of Supply and Demand

• A shift in demand that moves the demand curve to
  the right causes equilibrium price and quantity
  to rise.

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The Power of Supply and Demand

• A shift in supply that moves the supply curve to
  the left causes equilibrium price to rise and
  equilibrium quantity to fall.

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A Shift in Demand
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A Shift in Supply
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Six Real World Examples of Supply and Demand

• Supply and demand can shed light on a variety of
  real-world events
• Florida freeze.
• Financial assets and the baby boomers.
• Ten percent excise tax.
• Rice in Indonesia.
• Farm laborers.
• Christmas toys.

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Florida Freeze

• The crop-damaging freeze shifted the supply curve
  to the left.
• At the original price, quantity demanded exceeded
  quantity supplied.
• Price rose until the quantity demanded equaled
  the quantity supplied.

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Florida Freeze
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Financial Assets and the Baby Boomers

• Demographic changes among baby boomers moved the
  demand curve for financial assets to the right.
• At the original price, quantity demanded exceeded
  quantity supplied.
• Price rose until the quantity demanded equaled
  the quantity supplied.

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Financial Assets and the Baby Boomers
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Financial Assets and the Baby Boomers

• The same phenomenon occurred in the surging
  demand for housing among this group during the
  1980s.

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Excise Taxes

• Congress imposed a 10 percent surtax on luxury
  boats.

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Excise Taxes

• A 10 percent surtax on luxury boats levied on
  suppliers shifts the supply curve to the left.

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Excise Taxes
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Rice in Indonesia

• Drought, pestilence, and the financial crisis
  shifted the supply curve to the left.
• The steep demand curve means that the quantity
  demanded does not change much with changes in
  price.

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Rice in Indonesia

• Responding to high prices, the government
  imported rice and distributed it to the market,
  causing the supply curve to shift to the right.

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Rice in Indonesia
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Farm Laborers

• The compressed harvesting season increased the
  demand and increased INS patrols decreased
  supply.
• Demand shifted to the right and supply shifted to
  the left.

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Farm Laborers

• At the original price, the quantity of workers
  demanded exceeded the quantity supplied.

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Farm Laborers

• Price rises until the quantity demanded equaled
  the quantity supplied.

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Farm Laborers

• The effect on the number of laborers hired
  depended on the relative size of the supply shift.

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Farm Laborers
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Christmas Toys

• A Christmas craze for Furbies shifts demand to
  the right.
• A shortage ensued along with a black market.

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Christmas Toys

• Finally the supplier produced more, shifting the
  supply curve to the right, causing the price to
  drop.

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Christmas Toys
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A Review
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Government Interferences

• Buyers look to government for ways to hold prices
  down.
• Sellers look to government for ways to hold
  prices up.

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Price Ceilings

• A price ceiling is a government-imposed limit on
  how high a price can be charged.

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Rent Controls

• Rent control is a price ceiling on rents set by
  government.
• An example is rent control in Paris following
  World War I and World War II.

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Rent Controls

• The following were the consequences of rent
  control in Paris

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Rent Controls

• The following were the consequences of rent
  control in Paris

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Rent Controls
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Rent Controls

• A similar situation occurred in New York City.

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Price Floors

• A price floor is a government-imposed limit on
  how low a price can be charged.

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Minimum Wage

• The minimum wage is an example of a price floor.
• A minimum wage is set by government specifying
  the lowest wage a firm can legally pay an
  employee.

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Minimum Wage

• The minimum wage creates winners and losers

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Minimum Wage

• Economists disagree about the effects of the
  minimum wage.

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Taxes, Tariffs, and Quotas

• An excise tax is a tax that is levied on a
  specific good.
• A tariff is an excise tax on an imported good.
• Taxes and tariffs raise prices and reduce
  quantity.

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The Effect of an Excise Tax on Price and Quantity

• A 10 percent luxury tax on expensive boats was
  imposed in 1990.

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The Effect of an Excise Tax on Price and Quantity

• Because the luxury tax was imposed on the boat
  builders, the supply curve moved up by the amount
  of the tax.

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The Effect of an Excise Tax on Price and Quantity

• At a price equal to the original price plus the
  tax there was excess supply.

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The Effect of an Excise Tax on Price and Quantity
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The Effect of an Excise Tax on Price and Quantity

• The tax was repealed in 1993 because of tax
  revenue shortfalls.

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Quantity Restrictions Quotas

• A quota is a quantitative restriction on the
  amount that one nation can export to another.

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Quantity Restrictions Quotas

• The U.S. government restricted imports of
  Japanese cars.

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Quantity Restrictions Quotas
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The Relationship Between a Quota and a Tariff

• Tariffs and quotas can both be used to reduce
  quantity and raise prices.

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The Relationship Between a Quota and a Tariff

• There is a difference between imposing a tariff
  and imposing a quota.

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The Relationship Between a Quota and a Tariff

• As a consequence, once quotas are instituted,
  Japanese firms competed intensely to get them.

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The Relationship Between a Quota and a Tariff
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The Limitations Of Supply And Demand Analysis

• It is not enough to be able to explain what
  happens when supply or demand curves shift.
• It is necessary to understand the assumptions
  underlying the analysis.

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The Limitations Of Supply And Demand Analysis

• Other things don't remain constant.

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The Limitations Of Supply And Demand Analysis

• Deciding whether the effects are significant to
  consider requires a knowledge of the structure of
  the economy because all actions have ripple or
  feedback effects.

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The Limitations Of Supply And Demand Analysis

• The other-things-constant assumption is likely
  not to hold true when one the goods represent a
  large percentage of the entire economy.

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The Fallacy of Composition

• The fallacy of composition is the false
  assumption that what is true for a part will also
  be true for the whole.

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The Fallacy of Composition

• Thousands of small effects taken together add up
  to a large effect.

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The Fallacy of Composition

• When analyzing the aggregate, small effects that
  can be put aside in micro, can add up, and hence
  cannot be forgotten.

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The Fallacy of Composition

• Small effects comprise microeconomics while large
  effects comprise macroeconomics.

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The Roles of Government

• Provide a stable institutional framework.
• Promote effective and workable competition.
• Correct for externalities.
• Ensure economic stability and growth.
• Provide for public goods.
• Adjust for undesired market results.

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Provide a Stable Set of Institutions and Rules

• Only the government can create a stable
  environment and enforce contracts through its
  legal system.

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Provide a Stable Set of Institutions and Rules

• When governments do not provide a stable
  environment, as is now happening in Russia,
  economic growth is difficult - usually such
  economies are stagnant.

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Promote Effective and Workable Competition

• Government promotes competition and protect
  against monopolies.
• Monopoly power is the ability of individuals or
  firms currently in business to prevent other
  individuals or firms from entering the same kind
  of business

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Promote Effective and Workable Competition

• Monopoly power gives existing firms or
  individuals the power to raise prices.

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Promote Effective and Workable Competition

• Many players in the market insist on open
  competition except when it comes to themselves

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Correct for Externalities

• Unless they are required to do so, parties to any
  exchange are unlikely to take into account any
  externality.

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Correct for Externalities

• An externality is the effect that an action may
  have on a third party that the person who
  undertook that action did not take into account.

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Correct for Externalities

• The externality may be positive in which case
  society benefits even more than the two parties
  an example is education.

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Correct for Externalities

• The externality may be negative in which case
  society as a whole benefits less than the two
  parties an example is pollution.

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Correct for Externalities

• When there are externalities, government has the
  potential role to change the rules so that the
  parties must take into account the effect of
  their actions on others.

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Ensure Economic Stability and Growth

• Most Americans agree that government should
• Prevent large fluctuations in economic activity.
• Maintain a relatively constant price level.
• Provide an economic environment conducive to
  economic growth.

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Ensure Economic Stability and Growth

• Most economists support these goals since they
  involve macroeconomic externalities.

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Provide for Public Goods

• Public goods are those whose consumption by one
  individual does not prevent their consumption by
  other individuals an example is a public park.

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Provide for Public Goods

• In contrast, a private good is one that, when
  consumed by one individual, cannot be consumed by
  other individuals an example is an apple.

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Provide for Public Goods

• A free rider is a person who participates in
  something without having to pay for it.

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Provide for Public Goods

• Since most everyone would enjoy having public
  parks without having to pay for them, government
  requires that the public be taxed to pay for
  public parks, thereby eliminating free riders.

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Adjust for Undesired Market Results

• In an attempt to make the market fairer, the
  government, through taxes and expenditures,
  redistributes income among households.
• The result is controversy.

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Adjust for Undesired Market Results

• For example, in trying to be fair, which type of
  tax should the government use?

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Adjust for Undesired Market Results

• A progressive tax, such as the U.S. income tax is
  one whose rates increase as a person's income
  increases.

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Adjust for Undesired Market Results

• A regressive tax such as a sales tax is one whose
  effect decrease as income rises.

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Adjust for Undesired Market Results

• A proportional tax, such as the Social Security
  tax, is one whose rates are constant at all
  income levels, regardless of the taxpayer's total
  annual income.

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Adjust for Undesired Market Results

• Another controversial role for government
  involves deciding what is best for people
  independently of their desires.

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Adjust for Undesired Market Results

• Should government prohibit demerit goods and
  activities?

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Adjust for Undesired Market Results

• Demerit goods and activities are things
  government believes are bad for you, although you
  may like them.

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Adjust for Undesired Market Results

• Merit goods and activities are things the
  government believes are good for you, although
  you may not like them.

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Market Failures and Government Failures

• Market failures are the reason why government
  intervenes.

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Market Failures and Government Failures

• Market failures are situations where the market
  does not lead to a desired result.

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Market Failures and Government Failures

• Government intervention, however, may make
  matters worse.

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Market Failures and Government Failures

• Government failures are situations where the
  government intervenes and makes the situation
  worse government is always failing in one way
  or another.

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Market Failures and Government Failures

• Real-world policy makers are left with the choice
  of selecting that which is least bad -- market
  failure or government failure.

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Using Supply and Demand

• End of Chapter 5

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