978-0077660772 Chapter 3 Lecture Note Part 2

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Chapter 03 – Demand, Supply, and Market Equilibrium

I. Changes in Supply and Demand, and Equilibrium

A. Changing demand with supply held constant:

1. Increase in demand will have effect of increasing equilibrium price and quantity

(Figure 3.7a).

2. Decrease in demand will have effect of decreasing equilibrium price and quantity

(Figure 3.7b).

B. Changing supply with demand held constant:

1. Increase in supply will have effect of decreasing equilibrium price and increasing

quantity (Fig 3.7c).

2. Decrease in supply will have effect of increasing equilibrium price and decreasing

quantity (Fig 3.7d).

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Chapter 03 – Demand, Supply, and Market Equilibrium

C. Complex cases—when both supply and demand shift (see Table 3.3):

1. If supply increases and demand decreases, price declines, but new equilibrium quantity

depends on relative sizes of shifts in demand and supply.

2. If supply decreases and demand increases, price rises, but new equilibrium quantity

depends again on relative sizes of shifts in demand and supply.

3. If supply and demand change in the same direction (both increase or both decrease), the

change in equilibrium quantity will be in the direction of the shift but the change in

equilibrium price now depends on the relative shifts in demand and supply.

D. Consider This … Salsa and Coffee Beans

1. Demand is an inverse relationship between price and quantity demanded, other things

equal (unchanged). Supply is a direct relationship showing the relationship between

price and quantity supplied, other things equal (unchanged). It can appear that these rules

have been violated over time, when tracking the price and the quantity sold of a product

such as salsa or coffee.

2. Many factors other than price determine the outcome.

3. If neither the buyers nor the sellers have changed, the equilibrium price will remain the

same.

4. The most important distinction to make is to determine if a change has occurred because

of something that has affected the buyers or something that is influencing the sellers.

5. A change in any of the determinants of demand will shift the demand curve and cause a

change in quantity supplied. (See Figure 3.7 a & b)

6. A change in any of the determinants of supply will shift the supply curve and cause a

change in the quantity demanded. (See Figure 3.7 c & d)

7. Confusion results if “other things” (determinants) change and one does not take this into

account. For example, sometimes more is demanded at higher prices because incomes

rise, but if that fact is ignored, the law of demand seems to be violated. If income

changes, however, there is a shift or increase in demand that could cause more to be

purchased at a higher price. In this example, “other things” did not remain constant.

VII. Application: Government-Set Prices (Ceilings and Floors)

A. Government-set prices prevent the market from reaching the equilibrium price and quantity.

B. Price ceilings (gasoline).

1. The maximum legal price a seller may charge, typically placed below equilibrium.

2. Shortages result as quantity demanded exceeds quantity supplied (Figure 3.8).

3. Alternative methods of rationing must emerge to take the places of the price mechanism.

These may be formal (rationing coupons) or informal (lines at the pump).

4. Black markets may emerge to satisfy the unmet consumer demand.

5. Another example: Rent controls in large cities – intended to keep housing affordable but

resulting in housing shortages.

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Chapter 03 – Demand, Supply, and Market Equilibrium

C. Price floors (wheat)

1. The minimum legal price a seller may charge, typically placed above equilibrium.

2. Surpluses result as quantity supplied exceeds quantity demanded (Figure 3.9).

3. Resources are overallocated to the production of wheat and consumers pay higher than

efficient prices for wheat-based goods.

4. Another example: Minimum wage

Note: The federal minimum wage, for example, will be below equilibrium in some

labor markets (large cities). In that case the price floor has no effect.

VIII. LAST WORD: A Market for Human Organs?

A. Organ transplants have become increasingly common, but not everyone who needs a

transplant can get one. In 2010, there were 105,000 Americans on the waiting list. It is

estimated that there are 6,900 deaths per year in the U.S. because not enough organs are

available.

B. Why shortages?

1. No market exists for human organs.

2. The demand curve for human organs would resemble others in that a greater quantity

would be demanded at low prices than at higher prices.

3. Donated organs that are rationed by a waiting list have a zero price. The existing supply

is perfectly inelastic and is the fixed quantity offered by willing donors.

4. There is a shortage of human organs because at a zero price the quantity demanded

exceeds the quantity supplied.

C. Using a market.

1. A market for human organs would increase the incentive to donate organs. The higher

the expected price of an organ, the greater would be the number of people willing to have

their organs sold at death.

2. The shortage of organs would be eliminated, and the number of organs available for

transplanting would rise.

D. Objections.

1. The first is a moral objection that turning human organs into commodities

commercializes human beings and diminishes the special nature of human life.

2. An analytical critique based on the elasticity of supply, suggests that the likely increase in

the actual number of usable organs for transplants would not be great.

3. A health-cost concern suggests that a market for body organs would greatly increase the

cost of health care.

E. Prohibitions on a human organ market have given rise to a worldwide, $1 billion-per-year

illegal market. There is concern that those willing to participate in an illegal market such as

this may also be willing to take extreme measures to solicit organs from unwilling donors.

F. Supporters of legalizing the market for organs argue that it would increase the supply of legal

organs, drive down the price of organs, and reduce the harvesting of organs from unwilling

sellers (the lower price would make it less profitable).

QUIZ

1. The law of demand is illustrated by a demand curve that is:

A. Vertical

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Chapter 03 – Demand, Supply, and Market Equilibrium

B. Horizontal

C. Upward sloping

D. Downward sloping

2. Which would cause a decrease in the quantity of computers supplied?

A. An increase in the demand for computers

B. A decrease in the demand for computers

C. An increase in the incomes of consumers

D. A decrease in the price of parts for making computers

3. When the price of oil declines significantly, the price of gasoline also declines. The latter occurs

because of a(n):

A. increase in the demand for gasoline.

B. decrease in the demand for gasoline.

C. increase in the supply of gasoline.

D. decrease in the supply of gasoline.

4. A schedule which shows the various amounts of a product producers are willing and able to

produce at each price in a series of possible prices during a specified period of time is called:

A. Quantity supplied

B. Quantity demanded

C. Supply

D. Demand

5. If the quantity supplied of a product is less than the quantity demanded, then:

A. There is a shortage of the product

B. There is a surplus of the product

C. The product is a normal good

D. The product is an inferior good

6. If the market price is above the equilibrium price:

A. A shortage will occur and producers will produce more and lower prices

B. A surplus will occur and producers will produce less and lower prices

C. A surplus will result and consumers will bid prices up

D. Producers will make extremely high profits

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Chapter 03 – Demand, Supply, and Market Equilibrium

7. A competitive market will:

A. achieve an equilibrium price.

B. produce shortages.

C. produce surpluses.

D. create disorder.

8. A product market is in equilibrium:

A. when there is no surplus of the product.

B. when there is no shortage of the product.

C. when consumers want to buy more of the product than producers offer for sale.

D. where the demand and supply curves intersect.

9. A headline reads “Storms destroy half of the lettuce crop.” This situation would lead to a(n):

A. Increase in the price of lettuce and quantity purchased

B. Decrease in the price of lettuce and quantity purchased

C. Increase in the price of lettuce and decrease in quantity purchased

D. Decrease in the price of lettuce and increase in quantity purchased

10. Government-set price floors and price ceilings:

A. Do not affect the rationing function of price in a free market

B. Interfere with the rationing function of price in a free market

C. Result in surpluses of products in markets where they are used

D. Result in shortages of products in markets where they are used

APPENDIX TO CHAPTER 3: ADDITIONAL EXAMPLES OF SUPPLY AND DEMAND

I. Changes in Supply and Demand

A. Lettuce (Figure 1)

1. Weather events affect agricultural markets, usually on the supply side.

2. Extreme weather that destroys crops will reduce the supply, raising equilibrium price and

lowering equilibrium quantity.

B. Exchange Rates (Figure 2)

1. One of the largest foreign exchange markets is the euro-dollar market.

2. The price of a euro is expressed in dollars and is determined by demand and supply of

euros.

3. U.S. firms require euros to buy goods from European countries and this is reflected by

the demand for euros.

4. When European countries buy goods from the U.S. they must convert euros to dollars

thereby creating the supply of euros.

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5. Increased popularity of European goods in the U.S. increases the demand for euros,

causing equilibrium price to increase and the dollar depreciates while the euro

appreciates.

C. Pink Salmon (Figure 3)

1. This is an example of simultaneous changes in both supply and demand.

2. An increase in supply occurs because of more efficient fishing boats, the development of

fish farms, and new entrants to the industry.

3. There is a decrease in demand because of changes in consumer preference, and an

increase in income shows pink salmon to be an inferior good.

4. Both changes put downward pressure on the price of pink salmon. Because we know that

the increase in supply of pink salmon exceeded the decrease in demand, we can also

determine that the quantity purchased increased.

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D. Gasoline (Figure 4)

1. U.S. gas prices have rapidly increased over the past few years.

2. Middle East politics and military conflicts (both real and anticipated) have disrupted

supply, tending to drive gas prices up.

3. Increased popularity of SUVs and other low-gas-mileage vehicles has increased the

demand for gas, also tending to drive the price up.

4. While theoretically the affect on quantity is indeterminate, in reality the quantity

purchased has increased, suggesting that the increase in demand exceeded the decrease in

supply.

E. Sushi (Figure 5)

1. Despite fast-growing popularity of sushi bars in the United States, prices have remained

relatively constant.

2. The increase in demand can be attributed to an increased taste for sushi.

3. The opening of sushi bars in response to expected and realized demand has increased the

supply of sushi, helping to keep the price stable.

II. Upsloping versus Vertical Supply Curves

A. The supply schedule for a typical good or service will slope upward because a higher market

price will cause producers to increase the quantity supplied. There are, however, some goods

and services whose quantities supplied are fixed and unresponsive to a change in price.

B. Reactions to Demand Shifts:

1. Upsloping Supply Curves: When a market’s supply curve slopes upward, any shift in

demand will cause both the equilibrium price and equilibrium quantity to adjust. This was

the case discussed in the chapter (See figure 2 for reference).

2. Vertical Supply Curves: When a market has a vertical supply curve, any shift in demand

will cause only the equilibrium price to change. The equilibrium quantity will not change

because it is fixed and cannot adjust.

3. The Market for land in San Francisco (Figure 6): Because the quantity of land is fixed the

supply curve is vertical. If demand increases from D1 to D2 only the price will change. We

see the price rising from P1 to P2.

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Chapter 03 – Demand, Supply, and Market Equilibrium

III. Preset Prices

A. Preset prices are similar to price floors and ceilings in that they tend to result in shortages or

surpluses. They differ from floors and ceilings in that they are set by sellers, not by

government policy.

B. Olympic Figure Skating Finals (Figure 7)

1. Prices for sporting events are commonly preset.

2. Despite the high preset prices for events such as the figure skating finals, shortages often

result as people are willing to buy more tickets at that price than are available.

3. Shortages tend to result in legal or illegal secondary markets (e.g., ticket scalping).

C. Olympic Curling Preliminaries (Figure 8)

1. Less popular sporting events (for which prices are still preset) tend to result in surpluses

(empty seats at the arena).

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