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Using Supply and Using Supply and DemandDemand

Chapter 5

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Laugher CurveLaugher Curve

Q. How many conservative economists does it take to screw in a light bulb?

A. None.

If the government would just leave it alone, it would screw itself in.

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Real-World Supply and Real-World Supply and Demand ApplicationsDemand Applications Supply and demand can be used to

evaluate real-world events.

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The Market for The Market for AdvertisingAdvertising Supply in this market is relatively constant. Demand fluctuates significantly.

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The Market for The Market for AdvertisingAdvertising In 2001, demand for advertising fell as the

U.S. economy slowed down. The supply/demand model would predict

that price and quantity to fall.

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The Market for The Market for AdvertisingAdvertising

Quantity of advertisements

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The Market for The Market for AdvertisingAdvertising Instead of lowering price, the media

offered higher quality advertising at the same price.

This is equivalent to a decline in price.

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The Price of a Foreign The Price of a Foreign CurrencyCurrency The market for foreign currencies is called

the foreign exchange (forex) market. The exchange rate – the price of one

currency in terms of another currency.

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The Price of a Foreign The Price of a Foreign CurrencyCurrency People demand currencies of other

countries to buy those countries’ goods and assets.

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The Price of a Foreign The Price of a Foreign CurrencyCurrency The determination of exchange rate is the

same as the determination of price. A currency is just another good.

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The Price of a Foreign The Price of a Foreign CurrencyCurrency The euro is the currency used by 12 of the

members of the European Union. The euro dropped from $1.17 to about

$0.90 in the two years from when it was introduced.

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The Price of a Foreign The Price of a Foreign CurrencyCurrency

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Three Real World Three Real World ExamplesExamples Supply and demand can shed light on a

variety of real-world events: Florida freeze. Burkhas in Afghanistan. Coffee beans.

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Florida FreezeFlorida 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 FreezeFlorida Freeze

Demand

S0

(b)

P1

Q1

P0

Q0

S1

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Burkhas in AfghanistanBurkhas in Afghanistan

Once the Taliban was ousted in Afghanistan, demand for burkhas fell as many women stopped wearing them.

At the original price, quantity supplied exceeded quantity demanded.

Price fell until the quantity demanded equaled the quantity supplied.

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Burkhas in AfghanistanBurkhas in Afghanistan

Supply

(f)

P1

Q0Q1

P0

D1

D0

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Coffee BeansCoffee Beans

The supply of coffee increased as new growers entered the market, growing techniques improved, and weather was favorable.

Coffee-growers attempted to increase demand by instituting a successful marketing campaign.

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Coffee BeansCoffee Beans

The supply increase causes price to fall. If the marketing campaign is successful,

demand will increase, raising price back to its former level.

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Coffee BeansCoffee Beans

(b)

S1

D0

P1

S0

D1

P0

Q1Q0

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A ReviewA Review

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Government Intervention Government Intervention in the Marketin the Market 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 CeilingsPrice Ceilings

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

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Rent ControlsRent 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 ControlsRent Controls

Rent control in Paris resulted in: A huge shortage of living quarters. New housing construction stopped. Existing housing was allowed to

deteriorate. Many families had to double up with

other family members.

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Rent ControlsRent Controls

QS QD

Supply

Demand

Ren

tal P

rice

(per

mon

th)

Quantity of apartments

2.50

$17.00 Shortage

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Price FloorsPrice Floors

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

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Minimum WageMinimum 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 WageMinimum Wage

The minimum wage creates winners and losers: Those who can find work earn a higher

wage. Others become unemployed. Production costs increase. Consumers pay higher prices.

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Minimum WageMinimum Wage

Economists disagree about the effects of the minimum wage.

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Excise TaxesExcise Taxes

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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Excise TaxesExcise Taxes

A luxury tax was imposed on expensive boats in 1990.

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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Excise TaxesExcise Taxes

The price of expensive boats rose by less than the tax, while the quantity supplied and quantity demanded fell.

65,000

510

S1

420

$70,000

D

S0

Quantity of luxury boats

0

Pric

e of

luxu

ry b

oats

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

The supply curve shifts up by the $10,000 tax

60,000

600

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

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Excise TaxesExcise Taxes

A tariff has the same effect on equilibrium price and quantity as an excise tax.

The difference is that foreign producers sending goods into the U.S. pay the tax.

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Quantity RestrictionsQuantity Restrictions

Governments often regulate markets with licenses which limit entry into a market.

Quantity restrictions tends to increase price.

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Quantity Restrictions in Quantity Restrictions in the Market for Taxi the Market for Taxi LicensesLicenses

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Third-Party-Payer Third-Party-Payer MarketsMarkets In third-party-payer markets, the person

who receives the good differs from the person paying for the good.

Equilibrium quantity and total spending is much higher in third-party-payer markets.

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Third-Party-Payer Third-Party-Payer MarketsMarkets

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Using Supply and Using Supply and DemandDemand

End of Chapter 5