1.Course Name: Managerial Economics

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Lesson 1 Discussion Forum

Discussion assignments will be graded based upon the criteria and rubric specified in the Syllabus.

For this Discussion Question, complete the following.

1. Read the attached opinion piece where the author indicates that the Great Recession of 2009 was not caused by the Free Market but was instead caused by US Government policies.

2. Locate two JOURNAL articles which discuss this topic further. You need to focus on the Abstract, Introduction, Results, and Conclusion. For our purposes, you are not expected to fully understand the Data and Methodology.

3. Summarize these journal articles. Please use your own words. No copy-and-paste. Cite your sources.

4. During the second week of the Module, you will need to reply to the posts of two of your peers. Your replies must focus on increasing knowledge of the class and must advance the discussion further. Simply affirming your peers does not count as a substantive reply.

5.Please post (in APA format) your article citation.

6. Please provide 2 references under the discussion

7. Please post replies to 2 of my class mates their discussions are provided below. Follow my classmates pattern if instructions are not clear.ssss

Supplemental Resources:

Material Chapter 1and 2:

https://ari.aynrand.org/free-markets-didnt-create-the-great-recession/

Classmate post 1:

Abstract

In mid-2007, the global crisis converted to economic downfall in the US and the rest of the world which has seen the crisis for more than six decades. In-depth we will be reviewing the causes, outcomes, consequences.

Introduction

Great Recession means the sharp fall in the economy in the late 2000s. This was considered the greatest Depression during that time. At this time the US and whole world accounted for the Recession which lasted for almost 15 months(December 2007 to June 2009). During this time there was a recession not only in the US but globally. During the time 1930s the GDP(Gross Domestic Product) declined by more than 10% at that time the declined percentage was the worst percentage declined in the US history when compared to 1930s the fall was not that bad it was in the percentage of 0.3% in 2008 and 2.8% in 2009. However it true that it was unquestionably the worst economic drop fall in an event of time.

Causes

The immediate cause for the recession was the failure of the major investment back called “Bear Stearns” in March 2008 and later “Lehman Brothers” in September 2008. Many of the investment banks like this invested in the high-risk security and lost so much of their value when the US and European real-estate downfall started between 2007 to 2009. The reason the real estate went down was the US and European countries were charging low-interest rates, sudden growth in saving from the available nations due to trade issues.

Conclusion

After the great recession, the rise of the US was hard but they had come back by giving loans like auto loans personal loans, business loans. Most recently Donald trump rolled back many of the regulatory provisos to help the USA raise more than before.

Reference:

Bromwich, M., & Scapens, R. W. (2016). Management accounting research: 25 years on. Management Accounting Research, 31, 1-9.

Suran Un & Na Kyung Song. (2017). Great depression from elderly workers in unemployment, periodic unemployment, and physical hardship. Social Work Research, 41 (4), 249-260.

Classmate post2:

Abstract

Many Factors are directly or indirectly are the reasons why the Great Recession started in 2008 In the US and in the whole world. The main things we are goon discuss are about when the great recession started and how was USA government policies for the main reason for the Recession.

Introduction

The Immediate Crisis started in the mids of 2007 and it went till September 2009. The great recession was caused in the 1930s before in the past. During 2007 there were unprecedented fiscal, monetary and regulatory policies’ which were the scam of the federal government. They say that the federal government should not interfere in the private sector or the bank sector. In mid-2007 there was a drastic fall in the GDP of 2.8% which was taken as the worth economic fall off in history.

Causes

According to the report that was generated by the Financial Crisis Inquiry Commission the recession was not stoppable. There was a Communities appointed with 6 democrats and 4 republic people several key factors came into light why the recession has occurred. The first report generated was about the financial sector due to which the recession occurred. The failure was that the feds couldn’t control the outbreak of the curb toxic mortgage loans. And there were too many investment banks at high risk which affected the outcome of the business and the customers. There were so many factors that lead to the economic downfall but most of them were unclear why this happened and then all of sudden it happened. Millions of people were jobless. There is a survey saying that so many people went homeless because of the recession.

Conclusion

Following so many different policies and strategies that let to lift the economy in us. The companies started restructuring they flow of the business and the people by avoiding the high-risk cases like these task Regulations were in place to monitor the conditions and the financial structure the changes made in order to maintain profits.

References

Herkenhoff, K. F., & Ohanian, L. E. (2011). Labor market dysfunction during the great recession (No. w17313). National Bureau of Economic Research.

Kuttner, K. N. (2018). Outside the Box: Unconventional Monetary Policy in the Great Recession and Beyond. Journal of Economic Perspectives, 32(4), 121–146.

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1.pptx

Managerial Economics and Strategy

Third Edition

Chapter 1

Introduction

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Scarcity at the Bottom of Managerial Problems

Economics

Economics is the study of decision-making in the presence of scarcity.

Managerial Economics

Managerial economics is the application of economic analysis to managerial decision making.

Managers

Managers make economic decisions by allocating the scarce resources at their disposal.

They must understand the behavior of consumers, workers, other managers, and governments to make good decisions.

Learning Objectives

1.1 Managerial Decision Making

Describe the major business decisions managers face

1.2 Economic Models

Explain how economic models are useful in managerial decision making

1.3 Using Economics Skills in your Career

Illustrate how a knowledge of economics can help your career

1.1 Managerial Decision Making (1 of 5)

There are many decisions made by managers.

A production manager’s objective is normally to achieve a production target at the lowest possible cost. Of course, the manager has to use the existing factory.

Human resource managers design compensation systems to encourage employees to work hard. Of course, the manager has limited resources and employees are already in the firm.

A marketing manager must allocate an advertising budget to promote the product most effectively. Of course, the manager has a limited marketing budget.

The firm’s top manager must coordinate and direct all these activities.

Could you think on this manager’s constraints?

1.1 Managerial Decision Making (2 of 5)

Profit = Revenue − Costs

The job of the chief executive officer (C E O) is to focus on the bottom line: maximizing profit.

The C E O is also concerned with how a firm is positioned in a market relative to its rivals.

However, it is critical the C E O focuses on maximizing the firm’s profit rather than beating a rival.

Maximizing profit requires coordination.

The C E O orders the production manager to minimize the cost of producing the particular good or service.

The C E O asks the market research manager to determine how many units can be sold at any given price, and so forth.

It would be a major coordination failure if the marketing department sets up a system of pricing and advertising based on selling 8,000 units a year, while the production department managed to produce only 2,000.

1.1 Managerial Decision Making (3 of 5)

Trade-Offs

In an environment of scarcity, managers must focus on the trade-offs that directly or indirectly affect profits.

Evaluating trade-offs often involves marginal reasoning: considering the effect of a small change.

How to Produce

To produce a given level of output, a firm must use more of one input if it uses less of another input. Example: Metal and plastic substitute each other in the production of cars. Small increments and reductions of them affect the car’s weight, safety, and cost.

What Prices to Charge

Consumers buy fewer units of a product when its price rises given their limited budgets. Example: When a manager can set the price of a product, the manager must consider whether raising the price offsets the loss from selling fewer units.

Whether to Innovate

There are short-run and long-run profits. Example: Investment in innovation lowers short-run profit, but may raise the long-run profit.

1.1 Managerial Decision Making (4 of 5)

Other Decision Makers

Consumers purchase products subject to their limited budgets.

Workers decide on which jobs to take and how much to work given their scarce time and limits on their abilities.

Rivals may introduce new, superior products or cut the prices of existing products.

Governments around the world may tax, subsidize, or regulate products.

Rational Maximizers and Behavioral Economics

To understand how others make economic decisions, most economic analysis assumes those “others” are maximizers: they do the best they can with their limited resources.

However, in some contexts, behavioral economics explains those “others” cannot successfully maximize for a variety of psychological reasons.

1.1 Managerial Decision Making (5 of 5)

Other Decision Makers

Most interaction and economic decisions are done in markets.

A market is an exchange mechanism that allows buyers to trade with sellers.

The primary participants in a market are firms who supply the product and consumers who buy it.

But, government policies such as taxes also play an important role in the operation of markets.

Strategy

A strategy is a battle plan that specifies the actions or moves that the manager will make to maximize the firm’s profit when interacting with a small number of rival firms.

One tool that is helpful in understanding and developing such strategies is game theory, which we use in several chapters.

1.2 Economic Models (1 of 7)

A model is a description of the relationship between two or more variables.

Meteorologists use models to predict weather conditions.

Medical researchers use models to describe and predict the effect of medications on diseases.

Astronomers use models to describe and predict the movement of comets and meteors.

Economists use economic models to explain how managers and other decision makers make decisions and to explain the resulting market outcomes.

Managers use models to consider hypothetical situations—to use a what-if analysis—such as “What would happen if we raised our prices by 10%?” or “Would profit rise if we phased out one of our product lines?”

Models help managers predict answers to what-if questions and to use those answers to make good decisions.

1.2 Economic Models (2 of 7)

Simplifying Assumptions

The real economic world is too complex to analyze fully. To understand it and be able to make valid predictions, economic models include only the essential issues, leaving aside complications that might disguise those essential elements.

Economic models can be presented in words, using graphs or mathematics. Regardless of how the model is described, an economic model is a simplification of reality that contains only its most important features.

Part of the skill in using economic models lies in selecting a model that is appropriate for the task at hand.

Mini-Case: Income Threshold Model

To explain car purchasing behavior in China, we assume in this model that only income has an important effect on the decision to buy cars. Other factors are ignored, such as the color of cars.

If this assumption is correct, we make our analysis of the auto market simpler without losing important details. If the ignored issues are important, our predictions may be inaccurate.

1.2 Economic Models (3 of 7)

Testing Theories

Blore’s Razor: When given a choice between two theories, take the one that is funnier.

1.2 Economic Models (4 of 7)

Testing Theories

Economists test theories by checking whether the theory’s predictions are correct.

One model might argue that prices will go up next quarter. Another, using a different theory, may contend that prices will fall. Which one is correct?

Use empirical evidence (real facts) to find out which prediction is correct.

A good model makes clear predictions that are consistent with reality. A good model is one that is a close enough approximation to be useful.

It is not helpful to have simple models that make incorrect predictions or complex models that make untestable predictions. The skill is to have a model simple enough to make clear predictions but realistic enough to be accurate.

“If the price of a product rises, the quantity of the product demanded falls” provides a clear prediction.

“Human behavior depends on tastes, and tastes change randomly at random intervals” is not very useful.

1.2 Economic Models (5 of 7)

Positive and Normative Statements

A positive statement concerns what is or what will happen and describes reality.

A testable hypothesis about matters of fact such as cause-and-effect relationships

“If we double the amount of sugar in this soft drink, we will significantly increase sales to children.”

Positive does not mean that we are certain about the truth of our statement; it indicates only that we can test the truth of the statement.

A normative statement concerns what somebody believes should happen and prescribes a course of action.

A belief about whether something is good or bad

“The government should tax soft drinks so that people will not consume so much sugar.”

A normative statement cannot be tested because a value judgment cannot be refuted by evidence.

Good economists and good managers emphasize positive analysis.

1.2 Economic Models (6 of 7)

Positive and Normative Statements

1.2 Economic Models (7 of 7)

New Theories

Why does economics continually evolve?

Because economists always try to improve their understanding of the world around them.

For instance, traditional theory assumes decision makers always maximize. But, the new theory of behavioral economics studies how psychological biases and cognitive limits can prevent managers and others from optimizing.

Because economists have to develop new ways to think about disruptive innovations.

For instance, the internet is a disruptive innovation that has transformed retailing, media, and payment methods allowing two groups of users to interact in these new online markets. The two-sided markets theory has been important to the evolution and governmental policies toward these markets.

1.3 Using Economics Skills in Your Career

This book will help you to develop skills in economic analysis that are crucial in business decision making.

Assessing financial investment options at financial institutions.

Setting prices or planning other actions based on formal analysis, such as spreadsheet-based economic modeling.

Using economic skills in a variety of jobs because economic decisions come up everywhere in business.

All readers will benefit from familiarity with the application of economics presented in this book.

Economic skills help to predict the likely outcomes from government actions and other events.

Economic skills are also relevant for the analysis of personal decisions, such as investment or educational choices.

This work is protected by United States copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials.

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2.pptx

Managerial Economics and Strategy

Third Edition

Chapter 2

Supply and Demand

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Managerial Problem

Carbon Taxes

What will be the effect of imposing a carbon tax on the price of gasoline

Solution Approach

Managers use the supply-and-demand model to answer this type of questions.

Model

The supply-and-demand model provides a good description of many markets and applies particularly well to markets in which there are many buyers and many sellers.

In markets where this model is applicable, it allows us to make clear, testable predictions about the effects of new taxes or other shocks on prices and other market outcomes.

Learning Objectives (1 of 2)

2.1 Demand

Explain how the quantity of a good or service that consumers want depends on its price and other factors

2.2 Supply

Describe how the quantity of a good or service that firms want to sell depends on its price and other factors

2.3 Market Equilibrium

Show how the interaction between consumers’ demand and producers’ supply determines the market price and quantity

Learning Objectives (2 of 2)

2.4 Shocks to the Equilibrium

Predict how an event that affects consumers or firms changes the market price and quantity

2.5 Effects of Government Interventions

Analyze the market effects of government policy using the supply-and-demand model

2.6 When to Use the Supply-and-Demand Model

Discuss when to use the supply-and-demand model

2.1 Demand (1 of 7)

Consumers decide whether to buy a particular good or service.

If they decide to buy, how much is based on its own price and on other factors.

Own Price

Economists focus most on how a good’s own price affects the quantity demanded.

To determine how a change in price affects the quantity demanded, economists ask what happens to quantity when price changes and other factors are held constant.

Other Factors

The list of other factors usually includes income, price of related goods, tastes, information, government regulation.

Go to next slide for more detail about these other factors of demand

2.1 Demand (2 of 7)

Other factors of demand include the following:

Income

When a consumer’s income rises that consumer will often buy more of many goods.

Price of related goods

Substitute: Different brands of essentially the same good are close substitutes.

Complement: is a good that is used with the good under consideration.

Information

Information about characteristics and the effects of a good has an impact on consumer decisions

Tastes

Consumers do not purchase goods they dislike. Firms devote significant resources to trying to change consumer tastes through advertising.

Government Regulations

Governments may ban, restrict, tax, or subsidize goods or services

2.1 Demand (3 of 7)

The Demand Curve

A demand curve shows the quantity demanded at each possible price, holding constant the other factors that influence purchases.

The quantity demanded is the amount of a good that consumers are willing to buy at a given price, holding constant the other factors that influence purchases.

Graphical Presentation

In Figure 2.1, the demand curve hits the vertical axis at $12, indicating that no quantity is demanded when the price is $12 per l b or higher.

The demand curve hits the horizontal quantity axis at 12 million l b s, the quantity of avocados that consumers would want if the price were zero.

The quantity demanded at a price of $2 per l b is 10 million l b s per year.

Figure 2.1 A Demand Curve

2.1 Demand (4 of 7)

Effects of a Price Change on the Quantity Demanded

The Law of Demand states that consumers demand more of a good if its price is lower or less when its price is higher.

The law of demand assumes income, the prices of other goods, tastes, and other factors that influence the amount they want to consume are constant.

The law of demand is an empirical claim—a claim about what actually happens.

According to the law of demand, demand curves slope downward, as in Figure 2.1.

The demand curve is a concise summary of the answer to the question: What happens to the quantity demanded as the price changes, when all other factors are held constant?

Changes in the quantity demanded in response to changes in price are movements along the demand curve.

2.1 Demand (5 of 7)

Effects of Other Factors on Demand

A change in any relevant factor other than the price of the good causes a shift of the demand curve rather than a movement along the demand curve.

Example and Figure 2.2:

If average family income goes up from $35,000 to $50,000, the

global demand for coffee shifts to the right from

The price remains at $2 per pound, but the quantity demanded increases from 10 to 11.5 million pounds per year.

Verify the same shift of demand would occur if the price of a substitute of coffee, say tea, goes up.

Figure 2.2 A Shift of the Demand Curve

2.1 Demand (6 of 7)

The Demand Function:

Q of coffee demanded is a function of its price p, price of sugar p s and income Y. Other factors are constant.

Estimated Demand Function: Q = 8.56 − p − 0.3p s + 0.1Y

This specific linear form reflects empirical evidence; p and p s are negative and Y is positive. The constant term, 8.56, represents all other factors.

Demand Curve: Q = 12 − p

Straight-line demand curve

in Figure 2.1 with p s = 0.20, Y = 35. Notice that

Δ Q =−Δ p. So, if Δ p = −$2, then

million tons per year.

The Law of Demand and Calculus

The Law of Demand states that the derivative of the demand function with respect

to price is negative,

The demand function for coffee: Q = 12 − p. So, the derivative of the demand with

respect to price:

2.1 Demand (7 of 7)

Summing Demand Curves

The overall demand for coffee is composed of the demand of many individual consumers.

The total quantity demanded at a given price is the sum of the quantity each consumer demands at that price.

We can generalize this approach to look at the total demand for more than two consumers, or we can apply it to groups of consumers rather than just to individuals.

2.2 Supply (1 of 7)

Firms determine how much of a good to supply on the basis of the price of that good and on other factors, including the costs of producing the good.

Own Price

Usually, we expect firms to supply more quantity at a higher price.

Other Factors

These other factors usually include costs of production, technological change, government regulations, and other factors.

Go to next slide for more detail about these other supply factors.

2.2 Supply (2 of 7)

Costs of Production

The costs of labor, machinery, fuel, and other costs affect how much of a product firms want to sell.

As a firm’s cost falls, it is usually willing to supply more, holding price and other factors constant. Conversely, a cost increase will often reduce a firm’s willingness to produce.

Technological Change

If a technological advance allows a firm to produce its good at lower cost, the firm supplies more of that good at any given price, holding other factors constant.

Government Regulations

Government rules and regulations can affect supply directly without working through costs.

For example, in some parts of the world, retailers may not sell most goods and services on particular days of religious significance.

2.2 Supply (3 of 7)

The Supply Curve

A supply curve shows the quantity supplied at each possible price, holding constant the other factors that influence firms’ supply decisions.

The quantity supplied is the amount of a good that firms want to sell at a given price, holding constant other factors that influence firms’ supply decisions, such as costs and government actions.

Graphical Presentation

In Figure 2.3, the price on the vertical axis is measured in dollars per physical unit (dollars per l b), and the quantity on the horizontal axis is measured in physical units per time period (millions of tons per year).

The quantity supplied at a price of $2 per l b is 10 million tons per year and 11 million tons per year when the price is $4.

Figure 2.3 A Supply Curve

2.2 Supply (4 of 7)

Effects of Price on Supply

The supply curve is usually upward sloping. There is no “Law of Supply” stating that the supply curve slopes upward.

We observe supply curves that are vertical, horizontal, or downward sloping in particular situations. However, supply curves are commonly upward sloping.

Along an upward-sloping supply curve, a higher price leads to more output being offered for sale, holding other factors constant.

Changes in Quantity Supplied

An increase in the price of avocados causes a movement along the supply curve, resulting in more coffee being supplied.

As the price increases, firms supply more.

In Figure 2.3, if the price rises from $2 per l b to $4 per l b, the quantity supplied rises from 10 to 11 million tons per year.

2.2 Supply (5 of 7)

Effects of Other Variables on Supply

A change in a relevant variable other than the good’s own price causes the entire supply curve to shift rather than a movement along the supply curve.

Example and Figure 2.4:

When the price of cocoa rises from $3 per l b to $6 per l b, many coffee farmers switch to producing cocoa. As a consequence, the supply curve

for coffee shifts leftward, from

(Figure 2.4).

That is, firms want to supply less coffee at any given price than before the cocoa price increase. At a price of $2 per l b for coffee, the quantity

supplied falls from 10 million l b s on

to 9.4 million tons on

(after the cocoa price increase).

Figure 2.4 A Shift of a Supply Curve

2.2 Supply (6 of 7)

The Supply Function:

Q of coffee demanded is a function of its price p and the price of cocoa p c. Other factors are constant.

Estimated Supply Function: Q = 9.6 + 0.5p − 0.2p c

This specific linear form reflects empirical evidence; p is positive and p c is negative. The constant term, 9.6, represents all other factors.

Supply Curve: Q = 9 + 0.5p

Straight-line supply curve

in Figure 2.3 with p c = $3. Notice that

Δ S = 0.5Δ p. So, if Δ p = $1, then Δ S = 0.5 million tons per year.

Thus, a $1 increase in price causes the quantity supplied to increase by 0.5 million tons per year.

This change in q induced by a change in p is a movement along the supply curve.

2.2 Supply (7 of 7)

Summing Supply Curves

The total supply curve shows the total quantity produced by all suppliers at each possible price.

In the coffee case, for example, the overall market quantity supplied at any given price is the sum of the quantity supplied by Brazilian, Vietnamese, Colombian, and other producers in various countries.

2.3 Market Equilibrium (1 of 4)

The D curve shows the q consumers want to buy at various p

The S curve shows the q firms want to sell at various p

The S and D curves jointly determine the p and q at which a good or service is bought and sold.

The market is in equilibrium when all market participants are able to buy or sell as much as they want (no participant wants to change its behavior).

The p at which consumers can buy as much as they want and sellers can sell as much as they want is an equilibrium price.

The resulting q is the equilibrium quantity because the quantity demanded equals the quantity supplied.

2.3 Market Equilibrium (2 of 4)

Using a Graph to Determine the Equilibrium

In a graph, the market equilibrium is the point at which the demand and supply curves cross each other. This point gives the q and p of equilibrium.

Graphical Presentation

Figure 2.5 shows the supply curve, S, and demand curve, D, for coffee.

The D and S curves intersect at point e, the market equilibrium.

The equilibrium price is $2 per l b, and the equilibrium quantity is 10 million tons per year, which is the quantity firms want to sell and the quantity consumers want to buy.

Figure 2.5 Market Equilibrium

2.3 Market Equilibrium (3 of 4)

Using Math to Determine the Equilibrium

D and S Curves: Q d = 12 − p and Q s = 9 + 0.5p

We want to find the p at which Q d = Q s = Q, the equilibrium quantity. In equilibrium, it must be that Q s = Q d.

In Equilibrium Q d = Q s: 12 − p = 9 + 0.5p

We use algebra to find the equilibrium price: 3 = 1.5p, so p = $2. We can determine the equilibrium q by substituting this p into either Q d or Q s.

Using the D Curve: Q = 12 − 2 = 10

We find that the equilibrium quantity is 10 million tons per year. We can obtain the same result if we use the S curve.

2.3 Market Equilibrium (4 of 4)

Forces That Drive the Market to Equilibrium

Excess Demand

Figure 2.5 shows the supply curve, S, and demand curve, D, for coffee.

If the price of coffee were $1, firms are willing to supply 9.5 million tons per year but consumers demand 11 million tons. The market is in disequilibrium, and there is excess demand…but not for long.

Frustrated consumers may offer to pay suppliers more than $1 per l b and some suppliers might raise their prices. Such actions cause the market price to rise until it reaches the equilibrium price, $2 (excess D eliminated).

Excess Supply

If instead the price were $3, firms are willing to supply 10.5 million tons per year but consumers demand 9 million tons. The market is in disequilibrium again, and there is excess supply…but not for long.

To avoid unsold coffee to stale, firms lower the price to attract additional customers. The price falls until it reaches the equilibrium level, $2 (excess S eliminated and no more pressure to lower the price further).

2.4 Shocks to the Equilibrium (1 of 5)

The D curve shows the q consumers want to buy at various p

The S curve shows the q firms want to sell at various p

The equilibrium changes only if a shock occurs that shifts the D curve or the S curve.

These curves shift if one of the variables we were holding constant changes.

If tastes, income, government policies, or costs of production change, the D curve or the S curve or both may shift, and the equilibrium changes.

2.4 Shocks to the Equilibrium (2 of 5)

Effects of a Shift in the Demand Curve

Suppose that the average annual income in developed countries increases by $15,000 from $35,000 to $50,000, so consumers can buy more coffee at any given price. As a result, the demand curve for

coffee shifts to the right from

in Figure 2.6, panel (a).

At the original equilibrium, e1, price is $2, and there is excess demand of 1.5 million lbs per month. Market pressures drive the price up until it reaches $3 at the new equilibrium, e2.

Here the increase in income causes a shift of the demand curve, which in turn causes a movement along the supply curve from e1 to e2.

Figure 2.6 Equilibrium Effects of a Shift of a Demand or Supply Curve

2.4 Shocks to the Equilibrium (3 of 5)

Effects of a Shift in the Supply Curve

2.4 Shocks to the Equilibrium (4 of 5)

Effects of a Shift in the Supply Curve

Assuming that income remains at its $35,000 original level, an increase in the price of cocoa from $3 to $6 per lb causes some coffee producers to switch to cocoa production. So there are fewer suppliers and less coffee at every price. The supply curve for coffee

shifts to the left from

in Figure 2.6, panel (b).

At the original equilibrium, e1, price is $2 per l b, and there is excess demand of 0.6 million tons per year. Market pressures drive the price up until it reaches $2.40 at the new equilibrium, e2.

Here, a shift of the supply curve results in a movement along the demand curve.

2.4 Shocks to the Equilibrium (5 of 5)

Managerial Implication: Taking Advantage of Future Shocks

Managers can use the supply-and-demand model to anticipate how shocks to supply or demand will affect future business conditions and can take advantage of that knowledge.

Mars is one of the world’s largest chocolate producers and managers use a supply-and-demand model to make cocoa buying decisions.

If they expect prices to increase substantially, they immediately buy a great deal of cocoa at relatively low prices directly from suppliers in Africa.

Alternatively, if they expect prices to fall, they may hold off buying now and then buy later at a lower price from organized markets such as I C E Futures U.S. or the London International Financial Futures and Options Exchange.

2.5 Effects of Government Interventions (1 of 6)

Policies that Shift Curves

Limits on Who can Buy

For example, governments usually forbid selling alcohol to young people. This decreases the quantity demanded at each price and thereby shifts the demand curve to the left.

Restriction of Imports

The effect of this governmental restriction is to decrease the quantity supplied of imported goods at each price and shifts the importing country’s supply curve to the left.

Start buying a good

The effect of governments starting to buy goods is to increase the quantity demanded at each price for the good and shifts the demand curve to the right.

2.5 Effects of Government Interventions (2 of 6)

Price Controls—Price Ceilings

When the government sets a price ceiling at

and the unregulated

equilibrium price is above it, the price that is actually observed in the market is the price ceiling.

Price ceilings have no effect if they are set above the equilibrium price that would be observed in the absence of the price controls.

In Figure 2.7, the new equilibrium gasoline price would be p2 but a price ceiling of p1 is imposed, then the ceiling price of p1 is charged.

With a binding price ceiling, the supply-and-demand model predicts an equilibrium with a shortage: a persistent excess demand.

The new equilibrium with a shortage in Figure 2.7 occurs with a quantity Q s and price p1 (the excess demand is Q s−Q 1). If the price ceiling were removed, the new equilibrium would be e 2.

Deacon and Sonstelie (1989) found that for every dollar consumers saved during the 1980 gasoline price controls, they lost $1.16 in waiting time and other factors.

Figure 2.7 A Price Ceiling on Gasoline

2.5 Effects of Government Interventions (3 of 6)

Price Controls—Price Floors

When the government sets a price floor below the unregulated equilibrium price, the price that is actually observed in the market is the price floor.

A minimum wage law forbids employers from paying less than the minimum wage, w.

With a binding price floor, the supply-and-demand model predicts an equilibrium with a persistent excess supply.

The minimum wage prevents market forces from eliminating this excess supply, so it leads to an equilibrium with unemployment.

The new equilibrium with unemployment in Figure 2.8 occurs with a quantity L d and wage w (the excess supply is L s−L d). If the price ceiling were removed, the new equilibrium would be e 2

Figure 2.8 The Minimum Wage: A Price Floor

2.5 Effects of Government Interventions (4 of 6)

Why Supply Need Not Equal Demand

The theory says that the price and quantity in a market are determined by the intersection of the supply curve and the demand curve and the market clears if the government does not intervene.

However, the theory also tells us that government intervention can prevent market clearing.

The price ceiling and price floor examples show that the quantity supplied does not necessarily equal the quantity demanded in a supply-and-demand model.

The quantity that sellers want to sell and the quantity that buyers want to buy at a given price need not equal the actual quantity that is bought and sold.

2.5 Effects of Government Interventions (5 of 6)

Sales Taxes

Equilibrium Effects of a Specific Tax

The specific sales tax causes the equilibrium price consumers pay to rise, the equilibrium quantity that firms receive to fall, and the equilibrium quantity to fall (p 2, Q 2, and T in Figure 2.9)

Although the consumers and producers are worse off because of the tax, the government acquires new tax revenue, $27.84 billion in Figure 2.9.

Pass-Through

Common Confusion: Businesses pass-through any sales tax to consumers, so that the price that consumers pay increases by the amount of the tax.

This belief is not accurate in general. Full pass-through can occur, but partial pass-through is more common.

In Figure 2.9, after a $2.40 specific tax is imposed on firms, the price consumers pay rises from $7.20 to $8.00. So, firms pass-through $0.80 to consumers and absorb $1.60 of the tax.

The degree of the pass-through depends on the S and D shapes.

Figure 2.9 Effect of a $2.40 Specific Tax on Corn Collected from Producers

2.5 Effects of Government Interventions (6 of 6)

Managerial Implication: Cost Pass-Through

Managers should use pass-through analysis to predict the effect on their price and quantity from not just a new tax but from any per unit increase in costs.

Suppose that the cost of producing corn rises $2.40 per bushel because of an increase in the cost of labor or other factors of production, rather than because of a tax.

Then, the same analysis as in Figure 2.9 would apply, so a manager would know that only 80¢ of this cost increase could be passed through to consumers.

2.6 When to Use the Supply-And-Demand Model (1 of 2)

The Supply-and-Demand (S-D) model can help us to understand and predict real-world events in many markets. Like a map, it need not be perfect to be useful.

The model is useful if the market to be analyzed is “competitive enough.”

It is reliable in markets, such as those for agriculture, financial products, labor, construction, many services, real estate, wholesale trade, and retail trade.

The S-D model is accurate for perfectly competitive markets.

It is precisely accurate in perfectly competitive markets, which are markets in which all firms and consumers are price takers (no market participant can affect the market price).

See next slide for characteristics of perfectly competitive markets.

The S-D model is not accurate for noncompetitive markets.

In markets with firms that are price setters, the market price is usually higher than that predicted by the S-D model.

Monopoly and oligopoly markets have few sellers that are price setters. These markets need a different model.

2.6 When to Use the Supply-And-Demand Model (2 of 2)

Five characteristics of a perfect competitive market:

Many buyers and sellers, all relatively small with respect to the size of the market.

Consumers believe all firms produce identical products, so they only care about price.

All market participants have full information about price and product characteristics, so no participant can take advantage of each other.

Transaction costs (expenses over and above the price) are negligible.

Firms can easily enter and exit the market over time, so competition is very high.

Managerial Solution

Carbon Taxes

What will be the effect of imposing a carbon tax on the price of gasoline?

Solution

The degree to which a tax is passed through to consumers depends on the shapes of the demand-and-supply curves. Typically, short-run supply and demand curves differ from the long-run curves.

In the long-run, the supply curve is upward sloping, as in our typical figure. However, the U.S. short-run supply curve of gasoline is very close to vertical.

From empirical studies, we know that the U.S. federal gasoline specific tax of t = 18.4¢ per gallon is shared roughly equally between gasoline companies and consumers in the long run. However, based on what we learned, we expect that most of the tax will fall on firms that sell gasoline in the short run.

Manufacturing and other firms that ship goods are consumers of gasoline. They can expect to absorb relatively little of a carbon tax when it is first imposed, but half of the tax in the long run.

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