Midterm exam
kristie lccc
class_32016-07-06-14-38-02.pptCopyright © 2004 South-Western
3
Supply and Demand, and Supply and demand model
Copyright © 2004 South-Western/Thomson Learning
Supply, Demand, and Government Policies
- In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.
- While equilibrium conditions may be efficient, it may be true that not everyone is satisfied.
- One of the roles of economists is to use their theories to assist in the development of policies.
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2
2
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CONTROLS ON PRICES
- Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.
- Result in government-created price ceilings and floors.
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3
3
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CONTROLS ON PRICES
Price Ceiling
- A legal maximum on the price at which a good can be sold.
Price Floor
- A legal minimum on the price at which a good can be sold.
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4
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How Price Ceilings Affect Market Outcomes
- Two outcomes are possible when the government imposes a price ceiling:
- The price ceiling is not binding if set above the equilibrium price.
- The price ceiling is binding if set below the equilibrium price, leading to a shortage.
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5
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Figure 1 A Market with a Price Ceiling
(a) A Price Ceiling That Is Not Binding
Quantity of
Ice-Cream
Cones
0
Price of
Ice-Cream
Cone
Equilibrium
quantity
$4
Price
ceiling
Equilibrium
price
Demand
Supply
3
100
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Figure 1 A Market with a Price Ceiling
Copyright©2003 Southwestern/Thomson Learning
(b) A Price Ceiling That Is Binding
Quantity of
Ice-Cream
Cones
0
Price of
Ice-Cream
Cone
Demand
Supply
2
Price
ceiling
Shortage
75
Quantity
supplied
125
Quantity
demanded
Equilibrium
price
$3
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How Price Ceilings Affect Market Outcomes
- Effects of Price Ceilings
- A binding price ceiling creates
- shortages because QD > QS.
- Example: Gasoline shortage of the 1970s
- nonprice rationing
- Examples: Long lines, discrimination by sellers
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11
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- In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so the higher oil prices reduced the supply of gasoline.
- What was responsible for the long gas lines?
CASE STUDY: Lines at the Gas Pump
- Economists blame government regulations that limited the price oil companies could charge for gasoline.
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Figure 2 The Market for Gasoline with a Price Ceiling
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(a) The Price Ceiling on Gasoline Is Not Binding
Quantity of
Gasoline
0
Price of
Gasoline
1. Initially,
the price
ceiling
is not
binding . . .
Price ceiling
Demand
Supply,
S1
P1
Q1
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How Price Floors Affect Market Outcomes
- When the government imposes a price floor, two outcomes are possible.
- The price floor is not binding if set below the equilibrium price.
- The price floor is binding if set above the equilibrium price, leading to a surplus.
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15
12
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Figure 4 A Market with a Price Floor
Copyright©2003 Southwestern/Thomson Learning
(b) A Price Floor That Is Binding
Quantity of
Ice-Cream
Cones
0
Price of
Ice-Cream
Cone
Demand
Supply
$4
Price
floor
80
Quantity
demanded
120
Quantity
supplied
Equilibrium
price
Surplus
3
Copyright © 2004 South-Western/Thomson Learning
How Price Floors Affect Market Outcomes
- A price floor prevents supply and demand from moving toward the equilibrium price and quantity.
- When the market price hits the floor, it can fall no further, and the market price equals the floor price.
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24
15
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How Price Floors Affect Market Outcomes
- A binding price floor causes . . .
- a surplus because QS > QD.
- nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria.
- Examples: The minimum wage, agricultural price supports
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15
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The Minimum Wage
- An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay.
*
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Figure 5 How the Minimum Wage Affects the Labor Market
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Quantity of
Labor
Wage
0
Labor
demand
Labor
Supply
Equilibrium
employment
Equilibrium
wage
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TAXES
- Governments levy taxes to raise revenue for public projects.
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20
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Applying the Supply-and-Demand Model
Copyright © 2004 South-Western/Thomson Learning
Figure 3.01a How the Effect of a Supply Shock Depends on the
Shape of the Demand Curve
p
, $ per kg
(a)
215
220
176
0
Q
, Million kg of pork per year
3.55
3.30
S
1
D
1
S
2
e
1
e
2
*
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Figure 3.01b How the Effect of a Supply Shock Depends on the
Shape of the Demand Curve
(b)
p
, $ per kg
220
176
0
Q
, Million kg of pork per year
3.675
3.30
S
1
S
2
D
2
e
1
e
2
*
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Figure 3.01c How the Effect of a Supply Shock Depends on the
Shape of the Demand Curve
(c)
p
, $ per kg
220
205
176
0
Q
, Million kg of pork per year
3.30
S
1
S
2
D
3
e
1
e
2
*
Copyright © 2004 South-Western/Thomson Learning
Figure 3.02 Elasticity Along the Pork Demand Curve
p
, $ per kg
a
/
2 =
143
a
/
5 =
57.2
D
a
=
286
220
Q
, Million kg of pork per year
0
11.44
a
/
b
=
14.30
3.30
a
/(2
b
) = 7.15
Elastic:
e
<
–
1
e
=
–
4
Unitary:
e
=
–
1
e
=
–
0.3
Inelastic: 0 >
e
>
–
1
Perfectly
inelastic
Perfectly elastic
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Figure 3.03a Vertical and Horizontal Demand Curves
p
, Price per unit
(a)
Perfectly Elastic Demand
Q
, Units per
time period
p
*
Copyright © 2004 South-Western/Thomson Learning
Figure 3.03b Vertical and Horizontal Demand Curves
(b)
Perfectly Inelastic Demand
p
, Price per unit
Q
*
Q
, Units per
time period
Copyright © 2004 South-Western/Thomson Learning
Figure 3.03c Vertical and Horizontal Demand Curves
(c)
Individual
’
s Demand for Insulin
*
p
, Price of
insulin dose
*
Q
, Insulin
doses per day
p
Q
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Figure 3.04 Elasticity Along the Pork Supply Curve
p
, $ per kg
220
260
176
S
h
≈
0.71
h
≈
0.66
h
≈
0.6
h
≈
0.5
300
Q
, Million kg of pork per year
0
3.30
2.20
4.30
5.30
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Figure 3.05 Effect of a $1.05 Specific Tax on the Pork Market
Collected from Producers
p
, $ per kg
Q
2
=
206
Q
1
=
220
176
T
=
$216.3 million
Q
, Million kg of pork per year
0
p
2
= 4.00
p
1
= 3.30
p
2
–
t
= 2.95
t
= $1.05
S
1
e
1
e
2
S
2
D
Copyright © 2004 South-Western/Thomson Learning
Solved Problem 3.1
p
, Price per unit
Q
, Quantity per time period
Q
1
Q
2
p
1
p
2
=
p
1
+ 1
S
1
S
2
e
1
e
2
D
t
= $1
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= $1.05
= 2.95
Figure 3.06 Effect of a $1.05 Specific Tax on Pork Collected from
Consumers
p
, $ per kg
Q
2
=
206
Q
1
=
220
176
=
$216.3 million
Q
, Million kg of pork per year
0
p
2
= 4.00
p
1
= 3.30
p
2
–
t
= $1.05
Wedge,
t
D
1
D
2
e
1
e
2
S
T
t
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Figure 3.07 A Comparison of an Ad Valorem and a Specific Tax
on Pork
p
, $ per kg
Q
2
=
206
Q
1
=
220
176
T
=
$216.3 million
Q
, Million kg of pork per year
0
p
2
= 4.00
p
1
= 3.30
p
2
–
t
= 2.95
e
1
e
2
D
a
D
s
S
D
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Problem Solved 3.2
p
, Price per unit
Q
*
Q
, Quantity per time period
(1
–
)
p
*
p
*
a
p
*
D
1
e
1
e
2
D
2
S
a
