Introduction Thinking Like an Economist CHAPTER 5 Using

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Introduction: Thinking Like an Economist CHAPTER 5 Using Supply and Demand © 2017 Mc.

Introduction: Thinking Like an Economist CHAPTER 5 Using Supply and Demand © 2017 Mc. Graw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education. 1

Chapter Goals Ø Apply the supply and demand model to real-word events Ø Demonstrate

Chapter Goals Ø Apply the supply and demand model to real-word events Ø Demonstrate the effect of a price ceiling and a price floor on a market Ø Explain the effect of excise taxes and tariffs on a market Ø Explain the effect of quantity restrictions on a market Ø Explain the effect of a third-party-payer system on equilibrium price and quantity © 2017 Mc. Graw-Hill Education. All Rights Reserved. 2

Application: Apples in the United States Price A hurricane damages farms in the northeastern

Application: Apples in the United States Price A hurricane damages farms in the northeastern U. S. , destroying a significant portion of the apple crop Apples S 1 S 0 P 1 The damage shifts the supply curve for apples to the left P 0 Excess demand D 0 Q 1 Q 0 Price rises from P 0 to P 1 where quantity demanded = quantity supplied Quantity © 2017 Mc. Graw-Hill Education. All Rights Reserved. 3

Application: Sales of SUVs in the U. S. SUVs The price of gasoline in

Application: Sales of SUVs in the U. S. SUVs The price of gasoline in the U. S. rose to extremely Price high levels. S 0 Excess supply Increasing gas costs caused the demand curve to shift left P 0 Price for SUVs fell from P 0 to P 1 where Q demanded = Q supplied P 1 D 0 D 1 Q 1 © 2017 Mc. Graw-Hill Education. All Rights Reserved. Q 0 Quantity 4

Application: Edible Oils in the World Price Growing middle class in developing countries has

Application: Edible Oils in the World Price Growing middle class in developing countries has increased demand for edible oils Edible Oils S 1 P 1 S 0 P 0 D 1 D 0 At the same time, U. S. farmers are growing more corn and less soy (less soy oil) The result is increased prices for edible oils Quantity © 2017 Mc. Graw-Hill Education. All Rights Reserved. 5

A Review of Changes in Supply and Demand No change in Supply increases Supply

A Review of Changes in Supply and Demand No change in Supply increases Supply decreases No change in Demand P same Q same P down Q up P up Q down Demand increases P up Q up P ambiguous Q up P up Q ambiguous Demand decreases P down Q down P down Q ambiguous P ambiguous Q down © 2017 Mc. Graw-Hill Education. All Rights Reserved. 6

Government Intervention Ø The invisible hand is not the only factor in determining prices;

Government Intervention Ø The invisible hand is not the only factor in determining prices; social and political forces also determine price. Ø Other factors include: • Price ceilings and price floors • Excise taxes and tariffs • Quantity restrictions • Third-party-payer markets © 2017 Mc. Graw-Hill Education. All Rights Reserved. 7

Government Intervention: Price Ceilings Ø When a government wants to hold prices down to

Government Intervention: Price Ceilings Ø When a government wants to hold prices down to favor buyers, it imposes a price ceiling Ø A price ceiling is a government-imposed limit on how high a price can be charged Ø Price ceilings create shortages Ø Price ceilings below equilibrium price will have an effect on the market Ø With price ceilings, existing goods are no longer rationed entirely by price so other methods of rationing arise © 2017 Mc. Graw-Hill Education. All Rights Reserved. 8

Application: Rent Controls in Paris Housing P(rental price per month) S 0 After WWII,

Application: Rent Controls in Paris Housing P(rental price per month) S 0 After WWII, rent controls (a form of price ceiling) were put in place The rent controls caused a housing shortage $17 $2. 50 D 0 Shortage QS QD There would not be a shortage if rents had been allowed to increase to the equilibrium price of $17 Q (number of apartments) © 2017 Mc. Graw-Hill Education. All Rights Reserved. 9

Government Intervention: Price Floors Ø When a government wants to prevent a price from

Government Intervention: Price Floors Ø When a government wants to prevent a price from falling below a certain level to favor suppliers, it imposes a price floor Ø A price floor is a government-imposed limit on how low a price can be charged Ø Price floors create excess supply Ø Price floors above equilibrium price will have an effect on the market © 2017 Mc. Graw-Hill Education. All Rights Reserved. 10

Application: A Minimum Wage P (wage per hour) Labor Excess supply = unemployment S

Application: A Minimum Wage P (wage per hour) Labor Excess supply = unemployment S 0 Wmin W 0 A minimum wage is a type of price floor, it is the lowest wage a firm can legally pay an employee Minimum wages cause unemployment D 0 QD Q 0 Q (quantity of workers) QS © 2017 Mc. Graw-Hill Education. All Rights Reserved. 11

Government Intervention: Excise Taxes Ø Government impacts markets through taxation Ø An excise tax

Government Intervention: Excise Taxes Ø Government impacts markets through taxation Ø An excise tax is a tax that is levied on a specific good Ø A tariff is an excise tax on an imported good Ø The result of taxes and tariffs is an increase in equilibrium prices and reduce equilibrium quantities © 2017 Mc. Graw-Hill Education. All Rights Reserved. 12

Application: The Effect of an Excise Tax Price Luxury Boats Government imposes a $10,

Application: The Effect of an Excise Tax Price Luxury Boats Government imposes a $10, 000 luxury tax on the suppliers of boats S 1 S 0 $70, 000 $65, 000 Tax = $10, 000 $60, 000 $10, 000 420 510 600 D 0 The supply curve shifts up by the amount of the tax The price of boats rises by less than the tax to $65, 000 Quantity © 2017 Mc. Graw-Hill Education. All Rights Reserved. 13

Government Intervention: Quantity Restrictions Ø Government regulates markets with licenses, which limit entry into

Government Intervention: Quantity Restrictions Ø Government regulates markets with licenses, which limit entry into a market Ø Many professions require licenses, such as doctors, financial planners, cosmetologists, electricians, or taxi cab drivers Ø The results of limited number of licenses in a market are increases in wages and an increases in the price of obtaining the license © 2017 Mc. Graw-Hill Education. All Rights Reserved. 14

Application: The Effect of a Quantity Restriction NYC Taxi Drivers P (wages per week

Application: The Effect of a Quantity Restriction NYC Taxi Drivers P (wages per week ) Successful lobbying by taxi cab drivers in NYC resulted in quantity restrictions (medallions) QR D 1 $15 D 0 12, 000 When the demand for taxi services increased, because the number of taxi licenses was limited, wages increased Q (number of licensed taxis) © 2017 Mc. Graw-Hill Education. All Rights Reserved. 15

Application: The Effect of a Quantity Restriction NYC Taxis Medallions P (price of taxi

Application: The Effect of a Quantity Restriction NYC Taxis Medallions P (price of taxi medallion) QR The demand for taxi medallions also increased because wages were increasing. But because the number of taxi licenses was limited, the price of a medallion also increased $700, 000 D 1 Initial Fee D 0 Q (number of taxi of medallions) © 2017 Mc. Graw-Hill Education. All Rights Reserved. 16

Government Intervention: Third-Party-Payer Markets Ø In third-party-payer markets, the person who receives the good

Government Intervention: Third-Party-Payer Markets Ø In third-party-payer markets, the person who receives the good differs from the person paying for the good Ø Under a third-party-payer system, the person who chooses how much to purchase doesn’t pay the entire cost Ø Equilibrium quantity and total spending can be much higher in third-party-payer markets Ø Goods from a third-party-payer system will be rationed through social and political means © 2017 Mc. Graw-Hill Education. All Rights Reserved. 17

Application: Third-Party-Payer Markets Price With a copayment of $5, consumers demand 18 units Health

Application: Third-Party-Payer Markets Price With a copayment of $5, consumers demand 18 units Health Care Supply $45 Sellers require $45 per unit for that quantity Total expenditures for 18 units of health care $25 …are greater than when… $5 Demand 10 18 The consumer pays the entire cost Quantity © 2017 Mc. Graw-Hill Education. All Rights Reserved. 18

Chapter Summary Ø You can describe almost all events in terms of supply and

Chapter Summary Ø You can describe almost all events in terms of supply and demand Ø Price ceilings, government imposed limits on how high a price can be charged, create shortages Ø Price floors, government-imposed limits on how low a price can be charged, create surpluses Ø Taxes and tariffs paid by suppliers shift the supply curve up by the amount of the tax or tariff and increase equilibrium price and decrease quantity © 2017 Mc. Graw-Hill Education. All Rights Reserved. 19

Chapter Summary Ø Quantity restrictions increase equilibrium price and reduce equilibrium quantity Ø In

Chapter Summary Ø Quantity restrictions increase equilibrium price and reduce equilibrium quantity Ø In a third-party-payer market, the consumer and the one who pays the cost differ. Quantity demanded, price, and total spending are greater when a third party pays than when the consumer pays. © 2017 Mc. Graw-Hill Education. All Rights Reserved. 20