Chapter 4
Markets in Action
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
1
What can cause a shift
in a demand curve?
• Number of buyers in the market
• Tastes and preferences
• Income
• Expectations of consumers
• Prices of related goods
2
P
The Effects of Shift in Demand
on Market Equilibrium
$1200
S
$900
Shortage
$600
$300
D1
4
8
12
16
D2
Q
3
The Effects of Shift in Demand
on Market Equilibrium
$40
S
$30
Surplus
$20
$10
D1
D2
10
20
30
40
4
Increase in
Quantity
Supplied
Increase in
Equilibrium
Price
Increase in
Demand
5
Decrease in
Quantity
Supplied
Decrease in
Equilibrium
Price
Decrease
in Demand
6
What can cause a shift
in a supply curve?
• Technology
• Number of sellers in the market
• Resource prices
• Taxes and subsidies
• Expectations of producers
7
The Effects of Shift in Supply
on Market Equilibrium
$4
S1
$3
Surplus
S2
$2
$1
D
20
40
60
80
8
The Effects of Shift in Supply
on Market Equilibrium
$800
S2
$600
S1
Shortage
$400
$200
D
2
4
6
8
9
Increase in
Quantity
Demanded
Decrease in
Equilibrium
Price
Increase in
Supply
10
Decrease in
Quantity
Demanded
Increase in
Equilibrium
Price
Decrease
in Supply
11
Can the laws of demand
and supply be repealed?
In some markets, the
objective of politicians
is to prevent prices
from reaching the
equilibrium price
12
What are the two types
of price controls?
Price ceilings
Price floors
13
What is a price ceiling?
A legally established
maximum price a
seller can charge
14
P
Rent Control Results in a
Shortage of Rental Units
S
$800
$600
$400
Rent ceiling
Shortage
D
$200
2
4
6
8
Q
15
Shortage
Quantity Demanded
exceeds the
quantity supplied
Rent
Ceiling
16
What is the purpose of
price ceilings on rent?
So needy people will
pay lower rent than
the equilibrium rent
17
Why may rent controls
be counterproductive?
• Shortages
• Illegal markets
• Less maintenance
• Discrimination
18
What are other
examples of price
ceilings?
Wage and price controls
Usury laws
19
What is a price floor?
A legally established
minimum price a
seller can be paid
20
A Minimum Wage Results in
a Surplus of Labor
Wm
S
Minimum wage
Unemployment
We
D
QD
QE
QS
21
Unemployment
Minimum
wage
22
What are examples of
price floors?
Minimum wage law
Agricultural price supports
23
Why do we have price
ceilings and floors?
Because of failures in
the free market
24
What is market failure?
A situation in which the
price system creates a
problem for society or fails
to achieve society’s goals
25
Who was Adam Smith?
The father of modern
economics who wrote
The Wealth of Nations,
published in 1776
26
What did Adam Smith
say about competition?
There must be competition
for markets to function
properly
27
What happens when
competition is lacking?
Market failure results
28
Rigging the Personal Computer Market
$2500 Inefficient equilibrium
$2000
S2
S
1
$1500
$1000
$500
Efficient equilibrium
D
50 100 150 200 250 300
29
What is an example of
another market failure?
Externalities
30
What is an externality?
A cost or benefit imposed
on people other than the
consumers and producers
of a good or service
31
What is a
negative externality?
An externality that is
detrimental to third parties
32
What is an example of
a negative externality?
Pollution
33
External Cost of Pollution
Includes external costs of pollution
S2 S
1
P2
P1
D
Excludes external costs of pollution
Q2
Q1
34
What is a
positive externality?
An externality that is
beneficial to third parties
35
What is an example of
a positive externality?
Vaccinations
36
External Benefits of AIDS Vaccinations
Includes Vaccination benefits
S
P2
P1
D2
$10
Excludes Vaccination benefits
Q1
Q2
D1
37
Inefficient
equilibrium
External
costs
38
Inefficient
equilibrium
External
benefits
39
What is another
example of a positive
externality?
Public goods
40
What is a public good?
A good that, once produced,
has two properties:
(1) users collectively
consume benefits
(2) no one can be excluded
41
What are examples of
public goods?
• National defense
• Public education
• Roads
42
What is another
example of
market failure?
Income inequality
43
Key Concepts
44
Key Concepts
•
•
•
•
•
•
•
What can cause a shift in a demand curve?
What can cause a shift in a supply curve?
What are the two types of price controls?
What is a price ceiling?
What is a price floor?
Why do we have price ceilings and floors?
What is market failure?
45
Key Concepts cont.
•
•
•
•
•
•
What happens when competition is lacking?
What is an externality?
What is a negative externality?
What is a positive externality?
What is a public good?
What is another example of market failure?
46
Summary
47
Price ceilings and price floors are
maximum and minimum prices
enacted by law, rather than
allowing the forces of supply and
demand to determine prices. A
price ceiling is a maximum price
mandated by government, and a
price floor is a minimum legal price.
48
If a price ceiling is set below the
equilibrium price, a shortage will persist
P
S
$800
$600
$400 Rent ceiling
Shortage
D
$200
2
4
6
8
Q
49
If a price floor is set above the
equilibrium price, a surplus will persist
Wm
S
Minimum wage
Unemployment
We
D
QD
QE
QS
50
Market failure means that the
market mechanism does not
achieve desirable results. Sources
of market failure include lack of
competition, externalities, public
goods, and income inequality.
Although controversial, government
intervention is a possible way to
correct market failure.
51
An externality is a cost or benefit of
a good imposed on people who are
not buyers or sellers of that good.
Pollution is an example of an
external cost, which means too
many resources are used to
produce the product responsible for
the pollution. Two basic approaches
to solve this market failure are
taxes (like in pollution taxes) and
regulation (like in vaccinations).
52
External Cost of Pollution
Includes external costs of pollution
S2 S
1
P2
P1
D
Excludes external costs of pollution
Q2
Q1
53
External Benefits of AIDS Vaccinations
Includes Vaccination benefits
S
P2
P1
D2
Excludes Vaccination benefits
Q1
Q2
D1
54
Public goods are goods that are
consumed by everyone regardless
of whether they pay or not.
National defense, air traffic
control, and other public goods
can benefit many individuals
simultaneously and are provided
by the government.
55
Chapter 4 Quiz
©2002 South-Western College Publishing
56
1. Suppose prices for new homes have
risen, yet sales of new homes have also
risen. We can conclude that
a. the demand for new homes has risen.
b. the law of demand has been violated.
c. new firms have entered the
construction industry.
d. construction firms must be facing
higher costs.
A. The demand for new homes has risen
causing the price to increase and the
quantity of new homes to increase as
illustrated on the next page.
57
An increase in demand for new homes
S
P2
P1
D2
Q1
Q2
D1
58
2. Which of the following statements if true
of a market?
a. An increase in demand, with no change
in supply, will increase the equilibrium
price and quantity.
b. An increase in supply, with no change
in demand, will decrease the equilibrium
price and the equilibrium quantity.
c. A decrease in supply, with no change in
demand, will decrease the equilibrium
price and increase the equilibrium
quantity.
d. all of the above are true.
A. See previous graph.
59
3. Consider the market for chicken. An increase in
the price of beef will
a. decrease the demand for chicken, creating a
lower price and a smaller amount of chicken
purchased in the market.
b. decrease the supply of chicken, creating a
higher price a and a smaller amount of chicken
purchased in the market.
c. increase the demand for chicken, creating a
higher price and a greater amount of chicken
purchased in the market.
C. An increase in the price of beef will cause
an increase in the demand for chicken
because beef and chicken are substitutes.
60
4. An increase in consumer income increases the
demand for oranges. As a result of the
adjustment to a new equilibrium, there is a (an)
a. leftward shift of the supply curve.
b. downward movement along the supply curve.
c. rightward shift of the supple curve.
d. upward movement along the supply curve.
D. As the demand curve shifts to the right
along the upward sloping supply curve,
there is a movement along the supply
curve as illustrated on the next page.
61
The Effects of Shift in Demand
on Market Equilibrium
P
$1200
S
$900
Shortage
$600
$300
D1
4
8
12
16
D2
Q
62
5. An increase in the wage paid to grape pickers
will cause the
a. demand curve for grapes to shift to the
right, resulting in higher prices for grapes.
b. demand curve for grapes to shift to the left,
resulting in lower prices for grapes..
c. supply curve for grapes to shift to the left,
resulting in lower prices for grapes.
d. supply curve for grapes to shift to the left,
resulting in higher prices for grapes.
D. An increase in costs is one factor
that will cause the supply curve to
shift to the left as production
becomes more expensive as
illustrated on the next page.
63
The Effects of Shift in Supply
on Market Equilibrium
P
$800
S2
$600
S1
Shortage
$400
$200
D
2
4
6
8
Q
64
6. If the federal government wants to raise the
price of cheese, it will
a. take cheese from government storage and
sell it.
b. encourage farmers to research ways to
produce more cheese.
c. subsidize purchases of farm equipment.
d. encourage farmers to produce less
cheese.
D. As the supply curve for cheese shifts to
the left and moves along a downward
sloping demand curve, equilibrium price
will increase as illustrated on the next
page.
65
The Effects of Shift in Supply
on Market Equilibrium
P
$800
S2
$600
S1
Shortage
$400
$200
D
2
4
6
8
Q
66
7. Which of the following is least likely to result
from rent controls set below the equilibrium
price for rental housing?
a. Shortages and black markets.
b. Deterioration of existing rental housing.
c. The supply of rental housing will increase
rapidly.
d. People will demand more apartments than
are available.
C. The supply curve will shift to the left,
not to the right, as suppliers produce
fewer rental units due to the lower
price and lower profits.
67
8. Suppose the equilibrium price set by
supply and demand is lower than the
price ceiling set by the government.
The result will be
a. a shortage.
b. that quantity demanded is equal to
quantity supplied.
c. a surplus.
d. a black market.
B. The purpose of price ceilings is to set
a maximum price by law. If it is set
lower than the equilibrium price, it will
have no effect on the equilibrium price
as illustrated on the next page.
68
P
Rent Control Results in a
Shortage of Rental Units
S
$800
$600
$400
Price
ceiling
Shortage
D
$200
2
4
6
8
Q
69
9. A good that provides external benefits to
society has
a. too few resources devoted to production.
b. too many resources devoted to its
production.
c. the optimal resources devoted to its
production.
d. not provided profits to producers of the
good.
A. An external benefit is an
unintentional byproduct of the
market.
70
10. Pollution from cars is an example of
a (an)
a. harmful opportunity cost.
b. negative externality.
c. production dislocation.
d. none of the above.
B. A negative externality imposes costs
on third parties when drivers
discharge pollution into the air, they
erode the quality of life of others.
71
11. Which of the following is the best
example of a public good?
a. Pencils.
b. Education.
c. Defense.
d. Trucks.
C. None of the other answers fit the
definition of a public good. A public
good is something from which
everyone benefits and no one can be
excluded.
72
12. A public good may be defined as
any good or service that
a. allows users to collectively
consume benefits.
b. must be distributed equally to all
citizens in equal shares.
c. is never produced by government.
d. answers a and c above.
A. Once a public good is provided, for
instance a road, everyone collectively
benefits from it.
73
END
74