Macroeconomics
ECON 2301
Spring 2011
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 4
Announcement
 The first exam is scheduled for Feb. 16.
 More information will be provided in the
Chapter 1-4 Review PPTs, uploaded with the
other class notes.
Chapter 4: Extensions of Demand and Supply
Analysis
Learning Objectives
1. Discuss the essential features of the price system
2. Evaluate the effects of changes in demand and supply on
the market price and equilibrium quantity
3. Understand the rationing function of prices
4. Explain the effects of price ceilings
5. Explain the effects of price floors
6. Describe various types of government-imposed quantity
restrictions on markets
Changes in Demand and Supply
 Changes in supply and demand create a
disequilibrium.
 The market price and quantity adjust to a
new equilibrium.
Review of The D Side of the Mkt.:
Variables That SHIFT Market Demand
1. Price of related goods
 Substitutes Goods and services that can be
used for the same purpose.
 Complements Goods that are used together.
2. Income
 Normal good A good for which the demand
increases as income rises and decreases as
income falls.
 Inferior good A good for which the demand
increases as income falls, and decreases as
income rises.
The Demand Side of the Market
Variables That Shift Market Demand
3. Tastes
4. Population and demographics
Demographics The characteristics of a population
with respect to age, race, and gender.
5. Expectations
When two goods, X and Y, are complements,
which of the following occurs?
 a. An increase in the price of good X leads to an
increase in the price of good Y.
 b. An increase in the price of good X leads to a
decrease in the quantity demanded of good Y.
 c. An increase in the price of good X leads to a
decrease in the quantity demanded of good Y.
 d. An increase in the price of good X leads to an
increase in the quantity demanded of good Y.
The Demand Side of the Market
Variables That Shift Market Demand
3-1
Variables That Shift Market
Demand Curves
The Demand Side of the Market
Variables That Shift Market Demand
3 - 1 (continued)
Variables That Shift Market
Demand Curves
Refer to the graph below. Which of the following
moves best describes what happens when a
change in the price of printers affects the market
demand for printers?




a.
b.
c.
d.
A move from A to B.
A move from A to C.
Either move from A to B or A to C.
None of the above.
Figure 4-1 Shifts in Demand and in
Supply: Determinate Results, Panel (a)
Figure 4-1 Shifts in Demand and in
Supply: Determinate Results, Panel (b)
Which of the following defines a supply curve?
 a. The quantity of a good or service that a firm is
willing to supply at a given price.
 b. A table that shows the relationship between the
price of a product and the quantity of the product
supplied.
 c. A curve that shows the relationship between the
price of a product and the quantity of the product
supplied.
 d. None of the above.
The Supply Side of the Market
The Law of Supply
Law of supply Holding everything else
constant, increases in price cause increases
in the quantity supplied, and decreases in
price cause decreases in the quantity
supplied.
The Supply Side of the Market
Variables That Shift Supply
1. Price of inputs
2. Technological change
 A positive or negative change in the ability
of a firm to produce a given level of output
with a given amount of inputs.
3. Prices of substitutes in production
4. Expected future prices
5. Number of firms in the market
The Supply Side of the Market
Variables That Shift Supply
3-2
Variables That Shift Market
Supply Curves
The Supply Side of the Market
Variables That Shift Supply
Variables That Shift Market
3 - 2 (continued) Supply Curves
The Supply Side of the Market
Variables That Shift Supply
Refer to the graphs below. Each graph refers to
the supply for printers. Which best describes the
impact of an increase in productivity?




a. The graph on the left.
b. The graph on the right.
c. Both graphs.
d. Neither graph.
Figure 4-1 Shifts in Demand and in
Supply: Determinate Results, Panel (c)
Figure 4-1 Shifts in Demand and in
Supply: Determinate Results, Panel (d)
The Falling Price of
Large Flat-Screen Televisions
Corning’s breakthrough
spurred the manufacture of
LCD televisions in Taiwan,
South Korea, and Japan, and
an eventual decline in price.
Changes in Demand and Supply
 Changes in supply and demand create a
disequilibrium.
 The market price and quantity adjust to a
new equilibrium.
Changes in Demand and Supply (cont'd)
 Summary
Increases in demand increase equilibrium price
and quantity.
Decreases in demand decrease equilibrium
price and quantity.
Increases in supply decrease equilibrium price
and increase quantity.
Decreases in supply increase equilibrium price
and decrease quantity.
When BOTH Demand & Supply Are Shifting:
High Demand and Low Prices in the Lobster Market:
Supply and demand for lobster both increase in summer, but the supply
increase EXCEEDS the demand increase; therefore, equilibrium price falls.
Changes in Demand and Supply (cont'd)
 When both demand and supply increase:
Change in price is indeterminate
Quantity will increase
 When both demand and supply decrease:
Change in price is indeterminate
Quantity will decrease
Changes in Demand and Supply (cont'd)
 When supply decreases and demand increases:
Price will increase
Change in quantity is indeterminate
 When supply increases and demand decreases:
Price will decrease
Change in quantity is indeterminate
Remember: A Change in a Good’s Price Does Not Cause
the Demand or Supply Curve to Shift.
Changes in Demand and Supply (cont'd)
Price Flexibility and Adjustment Speed
 Prices quite flexible in unfettered markets can be
less flexible in other market scenarios.
May experience indirect adjustments such as
hidden payments, quality changes
May not reach equilibrium right away
Changes in Demand and Supply (cont'd)
 Adjustment speed
Market characteristics influence adjustment
speed.
Markets may overshoot in the adjustment
process.
Markets are subject to energy shocks, labor
strikes, severe weather.
Example: Why Gasoline Prices
Increased over the Past Year
 One factor: an increase in international
demand, shown by a rightward shift in the
demand curve
 Another factor: a reduction in supply,
shown by a leftward shift in the supply
curve
 As a result, the equilibrium price of
gasoline increased.
Prices are now falling. Why???
The Price System and Markets (cont'd)
 Transaction Costs: The costs associated
with exchange
Examples
• Price shopping
• Determining quality
• Determining reliability
• Service availability
• Cost of contracting
The Rationing Function of Prices
 Methods of non-price rationing include:
Rationing by queues (waiting in line)
Rationing by random assignment, and/or coupons
First come, first served
Political power
Physical force
Random assignment
Coupons
The Rationing Function of Prices (cont'd)
 The essential role of rationing (with scarcity
rationing must occur)
We must choose the rationing mechanism:
price or non-price.
Price rationing leads to most efficient use of
available resources; all gains from mutually
beneficial trade are captured.
The Rationing Function of Prices (cont'd)
 Question
If price rationing is the most efficient is it the
“best” way to ration?
 Answer
Economists cannot say which system is “best.”
They can say rationing via the price system
leads to the most efficient use of available
resources.
One Type of Government Policy:
Imposed Price Controls
 Price Controls Government-mandated
minimum or maximum prices
Price Ceiling A legal maximum price
Price Floor A legal minimum price
Government-Imposed Price Controls (cont'd)
 Price ceiling and illegal (black) markets
Price ceilings may prevent the equilibrium
price from being achieved if it is above the
ceiling price.
 Black Market A market in which price-
controlled goods are sold at an illegally high
price
Figure 4-3 Black Markets
The Policy of Controlling Rents
 The functions of rental prices:
1. Promote the efficient maintenance and
construction of housing
2. Allocate existing housing
3. Ration the use of housing
The Policy of Controlling Rents (cont'd)
 Rent controls and construction
Controls discourage construction
With a 16% vacancy rate and no controls, Dallas
recently built 11,000 new rental units.
With a 1.6% vacancy rate and controls, San
Francisco recently built 2,000 new rental units.
The Policy of Controlling Rents (cont'd)
 Effects on the existing supply of housing
and current use of housing
Property owners cannot recover costs
Maintenance, repairs, capital improvements
Rations the current use of housing
Reduces mobility, e.g., New York’s
“housing gridlock”
The Policy of Controlling Rents (cont'd)
 Attempts to evade rent controls
Forcing tenants to leave
Tenants subletting apartments
Housing courts
The Policy of Controlling Rents (cont'd)
 Who gains and who loses from rent controls?
Losers
• Property owners
• Some low-income individuals
Gainers
• Upper-income professionals
Price Floors in Agriculture
 Support Price The governmentally
established price floor
Usually associated with agricultural products
Later we’ll study the minimum wage with this same
analysis
Figure 4-4 Agricultural Price Supports
Price Floors in Agriculture (cont'd)
 Questions
How could the government keep the price
from falling?
Who benefits from agricultural price
supports?
Policy Example: King Cotton Receives Royal
Government Subsidies
 Every year, the federal government gives a direct payment




based on the average size of the farmer’s past planting.
After the crop is planted, the farmer can borrow from the
government, using the newly sown cotton as collateral.
If the world price of cotton falls below a price floor of 65
cents per pound, the grower receives a payment from the
government--compensating the farmer for surplus cotton
the farmer has planted—equal to 13 cents per pound.
If the world price of cotton falls below 52 cents per pound,
farmers turn their cotton over to the government, which
sells the cotton at the world price and absorbs loan losses.
Thus the government usually provides about 80% of all
revenues received by cotton farmers.
What would happen to cotton farmers’ revenues if the
price floor were raised? Lowered?
Price Floors in the Labor Market
 Minimum Wage A wage floor, legislated by
government, setting the lowest hourly wage
rate that firms may legally pay their workers
Figure 4-5 The Effect of
Minimum Wages
Quantity Restrictions
 Governments can impose quantity
restrictions, with the most obvious being the
banning of ownership or trading of a good
Human organs
Drugs
Hospital beds
Gold from 1933 to 1973
Quantity Restrictions (cont'd)
 Government Prohibitions and Licensing
Requirements
Some commodities cannot be purchased at all
legally; others require a license
 Import Quota Supply restriction that
prohibits the importation of more than a
specified quantity of a particular good
Summary of Learning Objectives
 Essential features of the price system
A price system (market system) allows prices
to respond to changes in supply and demand for
different commodities.
The terms of exchange – prices - are
communicated in markets, tending to minimize
transactions costs.
Summary of Learning Objectives (cont'd)
 How changes in demand and supply affect market
price and equilibrium quantity
Increases in demand increase equilibrium price and
quantity; decreases in demand decrease equilibrium
price and quantity.
Increases in supply decrease market price and increase
equilibrium quantity; decreases in supply increase
market price and decrease equilibrium quantity.
When both demand and supply shift at the same time,
the result is indeterminate.
Summary Discussion of Learning Objectives (cont'd)
 The rationing function of prices
In a market system, prices ration scarce goods and
services.
Other ways of rationing include first come, first served;
political power; physical force; random assignment;
and coupons.
Summary Discussion of Learning Objectives (cont'd)
 The effects of price ceilings
A price ceiling set below the market (equilibrium) price
results in a shortage.
• The resulting shortage can lead to non-price
rationing devices and black markets.
 The effects of price floors
If the price floor is set above the market price, a surplus
results.
• A price floor can take the form of a governmentimposed price support or minimum wage.
Summary Discussion of Learning Objectives (cont'd)
 The rationing function of prices
In a market system, prices ration scarce goods and
services.
Other ways of rationing include first come, first served;
political power; physical force; random assignment;
and coupons.
 The effects of price ceilings
A price ceiling set below the market (equilibrium) price
results in a shortage. The resulting shortage can lead to
non-price rationing devices and black markets.
Summary Discussion of Learning Objectives (cont'd)
 The effects of price floors
If the price floor is set above the market price, a surplus
results. A price floor can take the form of a
government-imposed price support or minimum wage.
 Government-imposed restrictions on market
quantities
Bans on sale or ownership
Licensing restrictions
Import quotas
Assignments to be completed
before our next class:
Study for Exam 1!
Before our next regular class:
Pre-read Ch.6 & look over end-of-chapter questions:
14th ed: Problems 6-2, 6-4, 6-6, 6-10 & 6-12, pp. 156-158
15th ed: Problems 6-2, 6-4, 6-8, 6-12 & 6-14, pp. 156-158