Supply and Demand: Price Supply and Demand: Price and Quantity - - PowerPoint PPT Presentation

Supply and Demand: Price Supply and Demand: Price and Quantity and Quantity Determination in Determination in Competitive Markets Competitive Markets

The Economics The Economics Department, UMR Department, UMR Presents: Presents:

N Demand N Supply N Equilibrium and

Disequilibrium

Starring Starring

Featuring Featuring

N NThe Law of Demand

The Law of Demand

N ND = D(PENTE)

D = D(PENTE)

N NThe Tendency of Supply

The Tendency of Supply

N NS = S(pent)

S = S(pent)

N NEquilibrium/

Equilibrium/Disequilibrium Disequilibrium

In Four Parts In Four Parts

Demand Demand Supply Supply Equilibrium/Disequilibrium Equilibrium/Disequilibrium (current show) (current show) Changes in Equilibrium Changes in Equilibrium

What Is Equilibrium? What Is Equilibrium?

N N It is a situation that exists in a market

It is a situation that exists in a market when the plans of buyers are consistent when the plans of buyers are consistent with the plans of sellers with the plans of sellers

N N Or, at the prevailing price, quantity

Or, at the prevailing price, quantity demanded equals the quantity supplied demanded equals the quantity supplied

N N Another, wider, view of equilibrium is

Another, wider, view of equilibrium is when the action taken leads to when the action taken leads to consequences that are expected, there is consequences that are expected, there is no incentive to change no incentive to change

Part 3

Notes About the Concept of Notes About the Concept of Equilibrium Equilibrium

N N First, there should be no prior

First, there should be no prior judgement about whether a given judgement about whether a given equilibrium is good or bad equilibrium is good or bad

N N Second, markets not in equilibrium are

Second, markets not in equilibrium are in in Disequilibrium Disequilibrium

O O Shortages, or

Shortages, or

O O Surpluses

Surpluses

The Ethics of Equilibrium The Ethics of Equilibrium

N N William Lynch’s (1742

William Lynch’s (1742-

• 1820) early

1820) early American tribunals dispatched swift American tribunals dispatched swift results with bodies soon coming to rest results with bodies soon coming to rest (an equilibrium) but most have rejected (an equilibrium) but most have rejected this as a good form of justice this as a good form of justice

N N Competitive equilibrium, under certain

Competitive equilibrium, under certain conditions, is efficient conditions, is efficient

O O Given scarcity, efficiency is a desirable

Given scarcity, efficiency is a desirable social objective social objective

N N It is the consequences of equilibrium we

It is the consequences of equilibrium we have to judge, not the state itself have to judge, not the state itself

Many Processes Are Not in Many Processes Are Not in Equilibrium Equilibrium

N N The one constant is change

The one constant is change

N N In economics change is purposeful and

In economics change is purposeful and may often be modeled successfully may often be modeled successfully

N N Equilibrium results from a given

Equilibrium results from a given change, an end state implied by these change, an end state implied by these models models

N N Many economic processes “tend

Many economic processes “tend toward” equilibrium toward” equilibrium

Disequilibrium Disequilibrium

N N Usually markets are “tending toward

Usually markets are “tending toward equilibrium” driven by the forces of supply and equilibrium” driven by the forces of supply and demand demand

O O Prices are used as a rationing mechanism

Prices are used as a rationing mechanism

N N Changing demand or supply conditions create

Changing demand or supply conditions create incentives for buyers and sellers to change their incentives for buyers and sellers to change their behavior behavior

N N Disequilibrium

Disequilibrium is characterized by is characterized by

O O Excess demand

Excess demand--

• -a shortage, or

a shortage, or

O O Excess supply

Excess supply--

• -a surplus

a surplus

N N Price controls (ceilings or floors) lead to

Price controls (ceilings or floors) lead to shortages or surpluses shortages or surpluses

Shortage Shortage

N N Shortage

Shortage -

• when Q

when QD

D > Q

> QS

S at current

at current market price market price

O O Amount of shortage = Q

Amount of shortage = QD

D -

• Q

QS

S

N N Note

Note -

• it is

it is not not correct correct to say demand to say demand exceeds supply, but rather quantity exceeds supply, but rather quantity demanded exceeds quantity supplied demanded exceeds quantity supplied

Surplus Surplus

N N Surplus

Surplus -

• when Q

when QS

S > Q

> QD

D at current market

at current market price price

• Amount of surplus = Q

Amount of surplus = QS

S -

• Q

QD

D

N N Note

Note -

• it is

it is not not correct correct to say supply to say supply exceeds demand, but rather that quantity exceeds demand, but rather that quantity supplied exceeds quantity demanded supplied exceeds quantity demanded

Price Controls Price Controls

There are two types of price controls There are two types of price controls -

• price ceilings

price ceilings and and price floors price floors

Price Ceilings Price Ceilings

N N Price ceiling

Price ceiling -

• sets a maximum price that

sets a maximum price that is allowed by law is allowed by law

N N Result of price ceiling

Result of price ceiling

O O Stay at a permanent shortage situation

Stay at a permanent shortage situation

N N Note that a price ceiling

Note that a price ceiling can can be any price be any price the government chooses. It is, however the government chooses. It is, however

• nly effective if it is
• nly effective if it is below

below the the equilibrium price equilibrium price

N N Examples include maximum rents for

Examples include maximum rents for apartments and UMR parking permits apartments and UMR parking permits

Price Floors Price Floors

N N Price floor

Price floor -

• sets a minimum price that is

sets a minimum price that is allowed by law allowed by law

N N Result of price floor

Result of price floor

O O Stay at a permanent surplus situation

Stay at a permanent surplus situation

N N Note that a price floor

Note that a price floor can can be any price be any price the government chooses. It is, however the government chooses. It is, however

• nly effective if it is
• nly effective if it is above

above the the equilibrium price equilibrium price

N N Examples include agriculture price

Examples include agriculture price supports and the minimum wage supports and the minimum wage

Equilibrium in the Market Equilibrium in the Market

N N Equilibrium

Equilibrium -

• where quantity

where quantity demanded equals quantity supplied demanded equals quantity supplied

N N Equilibrium price (P*)

Equilibrium price (P*) -

• price where

price where equilibrium occurs equilibrium occurs

N N At P

At P*

* there is no incentive for buyers or

there is no incentive for buyers or sellers to change their behavior. Their sellers to change their behavior. Their plans are consistent plans are consistent

Equilibrium, Graphically Equilibrium, Graphically

P Q/t S D E P* Q*

Equilibrium in the Market Equilibrium in the Market

What occurs at equilibrium What occurs at equilibrium

N N Demand side

Demand side -

• those who get the good

those who get the good are those are those willing and able willing and able to pay the P* to pay the P*

N N Supply side

Supply side -

• only those sellers which
• nly those sellers which

are able to produce at or below the cost are able to produce at or below the cost

• f P* will remain in business
• f P* will remain in business

N N Prices ration available supply to those

Prices ration available supply to those who value the good highest who value the good highest

Tendency Toward Tendency Toward Equilibrium in the Market Equilibrium in the Market

N N Note that if the price is

Note that if the price is below P* then there will below P* then there will be a shortage causing be a shortage causing price to rise price to rise

N N If the price is above P*

If the price is above P* then there will be a then there will be a surplus causing price to surplus causing price to fall fall

N N Self interest generates

Self interest generates these price changes these price changes

P Q/t S D P* Q*

An Example An Example--

• -UMR Student

UMR Student Parking Parking

N N It is easiest to see the tendency toward

It is easiest to see the tendency toward equilibrium by looking at a good that is equilibrium by looking at a good that is not not rationed by price rationed by price--

• -student parking

student parking

N N First, ask whether demand and supply curves are

First, ask whether demand and supply curves are typical typical

N N Demand

Demand--

• -is there an inverse relationship between

is there an inverse relationship between the number of parking spots wanted by UMR the number of parking spots wanted by UMR students and the price of the slots? Clearly YES students and the price of the slots? Clearly YES

N N Upward sloping supply? Again yes, the more the

Upward sloping supply? Again yes, the more the administration could extract from students, the administration could extract from students, the less important it would be for them to provide less important it would be for them to provide parking for staff and faculty parking for staff and faculty

UMR Student Parking Market UMR Student Parking Market in Equilibrium in Equilibrium

P Q/t S D P* Q*

Use the hypothetical P* and Q* as benchmarks. Where are actual P and Q relative to P* and Q*?

Where Are Actual P and Q Where Are Actual P and Q Relative to P Relative to P*

* and Q

and Q*?

*?

N N If you said “less than,” go

If you said “less than,” go to the head of the class to the head of the class

N N Administration policy

Administration policy regarding allocation of regarding allocation of scarce parking slots scarce parking slots creates a creates a shortage

shortage

N N In effect there is a price

In effect there is a price ceiling imposed by UMR ceiling imposed by UMR P Q/t S D P* Q*

Pa QD

Shortage Shortage

N N There are a lot more students wanting

There are a lot more students wanting to buy parking permits than UMR is to buy parking permits than UMR is willing to sell willing to sell

N N Why? Because at the current price, the

Why? Because at the current price, the quantity demanded is quite high. But quantity demanded is quite high. But UMR does not want to sell that many at UMR does not want to sell that many at such a low price such a low price

Shortage Shown Graphically Shortage Shown Graphically

P Q/t S D Pa QD

Amount of Shortage

Qa

P* Q*

Note the quantity supplied is the quantity sold: QS = Qa Pa = actual price Qa = actual quantity sold QS

When Price Is Not Used As a When Price Is Not Used As a Rationing Device Shortages Rationing Device Shortages Tend to Persist Tend to Persist

N N Students may act politically

Students may act politically

O O Letters to “

Letters to “the miner the miner” ”

O O Through student government

Through student government

N N Students may exit the market

Students may exit the market--

• -transfer

transfer to another school to another school

N N These are explicit reactions. An

These are explicit reactions. An advantage of price rationing is it is done advantage of price rationing is it is done implicitly implicitly

How Price Rationing Eliminates How Price Rationing Eliminates Shortages Shortages

P Q/t S D E P* Q* Pa QS QD

Buyers who expected to buy are unsatisfied Sellers find they have more buyers than supply

Shortage Eliminated Through Shortage Eliminated Through Price Increases Price Increases

N N Sellers find little resistance to price increases

Sellers find little resistance to price increases

N N Buyers can’t get all they want and are

Buyers can’t get all they want and are willing to pay more willing to pay more

N N P will increase

P will increase

O O Quantity demanded will fall

Quantity demanded will fall

O O Quantity supplied will increase

Quantity supplied will increase

N N The process continues until an equilibrium

The process continues until an equilibrium is established by price rationing is established by price rationing

How Price Rationing How Price Rationing Eliminates Shortages Eliminates Shortages

P Q/t S D E P* Q* Pa QS QD

Quantity demanded falls as price rises Quantity supplied increases as price rises Price continues to rise until: QD = QS

The Role of Prices The Role of Prices

N N Convey information

Convey information

O O When gasoline prices fell below $1.00 in

When gasoline prices fell below $1.00 in Rolla, it told us something about gas Rolla, it told us something about gas--

• -use

use more more

N N Rationing device

Rationing device

O O The price is what determines who can have

The price is what determines who can have the good the good

Student Parking Student Parking

N N Not rationed by price but by some type of

Not rationed by price but by some type of administrative decision administrative decision

O O We use queuing (first come

We use queuing (first come--

• -first served)

first served)

N N Other common rationing devises

Other common rationing devises

O O Alphabetical

Alphabetical

O O The government decides based on need

The government decides based on need

O O Height

Height

O O Gender

Gender

O O Age

Age

O O Location

Location

O O Rank or position

Rank or position

Advantages/disadvantages of Advantages/disadvantages of Queuing Queuing

N N Queuing typically favors those who

Queuing typically favors those who value time less than those that value value time less than those that value time more time more

N N Queuing leads to an outcome that is

Queuing leads to an outcome that is inefficient inefficient

O O Some student who get parking permits

Some student who get parking permits value them less than some students who value them less than some students who do not get permits do not get permits

Surplus, Revisited Surplus, Revisited

N N Surplus

Surplus -

• when Q

when QS

S > Q

> QD

D at current market

at current market price price

• Amount of surplus = Q

Amount of surplus = QS

S -

• Q

QD

D

N N Note

Note -

• it is

it is not not correct correct to say supply to say supply exceeds demand, but rather that quantity exceeds demand, but rather that quantity supplied exceeds quantity demanded supplied exceeds quantity demanded

Surplus Shown Graphically Surplus Shown Graphically

P Q/t S D Pa QD QS

Amount of Surplus

Pa = actual price Qa = actual quantity sold Note the actual quantity sold equals the quantity demanded Qa = QD Qa

Surplus Through Legislated Surplus Through Legislated Price Floors Price Floors

N N Price floor

Price floor -

• sets a minimum price that

sets a minimum price that is allowed by law is allowed by law

N N Result of price floor

Result of price floor

O O No tendency for price to play its rationing

No tendency for price to play its rationing function function

N N Note that a price floor can be set at any

Note that a price floor can be set at any price, but is only effective if it is above price, but is only effective if it is above the equilibrium price the equilibrium price

Price Floor Examples Price Floor Examples

N N Agriculture support prices

Agriculture support prices

O O Price of wheat supported at 80% of parity

Price of wheat supported at 80% of parity

N N 100% parity: setting the price of farm

100% parity: setting the price of farm commodities so they have the same purchasing commodities so they have the same purchasing power they had in the “golden age of power they had in the “golden age of agriculture” 1910 agriculture” 1910-

• 1914

1914

N N FAIR act of 1996

FAIR act of 1996 N N Minimum wage legislation

Minimum wage legislation

O O The conventional story

The conventional story

O O Renewed debate

Renewed debate

Agriculture Price Supports Agriculture Price Supports

N N FAIR: federal agricultural

FAIR: federal agricultural improvement and reform act, signed by improvement and reform act, signed by president Clinton in 1996 president Clinton in 1996

O O FAIR

FAIR: link to the U.S. Dept. Of agriculture : link to the U.S. Dept. Of agriculture to find out more to find out more

O O The act moves to replace price supports

The act moves to replace price supports with direct subsidy of farm income phased with direct subsidy of farm income phased

• ut over time
• ut over time

Price Support Maintained by Price Support Maintained by Government Purchases Government Purchases

P Q/t S D Pa QD QS

Amount of Surplus Pa = actual price, set at 80% of parity QS = quantity farmers want to sell Qa = quantity bought by consumers One policy has taxpayers buying the surplus, QS - Qa paying Pa x (QS - Qa )

Qa

Farm Support Maintained by Deficiency Farm Support Maintained by Deficiency Payments Payments

P Q/t S D Pt QD QS

Pt = target price, set at 80% of parity Pa = market price Qs = quantity farmers want to sell Qa = QS = quantity bought by consumers Deficiency payments are (Pt - Pa) x Qa )

Qa

Pa

Inefficiencies of Pre FAIR Act Inefficiencies of Pre FAIR Act Agriculture Policy Agriculture Policy (Gov.

(Gov. Purchases) Purchases)

N N Government purchases of surplus

Government purchases of surplus

O O Perpetual surpluses

Perpetual surpluses

O O Price sends the wrong signal to farmers

Price sends the wrong signal to farmers

N N Consumers buy only amount they value at target

Consumers buy only amount they value at target price, but farmers produce amount up to where price, but farmers produce amount up to where their marginal cost equal the target price their marginal cost equal the target price

N N The surplus costs more to produce than its worth

The surplus costs more to produce than its worth measured by consumers willingness to pay measured by consumers willingness to pay N N Consumers and taxpayers lose more than

Consumers and taxpayers lose more than farmers gain farmers gain

Inefficiencies of Pre FAIR Act Inefficiencies of Pre FAIR Act Agriculture Policy Agriculture Policy (Deficiency

(Deficiency Payments) Payments)

N N Government deficiency payments

Government deficiency payments

O O Perpetual overproduction but no surpluses

Perpetual overproduction but no surpluses

O O Price sends the wrong signal to farmers

Price sends the wrong signal to farmers

N N Consumers buy all that is brought to market,

Consumers buy all that is brought to market, but marginal cost (= target price) exceeds the but marginal cost (= target price) exceeds the value consumers put on the good value consumers put on the good

N N On the margin the good costs more to produce

On the margin the good costs more to produce than its worth than its worth N N Taxpayers lose more than consumers

Taxpayers lose more than consumers and farmers gain and farmers gain

Price Floors in the Unskilled Labor Price Floors in the Unskilled Labor Market Market--

• -the Minimum Wage

the Minimum Wage

N N When we look at the labor market it is

When we look at the labor market it is similar to other supply and demand similar to other supply and demand diagrams except for the labels diagrams except for the labels

• L

L -

• quantity of workers per period

quantity of workers per period

• W

W -

• wages (the price we pay workers)

wages (the price we pay workers)

N N It is also different because the suppliers

It is also different because the suppliers

• f labor are person, not firms and the
• f labor are person, not firms and the

demanders of labor are firms demanders of labor are firms

Minimum Wage Legislation Minimum Wage Legislation--

• the Conventional Story

the Conventional Story

L* LD LS Wage

# of Workers/t

S D w* wfloor

Amount of Unemployed Workers

Winners and Losers of the Minimum Winners and Losers of the Minimum Wage Wage--

• -the Conventional Story

the Conventional Story

N N Benefit

Benefit -

• those who get higher wages

those who get higher wages

N N Losers

Losers -

• those who can’t find jobs at

those who can’t find jobs at the higher wage the higher wage

N N Losers

Losers -

• firms who must pay higher

firms who must pay higher wages and consumers who have to wages and consumers who have to pay higher prices due to the higher pay higher prices due to the higher costs of the firm costs of the firm

N N Inefficient since the sum of the loses

Inefficient since the sum of the loses exceeds the sum of the benefits exceeds the sum of the benefits

The Minimum Wage The Minimum Wage--

• -a New Debate

a New Debate

N N Any inefficiency that may be created is

Any inefficiency that may be created is small small

N N Equity objectives are furthered by

Equity objectives are furthered by having a “livable” minimum wage having a “livable” minimum wage

N N Due to market power possessed by

Due to market power possessed by firms hiring minimum wage workers, firms hiring minimum wage workers, an increase in the wage may increase an increase in the wage may increase employment employment

N N Increased wages increase labor

Increased wages increase labor productivity by giving workers a productivity by giving workers a “stake” in their effort “stake” in their effort

Demand and Supply of Demand and Supply of Unskilled Labor Are “Steep” Unskilled Labor Are “Steep”

N N Firms that hire unskilled labor are not

Firms that hire unskilled labor are not very sensitive to small changes in the very sensitive to small changes in the minimum wage, so the quantity minimum wage, so the quantity demanded will not change much demanded will not change much

N N Unskilled persons supply of labor are

Unskilled persons supply of labor are not very sensitive to changes in their not very sensitive to changes in their wage wage

N N Thus any unemployment caused by

Thus any unemployment caused by increases in the minimum wage will be increases in the minimum wage will be small small

Unskilled Labor Market Unskilled Labor Market

Wage

# of Workers/t

S D w* wfloor

Amount of Unemployed Workers

Wage

# of Workers/t

S D w* wfloor

Amount of Unemployed Workers

not this but this

Equity Vs. Efficiency Equity Vs. Efficiency

N N Equity objectives are furthered by

Equity objectives are furthered by having a “livable” minimum wage having a “livable” minimum wage

N N This “trade

This “trade-

• off” is in society’s interest
• ff” is in society’s interest

as we seek to do something about the as we seek to do something about the growing inequality of incomes in the growing inequality of incomes in the united states united states

Monopsony Power Monopsony Power

N N Due to market power possessed by

Due to market power possessed by firms hiring minimum wage workers, firms hiring minimum wage workers, an increase in the wage may increase an increase in the wage may increase employment employment

N N You will discuss this in chapter 9

You will discuss this in chapter 9

“Efficiency Wage” “Efficiency Wage”

N N Increased wages increase labor

Increased wages increase labor productivity by giving workers a productivity by giving workers a “stake” in their effort “stake” in their effort

N N Increased productivity lowers cost

Increased productivity lowers cost

• ffsetting, at least partly the higher
• ffsetting, at least partly the higher

wages due to increases in the minimum wages due to increases in the minimum wage wage

How Price Rationing Eliminates How Price Rationing Eliminates Surpluses Surpluses

P Q/t S D P* Q* Pa QS QD

Sellers who expected to sell are unsatisfied Buyers find they have more sellers to choose from

P Q/t S D Pa QD QS

Amount of Surplus

Qe Pe

How Price Rationing Eliminates How Price Rationing Eliminates Surpluses Surpluses

Quantity demanded increases as price falls Quantity supplied decreases as price falls Price continues to fall until: QD = QS

Surplus Eliminated Through Surplus Eliminated Through Price Decreases Price Decreases

N N Buyers find little resistance to lower price

Buyers find little resistance to lower price

• ffers
• ffers

N N Sellers can’t sell all they want and are

Sellers can’t sell all they want and are willing to accept less willing to accept less

N N P will fall

P will fall

O O Quantity demanded will increase

Quantity demanded will increase

O O Quantity supplied will decrease

Quantity supplied will decrease

O O The process continues until an

The process continues until an equilibrium is established by price equilibrium is established by price rationing rationing

The End