Principles of Microeconomics PDF - Chapter 3

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 3 Demand and Supply: An Elaboration Prepared by Ifeanyi Uzoka, Sheridan College ...

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 3 Demand and Supply: An Elaboration Prepared by Ifeanyi Uzoka, Sheridan College  Demand and CHAPTER 3 Supply: An Elaboration Learning Objectives: 1. Understand that even where markets are not competitive, the forces of demand and supply still apply 2. Explain the effects of simultaneous changes in supply and demand on equilibrium price and quantity traded 3. Explain why markets do not always work well © 2024 McGraw Hill 3-2  Demand and CHAPTER 3 Supply: An Elaboration Learning Objectives: 4. Describe why price ceilings cause shortages 5. Demonstrate that price floors cause surpluses 6. Explain how quotas work and what effect they have on production and prices. 7. Explain how sales taxes and subsidies affect markets. © 2024 McGraw Hill 3-3  LO1: Markets Matter © 2024 McGraw Hill 2-4  Markets Matter Even when a big corporation dominates a particular market, supply and demand are still relevant. © 2024 McGraw Hill 3-5  Markets Matter Under what circumstances do the forces of demand and supply determine the price of products? – In what economists term a “perfectly competitive” market – Where there are no big dominant firms and no government interference. © 2024 McGraw Hill 3-6  Markets Matter Note: competitive markets as described in Chapter 2 only work well if they are truly competitive. – Generally, whenever a group of participants are collectively buying or selling in the market, the benefits of competition are seriously reduced. © 2024 McGraw Hill 3-7  Markets Matter EXAMPLE - The firm can price its Fusion car at whatever level it wishes. But, if it wants to sell all of its output, it must sell them at a price of $20,000 or less. If it overprices it at, say, $25,000, the result will be 20,000 unsold vehicles. © 2024 McGraw Hill 3-5  LO2: Simultaneous Changes in Demand and Supply © 2024 McGraw Hill 2-9  Determinants of Demand and Supply Table 3.1 Determinants of Demand and Supply Determinants of Demand Determinants of Supply Consumer preferences Prices of productive resources Consumer incomes Sales taxes and subsidies Prices of related products Technology Expectations of future prices, Prices of substitutes in production incomes, or availability Population: size, income distribution, and age Future expectations of suppliers distribution Number of suppliers © 2024 McGraw Hill 3-6  Simultaneous Changes in Demand and Supply When demand and supply change at the same time, the effect on either the price or quantity is inconclusive (indeterminate) unless we know the magnitude of the changes. © 2024 McGraw Hill 2-11 Simultaneous Increases in Demand and Supply Scenario 1: The demand and supply increase by the same amount: Equilibrium quantity increases but the equilibrium price remains unchanged Note: The price of labour is © 2024 McGraw Hill 3-7 Simultaneous Increases in Demand and Supply Scenario 2: The demand increases more than does the supply: Equilibrium quantity increases and the equilibrium price also increases © 2024 McGraw Hill 3-8  Simultaneous Increases in Demand and Supply Scenario 3: The supply increases more than does the demand Equilibrium quantity increases but the equilibrium price falls © 2024 McGraw Hill 3-9  Simultaneous Increases in Demand and Supply: Conclusion An increase in both the demand and supply leads to an increase in equilibrium quantity but unless we know how much they change, the resulting equilibrium price is indeterminate. © 2024 McGraw Hill 2-15 Simultaneous Changes in Demand and Supply One way to analyse the result of simultaneous changes is by looking at each change separately using arrows: © 2024 McGraw Hill 2-16 Simultaneous Increases in Demand and Supply ↑D ↑S ↑P↑Q ↓P↑Q ?P↑Q © 2024 McGraw Hill 3-(#) Simultaneous Increase in Demand and a Decrease in Supply ↑D ↓S ↑P↑Q ↑P↓Q ↑P?Q © 2024 McGraw Hill 3-(#) Simultaneous Decreases in Demand and an Increase in Supply ↓D ↑S ↓P↓Q ↓P↑Q ↓P?Q © 2024 McGraw Hill 3-(#) Simultaneous Decreases in Demand and Supply ↓D ↓S ↓P↓Q ↑P↓Q ?P↓Q © 2024 McGraw Hill 3-(#)  Test Your Understanding Explain what effect the changes will have on equilibrium price and quantity in the following Market Change Effect markets: Day-care More mothers with small children are returning to __ services the labour force; at the same time, government decides to introduce subsidies for day-care operators. Marijuana Government severely increases the penalties for __ both buying and selling marijuana. Music A new processing method significantly reduces the __ Streamin costs of streaming; at the same time, more g consumers stream music content directly onto their computers. Organic Vegetarianism increases as a result of medical __ vegetable reports extolling its health benefits; at the same s time, tighter regulations on the definition of organically grown products are introduced. © 2024 McGraw Hill 3-10  Test Your Understanding Explain what effect the changes will have on equilibrium price and quantity in the following Market Change Effect markets: Day-care More mothers with small children are returning to the DSP?Q services labour force; at the same time, government decides  to introduce subsidies for day-care operators. Marijuana Government severely increases the penalties for both __ buying and selling marijuana. Music A new processing method significantly reduces the Streaming costs of streaming; at the same time, more __ consumers stream music content directly onto their computers. Organic Vegetarianism increases as a result of medical reports vegetables extolling its health benefits; at the same time, tighter __ regulations on the definition of organically grown products are introduced. © 2024 McGraw Hill 3-10  Test Your Understanding Explain what effect the changes will have on equilibrium price and quantity in the following Market Change Effect markets: Day-care More mothers with small children are returning to the DSP?Q services labour force; at the same time, government decides  to introduce subsidies for day-care operators. Marijuana Government severely increases the penalties for both DSP?Q buying and selling marijuana.  Music A new processing method significantly reduces the Streaming costs of streaming; at the same time, more __ consumers stream music content directly onto their computers. Organic Vegetarianism increases as a result of medical reports vegetables extolling its health benefits; at the same time, tighter __ regulations on the definition of organically grown products are introduced. © 2024 McGraw Hill 3-10  Test Your Understanding Explain what effect the changes will have on equilibrium price and quantity in the following Market Change Effect markets: Day-care More mothers with small children are returning to the DSP?Q services labour force; at the same time, government decides  to introduce subsidies for day-care operators. Marijuana Government severely increases the penalties for both DSP?Q buying and selling marijuana.  Music A new processing method significantly reduces the Streaming costs of streaming; at the same time, more S  D  P Q ? consumers stream music content directly onto their computers. Organic Vegetarianism increases as a result of medical reports vegetables extolling its health benefits; at the same time, tighter __ regulations on the definition of organically grown products are introduced. © 2024 McGraw Hill 3-10  Test Your Understanding Explain what effect the changes will have on equilibrium price and quantity in the following Market Change Effect markets: Day-care More mothers with small children are returning to the DSP?Q services labour force; at the same time, government decides  to introduce subsidies for day-care operators. Marijuana Government severely increases the penalties for both DSP?Q buying and selling marijuana.  Music A new processing method significantly reduces the Streaming costs of streaming; at the same time, more S  D  P Q ? consumers stream music content directly onto their computers. Organic Vegetarianism increases as a result of medical reports vegetables extolling its health benefits; at the same time, tighter S  D  P Q ? regulations on the definition of organically grown products are introduced. © 2024 McGraw Hill 3-10  LO3: How Well Do Markets Work? © 2024 McGraw Hill 2-26  How Well Do Markets Work? Problems with markets: – Markets do not always adjust as quickly as we would like – Markets do not always produce equitable results – Competitive markets may not exist for some goods or services © 2024 McGraw Hill 3-16  LO4: Price Ceilings © 2024 McGraw Hill 2-28  Price Controls When the government regulates the price of a product it is called a Price Control – Price Ceiling: A government regulation stipulating the maximum price that can be charged for a product – Price Floor: A government regulation © 2024 McGraw Hill 3-17 stipulating the minimum price that can be  Price Ceiling Used when present market price for a particular product is considered too high for many buyers – Examples: Necessities during wartime shortages Rent control – Price ceilings cause shortages © 2024 McGraw Hill 3-18  Price Ceiling Example: Rent Control The initial equilibrium is $1000 rent and 100,000 rental units A price ceiling (rent control) of $600 causes a shortage of © 2024 McGraw Hill 3-19  Allocating Shortages How to decide who gets the scarce product? – The market (supply and demand) – Lottery – First come, first served – Producers’ preferences – Rationing by government © 2024 McGraw Hill 3-20  Test Your Understanding Suppose the government introduces an effective price ceiling that is 20 cents different from the present equilibrium price. Would the result be a surplus or a shortage? Of what quantity? If an illegal market were to develop, what would be the © 2024 McGraw Hill 3-21 maximum illegal Test Your Understanding Suppose the government introduces a price ceiling that is 20 cents different from the present equilibrium price. Would the result be a surplus or a shortage? Of what quantity? Shortage of 12,000 L Price = 0.90 © 2024 McGraw Hill 3-21 Test Your Understanding Suppose the government introduces a price ceiling that is 20 cents different from the present equilibrium price. If an illegal market were to develop, what would be the maximum illegal market price? $1.20 © 2024 McGraw Hill 3-21  LO5: Price Floors © 2024 McGraw Hill 2-36  Price Floor Used when present market price for a particular product is considered too low for sellers – Examples: Minimum wages Sometimes in the market for some agricultural products – Price floors cause surpluses © 2024 McGraw Hill 3-24  Price Floor The initial equilibrium is a price of $5/bushel and quantity of 20 million bushels of wheat per year - A price floor of $7/bushel creates a surplus of 10 million bushels of wheat per year © 2024 McGraw Hill 3-25  Price Floor Minimum wage (an example of price floor) may cause unemployment The equilibrium wage is $11/hr at a quantity of 100,000 workers A minimum wage of $15/hr causes a surplus of 20,000 workers (unemployment) © 2024 McGraw Hill 3-26  Dealing with Surpluses What to do with the surplus product? – Store it – Convert it – Sell it abroad at a reduced price (dump) – Donate it – © 2024 McGraw Hill 3-27  Test Your Understanding In equilibrium, what is the total revenue received by producers? Suppose that government imposes a price floor of $4 per kilo. – What quantity will be demanded? – What quantity will farmers produce? – What quantity will government buy? – How much will it cost to buy the surplus? © 2024 McGraw Hill 3-29  Test Your Understanding In equilibrium, what is the total revenue received by producers? TR = Q x P = 5 x 3.50 = $17.50 © 2024 McGraw Hill 3-29  Test Your Understanding Suppose that government imposes a price floor of $4 per kilo. – Q d=4 quantity What million will be bushels demanded? Qs=6 million bushels – What quantity will farmers Buy 6–4 = 2 million produce? bushels – What quantity will government 2 x $4 = $8 buy? million © 2024 McGraw Hill 3-29  LO6: Production Quotas © 2024 McGraw Hill 2-44  Quota A production quota, or restricting output, can raise price without causing a surplus - It is another type of government intervention The equilibrium price is $4 at a quantity of 6 million kilos A quota of 4 million kilos raises the price to $6 © 2024 McGraw Hill 3-28  Test Your Understanding In equilibrium, what is the total revenue received by producers? Suppose that government imposes a production quota of 6 million tonnes. – What will be the new price per tonne? – What will be the total sales revenue? © 2024 McGraw Hill 3-29  Test Your Understanding In equilibrium, what is the total revenue received by producers? TR = Q x P = 8 x 400 = $3200 © 2024 McGraw Hill 3-29  Test Your Understanding Suppose that government imposes a production quota of 6 million tonnes. – What will be the new price per tonne? $600 per tonne – What will be the total sales revenue? TR = Q x P = 6 x 600 © 2024 McGraw Hill 3-29  LO7: Taxes and Subsidies © 2024 McGraw Hill 2-49  Taxes Excise Taxes – a sales tax imposed on a particular products such as alcohol, gasoline and cigarettes – Carbon tax also falls in this category – An excise tax whether imposed on the buyer or the seller will decrease the equilibrium quantity of the product © 2024 McGraw Hill 3-33  Taxes Example: Excise Tax on Energy drinks – a salesprice Equilibrium tax imposed on the product is originally $8. A $2 per case excise tax shifts supply curve left, with the new equilibrium price $9. Consumers pay $9 and the firm gets $7. The tax cost of $2 is shared equally. © 2024 McGraw Hill 3-33  Subsidies Subsidies: Opposite of a tax. – Used by the government to promote economic and social policy – Usually given per unit produced. – Given in the form of direct cash grant, rent rebates, interest free loans, etc. – A subsidy whether given to the buyer or the seller will increase the equilibrium quantity3-33of © 2024 McGraw Hill  Subsidies Example: Subsidy to Egg Producers Original equilibrium price is $2. A $1 per case subsidy shifts supply curve right, with the new equilibrium price $1.5. The equilibrium quantity increases from 40 million to 60 million dozen. © 2024 McGraw Hill 3-34  CHAPTER 3 Key Concepts to Remember 1. Markets work best in a competitive environment 2. The effects on equilibrium price and quantity of simultaneous changes in supply and demand 3. Why markets don’t always work well 4. Why price ceilings create shortages 5. Why price floors create surpluses 6. The effects of quotas, taxes and subsidies © 2024 McGraw Hill 3-35