Carlos Andres Rodriguez Herrera 1 26 23 Principles of Macroeconomics ECON 2002 01 Chapter 4 Extensions of Demand and Supply Analysis Introduction In recent years shoppers have experiences a type of sticker shock when they find that prices of used cars are only slightly lower than prices of new models You can use the concept of simultaneous shifts in supply and demand to explain why we observe this outcome in the vehicle market Chapter 4 will show you how to represent the effects of a simultaneous change in supply and demand Learning Objectives Discuss the essential features of the price system Evaluate the effects of changes in demand and supply on the market price and equilibrium quantity Understand the rationing function of prices Describe various types of government imposed quantity restrictions on markets Explain the effects of price ceilings Explain the effects of price floors Chapter Outline The Price System and Markets Changes in Demand and Supply The Rationing Function of Prices The Policy of Government Imposed Price Controls The Policy of Controlling Rents Price Floors in Agriculture Price Floors in the Labor Market Quantity Restrictions The Price System and Markets Price System or Market System Voluntary Exchange An economic system in which relative prices are constantly changing to reflect changes in supply and demand a The prices are signals as to what is relatively scarce and relatively abundant b Prices provide information to individuals and businesses c Changes in supply and demand influence our use of resources An act of trading between individuals in the price system Make both parties to the trade subjectively better off Terms of exchange the prices we pay for desired items determined by forces of supply and demand The majority of exchanges take place voluntarily in markets The Ohio State University 1 a A market encompasses the exchange arrangement of both buyers and sellers Transaction Costs All of the costs associated with exchange Including The role of middlemen a The informational costs of finding out the price and quality service record and durability of a product b The cost of contracting and enforcing that contract The more organized the market the lower the transaction costs Middlemen intermediaries or brokers reduce transaction costs by providing information to buyers and sellers Whenever producers do not sell their products directly to the final consumer one or more middlemen are involved Examples a Real estate brokers b Stock brokers c Consignment shops d Car dealerships Changes in Demand and Supply Changes in supply and demand create a disequilibrium The market price and quantity adjust to a new equilibrium 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 equilibrium quantity Decreases in supply increase equilibrium price and decrease equilibrium quantity If both the supply and demand curves shift simultaneously the outcome is indeterminate for either equilibrium price or equilibrium quantity The resulting effect depends upon how much each curve shifts When both demand and supply change When both demand supply increase Change in equilibrium price is indeterminate Equilibrium and quantity increases unambiguously When both demand supply decrease Change in equilibrium price is indeterminate Equilibrium quantity decreases unambiguously When supply decreases demand increases Equilibrium price increases The change in the equilibrium quantity is uncertain without more information When supply increases demand decreases Equilibrium price decreases The change in the equilibrium quantity is uncertain without more information Price flexibility Prices quite flexible in some markets can be less flexible in other market scenarios a May take the form of subtle adjustments such as hidden payments quality changes b May not reach equilibrium right away Adjustment speed Market characteristics influence adjustment speed Markets may overshoot in the adjustment process Carlos Andres Rodriguez Herrera 1 26 23 Markets are subject to energy shocks labor strikes sever weather The Rationing Function of Prices Synchronization of decision of buyers and sellers that leads to equilibrium is called the rationing function of prices Methods of non price rationing Rationing by queues waiting in line Rationing by random assignment or coupons The essential role of rationing Implied by the presence of scarcity Price vs non price rationing mechanism a Price rationing leads to the most efficient use of available resources b All gains from mutually beneficial trade are captured in a freely rationing price system The Policy of Government Imposed Price Controls Government mandated minimum or maximum prices Price Controls Price Ceiling Price Floor A legal minimum price Price ceiling and black markets A legal maximum price that is below equilibrium A price ceiling may prevent the equilibrium price from being achieved if it is above the ceiling price A price ceiling that is set below the market clearing price creates a shortage Non Price Rationing Devices Black Market All methods used to ration scarce goods that are price controlled A market in which price controlled goods are sold at an illegally high price The Policy of Controlling Rents The functions of rental prices Promote the efficient maintenance and construction of housing Allocate existing housing Ration the use of housing Rent controls and construction Controls discourage construction a With a 16 vacancy rate and no controls Dallas recently built 11 000 new rental units b With a 1 6 vacancy rate and controls San Francisco recently built 2 000 new rental units Effects on the existing supply of housing and current use of housing Property owners cannot recover costs a Maintenance repairs capital improvements Rations the current use of housing a Reduces mobility e g New York s housing gridlock Attempts to evade rent controls Forcing tenants to leave Tenants subletting apartments Housing courts Who wins and who loses from rent controls The Ohio State University 3 Losers Winners a Property owners b Low income individuals a Upper income professionals Price Floors in Agriculture Support Price The government chooses a price floor for a product and the acts to ensure that the price of the product never falls below the support level a Associated with may agricultural products b A price floor that is set above