© 2003 mcgraw-hill ryerson limited using supply and demand chapter 5

© 2003 McGraw-Hill Ryerson Limited

Using Supply and Using Supply and DemandDemand

Chapter 5Chapter 5

© 2003 McGraw-Hill Ryerson Limited

5 - 2

The Power of Supply The Power of Supply and Demandand Demand Changes in supply and demand will

change equilibrium price and quantity.

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5 - 3

The Power of Supply The Power of Supply and Demandand Demand A shift in demand that moves the

demand curve to the right causes equilibrium price and quantity to rise.

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5 - 4

The Power of Supply The Power of Supply and Demandand Demand A shift in supply that moves the supply

curve to the left causes equilibrium price to rise and equilibrium quantity to fall.

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Pric

e (p

er c

ass e

tte)

A

S0

Quantity of cassettes (per week)

$2.50

2.25

0 98 10

Excess demand

D1

A Shift in Demand A Shift in Demand Fig. 5-1a, p Fig. 5-1a, p

105105

D0

B

(a)

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A

A Shift in Supply A Shift in Supply Fig. 5-1b, p Fig. 5-1b, p

105105P

rice

(per

cas

s ett

e)

Quantity of cassettes (per week)

$2.50

2.25

0 98 10

D0

S1S0

C

B Excess demand

(b)

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5 - 7

Six Real World Six Real World Examples of Supply and Examples of Supply and Demand changesDemand changes Supply and demand can shed light on a

variety of real-world events: Brazil freeze. Financial assets and the baby

boomers. Twenty percent excise tax. Rice in Indonesia. Farm labourers. Christmas toys.

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Sugar Shock in BrazilSugar Shock in Brazil

The crop-damaging freeze shifted the supply curve to the left.

At the original price, quantity demanded exceeded quantity supplied.

Price rose until the quantity demanded equaled the quantity supplied.

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Brazil Freeze Brazil Freeze Fig. 5-2c, p 107Fig. 5-2c, p 107

Demand

S0

(c)

P1

Qe

P0

QDQS

S1

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Financial Assets and Financial Assets and the Baby Boomersthe Baby Boomers Demographic changes among baby

boomers moved the demand curve for financial assets to the right.

At the original price, quantity demanded exceeded quantity supplied.

Price rose until the quantity demanded equaled the quantity supplied.

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Financial Assets and Financial Assets and the Baby Boomers the Baby Boomers Fig. 5-2f, p Fig. 5-2f, p

107107

S

(f)

D0

P1

Q1Q0

P0D1

QD

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Housing Market and Housing Market and the Baby Boomersthe Baby Boomers The same phenomenon occurred in the

surging demand for housing among this group during the 1980s.

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Excise TaxesExcise Taxes

Korean Government imposed a 20 percent luxury tax on imported golf clubs.

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Excise TaxesExcise Taxes

A 20 percent tax levied on suppliers shifts the supply curve to the left.

After the tax is imposed, the quantity of imported clubs demanded drops.

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Excise Taxes Excise Taxes Fig. 5-2e, p 107Fig. 5-2e, p 107

S0

D0

P1

Q1

P0

Q0

S1

(e)

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Rice in IndonesiaRice in Indonesia

Drought, pestilence, and the financial crisis shifted the supply curve to the left.

The steep demand curve means that the quantity demanded does not change much with changes in price.

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Rice in IndonesiaRice in Indonesia

Responding to high prices, the government imported rice and distributed it to the market, causing the supply curve to shift to the right.

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Rice in Indonesia Rice in Indonesia Fig. 5-2a, p Fig. 5-2a, p

107107

(a)

S0

Demand

P1

Q1

P2

Q2

P0

Q0

S1 S2

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Farm LabourersFarm Labourers

The compressed harvesting season increased the demand and increased authority border patrols decreased supply of labour.

Demand shifted to the right and supply shifted to the left.

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Farm LabourersFarm Labourers

At the original price, the quantity of workers demanded exceeded the quantity supplied.

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Farm LabourersFarm Labourers

Price rises until the quantity demanded equals the quantity supplied.

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Farm LabourersFarm Labourers

The effect on the number of labourers hired depended on the relative size of the supply shift.

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Farm Labourers Farm Labourers Fig. 5-2b, p 107Fig. 5-2b, p 107

(b)

S0

D0

P1

S1

D1P0

Qe

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Christmas ToysChristmas Toys

A Christmas craze for Furbies shifts demand to the right.

A shortage ensued along with a black market.

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Christmas ToysChristmas Toys

Finally the supplier produced more, shifting the supply curve to the right, causing the price to drop.

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Christmas Toys Christmas Toys Fig. 5-2d, p 107Fig. 5-2d, p 107

(d)

P1

P0

QS0

S0

D0

S1

D1

QD0 QD1

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Effects of Shifts of Effects of Shifts of Demand and Supply on Demand and Supply on Price and Quantity,Price and Quantity, Table 5-1, p Table 5-1, p

110110

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Government Government InterventionsInterventions Buyers look to government for ways to

hold prices down. Sellers look to government for ways to

hold prices up.

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Price CeilingsPrice Ceilings

A price ceiling is a government-imposed limit on how high a price can be charged.

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Rent ControlsRent Controls

Rent control is a price ceiling on rents set by government.

An example is rent control in Paris following World War I and World War II.

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Rent ControlsRent Controls

The following were the consequences of rent control in Paris: A huge shortage of living quarters. New housing construction stopped. Existing housing was allowed to

deteriorate.

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Rent ControlsRent Controls

The following were the consequences of rent control in Paris: For many, the only way to get living

quarters was to offer a huge bribe to the landlord.

Many families had to double up with other family members.

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Rent Controls Rent Controls Fig. 5-3, p 111Fig. 5-3, p 111

QS QD

Supply

Demand

Ren

tal P

rice

(per

mon

th)

Quantity of apartments

2.50

$17.00 Shortage

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Rent ControlsRent Controls

With price ceilings, existing goods are no longer rationed entirely by price

Non-price rationing occurs

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Rent Controls Over Rent Controls Over TimeTime Short run supply for rental units is

relatively fixed (inelastic). In the long run supply is more elastic,

indicating that landowners will increase the quantity of apartments supplied if rents rise, over time.

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Rent Controls Over Rent Controls Over TimeTime Rent controls will set the price below

equilibrium and create shortages. This will cause the short run supply to

decrease.

If rent controls are removed, the short run supply will increase again.

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Rent Controls Over Rent Controls Over Time, Time, Fig. 5-4, p 113Fig. 5-4, p 113

SL

D

Ren

tal P

rice

($ /

mon

th)

Quantity of rental units

SSS’S

A

B

C500

250

1000

750

1250

© 2003 McGraw-Hill Ryerson Limited

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When Rent Controls When Rent Controls WorkWork If a temporary increase in the demand

for housing is expected, rent controls may be effective.

This would create a temporary shortage of housing, but it would prevent high prices and a windfall to landlords.

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When Rent Controls When Rent Controls Work,Work, Fig. 5-5, p 114 Fig. 5-5, p 114

Ren

tal P

rice

Quantity of rental units

SL

D

SS

AB

D’

R0

R1

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Price FloorsPrice Floors

A price floor is a government-imposed limit on how low a price can be charged.

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Minimum WageMinimum Wage

The minimum wage is an example of a price floor.

A minimum wage is set by government specifying the lowest wage a firm can legally pay an employee.

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Minimum WageMinimum Wage

The minimum wage creates winners and losers: Those who can find work earn a higher wage. Others become unemployed. Production costs increase. Consumers pay higher prices.

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Minimum WageMinimum Wage

Economists disagree about the effects of the minimum wage.

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A Minimum Wage,A Minimum Wage, Fig. 5-6, p Fig. 5-6, p

115115W

age

(per

hou

r)

Quantity of workers

S

D

We

Wmin

QeQ2 Q1

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Taxes, Tariffs, and Taxes, Tariffs, and QuotasQuotas An excise tax is a tax that is levied on a

specific good. A tariff is an excise tax on an imported

good. Taxes and tariffs raise prices and

reduce quantity exchanged.

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The Effect of an Excise The Effect of an Excise Tax on Price and Tax on Price and QuantityQuantity A luxury tax on jewellery manufactured

in Canada is imposed.

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The Effect of an Excise The Effect of an Excise Tax on Price and Tax on Price and QuantityQuantity Because the luxury tax was imposed on

the jewellery manufacturers, the supply curve shifted up by the amount of the tax.

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The Effect of an Excise The Effect of an Excise Tax on Price and Tax on Price and QuantityQuantity At a price equal to the original price plus

the tax there was excess supply. The price for rings rose by less than the

tax, while quantity supplied and demanded fell.

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$610

510

S1

420

$620

D

S0

Quantity of rings

0

Pric

e of

rin

gs

The Effect of an Excise The Effect of an Excise Tax Tax Fig. 5-7, p 116Fig. 5-7, p 116

The supply curve shifts up by the $20 tax

$600

600

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Quantity Restrictions: Quantity Restrictions: QuotasQuotas A quota is a quantitative restriction on

the amount that can be bought or sold. In international trade, it is a restriction

on the amount one nation can export to another.

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Quantity Restrictions: Quantity Restrictions: QuotasQuotas The Canadian government restricted

imports of Japanese cars. The effect was to raise the prices of

Japanese automobiles in Canada.

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5

Supply

Demand

20,000

8

$27,000

16,000

Japanese exports of cars (in millions)

Quantity Restrictions: Quantity Restrictions: Quotas Quotas Fig. 5-8a, p 117Fig. 5-8a, p 117

Quota

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The Relationship The Relationship Between a Quota and a Between a Quota and a TariffTariff Tariffs and quotas can both be used to

reduce quantity and raise prices.

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The Relationship The Relationship Between a Quota and a Between a Quota and a TariffTariff There is a difference between imposing

a tariff and imposing a quota. In the case of a quota, the profits from a

higher price goes to the manufacturer. In the case of the tariff, the tax goes to

the government.

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The Relationship The Relationship Between a Quota and a Between a Quota and a TariffTariff As a consequence, once quotas are

instituted, Japanese firms competed intensely to get them.

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The Relationship The Relationship Between a Quota and a Between a Quota and a Tariff Tariff Fig. 5-8b, p 117Fig. 5-8b, p 117

Japanese exports of cars

S1

Demand

Pric

e of

Jap

anes

e ca

rs

S0Tariff

revenue 20,000

8

$11,000

16,000

$27,000

5

© 2003 McGraw-Hill Ryerson Limited

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The Limitations Of The Limitations Of Supply And Demand Supply And Demand AnalysisAnalysis It is not enough to be able to explain

what happens when supply or demand curves shift.

It is necessary to understand the assumptions underlying the analysis.

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The Limitations Of The Limitations Of Supply And Demand Supply And Demand AnalysisAnalysis Other things don't remain constant. Sometimes supply and demand are interconnected. Supply/demand analysis is the first step to analysis,

not the complete analysis.

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The Limitations Of The Limitations Of Supply And Demand Supply And Demand AnalysisAnalysis Deciding whether the effects are

significant to consider requires a knowledge of the structure of the economy because all actions have ripple or feedback effects.

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The Limitations Of The Limitations Of Supply And Demand Supply And Demand AnalysisAnalysis The other-things-constant assumption

will likely not hold true when one analyses the goods which represent a large percentage of the entire economy.

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Using Supply and Using Supply and DemandDemand

End of Chapter 5End of Chapter 5