Chapter. Demand and Supply CHAPTER IN PERSPECTIVE

Transcription

1 Demand and Supply Chapter 4 CHAPTER IN PERSPECTIVE The tools of demand and supply explain how competitive markets work. We use the demand and supply tools to determine the quantities and prices of the goods and services produced and consumed. Distinguish between quantity demanded and demand and explain what determines demand. The quantity demanded is the amount that buyers are willing and able to buy during a specified period at a specified price. The law of demand states that other things remaining the same, if the price of a good falls (rises), the quantity demanded of that good increases (decreases). A demand curve graphs the relationship between the quantity demanded of a good and its price. A change in price leads to a change in the quantity demanded, a movement along the demand curve. Influences on buying plans that change demand are: prices of related goods (substitutes and complements); income; expectations; number of buyers; and preferences. If demand increases (decreases), the demand curve shifts rightward (leftward). Distinguish between quantity supplied and supply and explain what determines supply. The quantity supplied is the amount that sellers will sell during a specified period at a specified price. The law of supply states that other things remaining the same, if the price of a good falls (rises), the quantity supplied decreases (increases). A supply curve graphs the relationship between the price and the quantity supplied. A change in price creates a change in the quantity supplied, a movement along the supply curve. Influences on selling plans that change supply are: prices of related goods; prices of inputs; expectations; number of sellers; and productivity. If supply increases (decreases), the supply curve shifts rightward (leftward). Explain how demand and supply determine price and quantity in a market and explain the effects of changes in demand and supply. The equilibrium price is the price at which the quantity demanded equals the quantity supplied, and the quantity at this price is the equilibrium quantity. An increase (decrease) in demand raises (lowers) the price and increases (decreases) the quantity. An increase (decrease) in supply lowers (raises) the price and increases (decreases) the quantity. An increase (decrease) in both demand and supply increases (decreases) the quantity but the effect on the price is ambiguous. An increase in demand and a decrease in supply raises the price but the effect on the quantity is ambiguous. A decrease in demand and an increase in supply lowers the price but the effect on the quantity is ambiguous. Explain how price ceilings, price floors, and sticky prices cause shortages, surpluses, and unemployment. A price ceiling set below the equilibrium price creates a shortage. A price floor set above the equilibrium price creates a surplus. Sticky prices can create temporary shortages or surpluses.

2 52 Part 1. INTRODUCTION EXPANDED CHAPTER CHECKLIST When you have completed this chapter, you will be able to: 1 Distinguish between quantity demanded and demand and explain what determines demand. Define quantity demanded. State and explain the law of demand. Define demand, demand schedule, and demand curve. Illustrate the law of demand using a demand schedule and a demand curve. List the influences on buying plans that change demand. Distinguish between a change in the quantity demanded and a change in demand. 2 Distinguish between quantity supplied and supply and explain what determines supply. Define quantity supplied. State and explain the law of supply. Define supply, supply schedule, and supply curve. Illustrate the law of supply using a supply schedule and a supply curve. List the influences on selling plans that change supply. Distinguish between a change in the quantity supplied and a change in supply. 3 Explain how demand and supply determine the price and quantity in a market and explain the effects of changes in demand and supply. Determine the equilibrium price and quantity in a supply and demand diagram. Indicate the amount of a surplus or shortage if the price is not the equilibrium price. Illustrate the effects of a change in demand and a change in supply. 4 Explain how price ceilings, price floors, and sticky prices cause shortages, surpluses, and unemployment. Explain the effect of a price ceiling. Explain the effect of a price floor. Discuss why some prices might be sticky and illustrate how sticky prices create shortages or surpluses. KEY TERMS demanded (page 83) Law of demand (page 83) Demand (page 83) Demand schedule (page 84) Demand curve (page 84) Change in the quantity demanded (page 85) Change in demand (page 85) Substitute (page 85) Complement (page 85) Normal good (page 85) Inferior good (page 85) supplied (page 88) Law of supply (page 88) Supply (page 88) Supply schedule (page 89) Supply curve (page 89) Change in the quantity supplied (page 90) Change in supply (page 90) Substitute in production (page 90) Complement in production (page 90) Market equilibrium (page 93) Equilibrium price (page 93) Equilibrium quantity (page 93) Surplus or excess supply (page 94) Shortage or excess demand (page 94) Price ceiling (page 101) Rent ceiling (page 101) Price floor (page 103) Minimum wage law (page 103)

3 Chapter 4. Demand and Supply 53 CHECKPOINT 4.1 Distinguish between quantity demanded and demand and explain what determines demand. Practice Problem 4.1 In the market for scooters, several events occur, one at a time. Explain the influence of each event on the quantity demanded of scooters and on the demand for scooters. Illustrate the effects of each event by either a movement along the demand curve or a shift in the demand curve for scooters and say which event (or events) illustrates the law of demand in action. These events are: a. The price of a scooter falls. b. The price of a bicycle falls. c. Citing rising injury rates, cities and towns ban scooters from sidewalks. d. Income increases. e. Rumor has it that the price of a scooter will rise next month. f. Scooters become unfashionable and the number of buyers decreases. Solution to Practice Problem 4.1 This problem emphasizes the distinction between a change in the quantity demanded and a change in demand. Quick Review Change in the quantity demanded A change in the quantity of a good that people plan to buy that results from a change in the price of the good. Law of demand A rise in the price of a good brings a decrease in the quantity demanded of that good; a fall in the price of a good brings an increase in the quantity demanded of that good. Change in demand A change in the quantity that people plan to buy when any influence on buying plans, other than the price of the good, changes. These other influences include: prices of related goods, income, expectations, number of buyers, and preferences. a. The price of a scooter falls. A fall in the price of a scooter brings an increase in the quantity demanded of scooters, which is illustrated by a movement down along the demand curve for scooters. This event illustrates the law of demand in action. b. The price of a bicycle falls. A bicycle is a substitute for a scooter. With the lower price of a bicycle, some people who would previously have bought a scooter will now buy a bicycle instead. So a fall in the price of a bicycle decreases the demand for scooters. The demand curve for scooters shifts leftward. c. Citing rising injury rates, cities and towns ban scooters from sidewalks. Rising injury rates and banning scooters from sidewalks changes preferences. The demand for scooters decreases and the demand curve for the scooters shifts leftward. d. Income increases. A scooter is Price (dollars per scooter) probably a normal good. So, people will buy more scooters when their income increases. D 1 The demand for D scooters increases 0 and the demand (scooters per week) curve shifts rightward as illustrated in the figure. e. Rumor has it that the price of a scooter will increase next month. A rise in the expected future price of a scooter increases the demand for scooters now. The demand curve shifts rightward. f. Scooters become unfashionable and the number of buyers decreases. A decrease in the number of buyers decreases the demand for scooters. The demand curve shifts leftward.

4 54 Part 1. INTRODUCTION Additional Practice Problem 4.1a Price (dollars per scooter) (scooters per week) The information in the table shows the demand schedule for scooters in a town. Using this information, label the axes in Figure 4.1 and then graph the demand curve. FIGURE 4.1 Solution to Additional Practice Problem 4.1a The axes are labeled and the demand curve is graphed in Figure 4.2. FIGURE 4.2 Price (dollars per scooter) (scooters per week) Self Test 4.1 D Fill in the blanks The (demand schedule; law of demand) states that other things remaining the same, if the price of a good rises, the (quantity demanded of; demand for) that good decreases. A is a graph of the relationship between the quantity demanded of a good and its price. Demand curves are (downward; upward) sloping. An increase in demand shifts the demand curve. Factors that change demand lead to a (shift of; movement along) the demand curve. Factors that change demand are,,,, and. True or false 1. The law of demand states that other things remaining the same, if the price of a good rises, the quantity demanded of that good increases. 2. If the quantity of ice cream demanded at each price increases and other influences on buying plans do not change, there is a movement along the demand curve for ice cream. 3. When Sue s income increases, her demand for movies increases. For Sue, movies are a normal good. 4. If average income falls and all other influences on buying plans remain the same, the demand for computers will decrease and there will be a movement along the demand curve. Multiple choice 1. Other things remaining the same, the quantity of a good or service demanded will increase if the price of the good or service a. rises. b. falls. c. does not change. d. rises or falls. 2. Hot dogs and hot dog buns are complements. If the price of a hot dog falls, then a. the demand for hot dogs will increase. b. the demand for hot dog buns will decrease. c. the quantity demanded of hotdogs will decrease. d. the demand for hot dog buns will increase.

5 Chapter 4. Demand and Supply Over the next few years the number of buyers in the market for sport utility vehicles decreases sharply. As a result, a. the demand curve for sport utility vehicles shifts leftward. b. the demand curve for sport utility vehicles shifts rightward. c. there is neither a shift nor a movement along the demand curve for sport utility vehicles. d. there is a movement downward along the demand curve for sport utility vehicles. 4. When moving along a demand curve, which of the following changes? a. the consumers incomes b. the prices of other goods c. the number of buyers d. the price of the good 5. If the price of a CD falls, a. the demand for CDs will increase and the demand curve for CDs will shift rightward. b. the demand for CDs will be unaffected, so the demand curve for CDs will not shift. c. the quantity of CDs demanded will increase and there will be a movement along the demand curve for CDs. d. Both answers (b) and (c) are correct. 6. Pizza and tacos are substitutes and the price of a pizza rises. Which of the following correctly indicates what happens? a. The demand for pizzas decreases and the demand for tacos increases. b. The demand for both goods decreases. c. The quantity of tacos demanded increases and the quantity of pizza demanded decreases. d. The quantity of pizza demanded decreases and the demand for tacos increases. Complete the graph 1. The demand schedule for cotton candy is given in the following table. In Figure 4.3, draw the demand curve. Label the axes. Price (dollars per bundle of cotton candy) (bundles of cotton candy per month) 1 10, , , ,000 a. If the price of cotton candy is $2 a bundle, what is the quantity demanded? b. If the price of cotton candy is $3 a bundle, what is the quantity demanded? c. Does the demand curve you drew slope upward or downward? FIGURE 4.3 Short answer and numeric questions 1. Explain the difference between a change in the quantity demanded and a change in demand. 2. What is the difference between a movement along a demand curve and a shift of a demand curve? CHECKPOINT 4.2 Distinguish between quantity supplied and supply and explain what determines supply. Practice Problem 4.2 In the market for timber beams, several events occur one at a time. Explain the influence of each event on the quantity supplied of timber beams and the supply of timber beams. Illustrate the effects of each event by either a

6 56 Part 1. INTRODUCTION movement along the supply curve or a shift in the supply curve of timber beams and say which event (or events) illustrates the law of supply in action. These events are a. The wage rate of sawmill workers rises. b. The price of sawdust rises. c. The price of a timber beam rises. d. The price of a timber beam is expected to rise next year. e. Environmentalists convince Congress to introduce a new law that reduces the amount of forest that can be cut for timber products. f. A new technology lowers the cost of producing timber beams. Solution to Practice Problem 4.2 Practice Problem 4.2 stresses a key point, the distinction between a change in the quantity supplied and a change in supply. Quick Review Change in the quantity supplied A change in the quantity of a good that suppliers plan to sell that results from a change in the price of the good. Change in supply A change in the quantity that suppliers plan to sell when any influence on selling plans, other than the price of the good, changes. These other influences include: prices of related goods, prices of inputs, expectations, number of sellers, and productivity. a. The wage rate of sawmill workers rises. Sawmill workers are resources used to produce timber beams. So a rise in their wage rate decreases the supply of timber beams and shifts the supply curve leftward, as illustrated. Price (dollars per unit) S 1 (units per month) S 0 b. The price of sawdust rises. Sawdust is produced when timber beams are produced, so sawdust and timber beams are complements in production. A rise in the price of a complement in production increases the supply of timber beams and the supply curve of timber beams shifts rightward. c. The price of a timber Price (dollars per unit) beam rises. S The law of supply states that a rise in the price of a good increases the quantity supplied. So a rise in the price of a (units per month) timber beam increases the quantity of timber beams supplied and there is a movement up along the supply curve as shown in the figure. d. The price of a timber beam is expected to rise next year. The higher price expected next year decreases the current supply of beams as producers store their beams in order to sell them at the (expected) higher price next year. The supply curve of timber beams shifts leftward. e. Environmentalists convince Congress to introduce a new law that reduces the amount of forest that can be cut for timber products. The new law decreases the supply of timber beams. The supply of trees decreases and so the price of a tree, a resource for timber beams, rises. The supply curve of beams shifts leftward. f. A new technology lowers the cost of producing timber beams. With the lower cost from the new technology, the supply of timber beams increases. The supply curve shifts rightward. Additional Practice Problem 4.2a The information in the table shows the supply schedule for scooters in a town. Using this in-

7 Chapter 4. Demand and Supply 57 formation, label the axes in Figure 4.4 and then graph the supply curve. Price (dollars per scooter) (scooters per week) FIGURE 4.4 Solution to Additional Practice Problem 4.2a The axes are labeled and the supply curve is graphed in Figure 4.5. FIGURE 4.5 Price (dollars per scooter) (scooters per week) Self Test 4.2 Fill in the blanks The (quantity supplied; supply) of a good is the amount people are willing and able to sell during a specified period at a specified price. The law of supply states that other things remaining the same, if the price of a good rises, the quantity supplied. A supply curve is (upward; downward) sloping. A change in S the price of a good changes (supply; the quantity supplied) and is illustrated by a the supply curve. Factors that change supply are,,,, and. True or false 1. The law of supply states that other things remaining the same, if the price of a good rises, the quantity supplied increases. 2. If the wage rate paid to chefs rises and all other influences on selling plans remain the same, the supply of restaurant meals will increase. 3. If the price of coffee is expected to rise next month, the supply of coffee this month will decrease. 4. When new technology for producing computers is used by manufacturers, the supply of computers increases. Multiple choice 1. The quantity supplied is during a specified period and at a specified price. a. the amount that people are able to sell b. the amount that people are willing to sell c. the amount that people are able and willing to sell d. the amount that people are willing and able to buy 2. An increase in supply is shown by a a. rightward shift of the supply curve. b. leftward shift of the supply curve. c. movement up along the supply curve but no shift in the supply curve. d. movement down along the supply curve but no shift in the supply curve. 3. If the costs to produce pizza increase, which will occur? a. The supply of pizza will decrease. b. The quantity of pizzas supplied will increase as sellers try to cover their costs. c. Pizza will cease to be produced and sold. d. The demand curve for pizza will shift leftward when the price of a pizza increases.

8 58 Part 1. INTRODUCTION 4. A rise in the price of a substitute in production for a good will lead to a. an increase in the supply of that good. b. a decrease in the supply of that good. c. no change in the supply of that good. d. a decrease in the quantity of that good supplied. 5. A technological advancement in the production of jeans will bring about which of the following? a. The quantity of jeans supplied will increase. b. The supply of jeans will increase. c. Buyers will demand more jeans because they are now more efficiently produced. d. The impact on the supply of jeans is impossible to predict. 6. Suppose the price of leather used to produce shoes increases. As a result, there is in the supply of shoes and the supply curve of shoes shifts. a. an increase; rightward b. an increase; leftward c. a decrease; rightward d. a decrease; leftward Complete the graph 1. Suppose that the supply schedule for cotton candy is given in the table below. In Figure 4.3, you previously drew a demand curve for cotton candy. Now use the supply schedule to draw the supply curve in Figure 4.3. Price (dollars per bundle of cotton candy) (bundles of cotton candy per month) 1 4, , , ,000 a. If the price of cotton candy is $2 a bundle, what is the quantity supplied? b. If the price of cotton candy is $3 a bundle, what is the quantity supplied? c. Does the supply curve you drew slope upward or downward? FIGURE 4.6 Price (dollars per box of rubber bands) (boxes of rubber bands per year) 2. Figure 4.6 shows a supply curve for rubber bands. Suppose the technology used to produce rubber bands advances. In Figure 4.6, illustrate the effect of this event. FIGURE 4.7 Price (dollars per ton of copper) S (tons of copper per year) 3. Figure 4.7 shows a supply curve for copper. The cost of the natural gas used to refine copper ore into copper rises. In Figure 4.7, show the effect of this event. Short answer and numeric questions 1. What is the law of supply? 2. What influence(s) lead to a change in the quantity supplied? 3. What influences(s) cause a change in supply? S

9 Chapter 4. Demand and Supply 59 CHECKPOINT 4.3 Explain how demand and supply determine price and quantity in a market and explain the effects of changes in demand and supply. Practice Problem 4.3 Price (dollars per carton) demanded (cartons per day) supplied The table shows the demand and supply schedules for milk: a. What is the market equilibrium in the milk market? b. Describe the situation in the milk market if the price is $1.75 a carton. c. If the price is $1.75 a carton, explain how the market reaches equilibrium. d. A drought decreases the quantity supplied by 45 cartons a day at each price. What is the new equilibrium and how does the market adjust to it? e. Milk becomes more popular and the quantity demanded increases by 5 cartons a day at each price. Improved feeds for dairy cows increase the quantity of milk supplied by 50 cartons a day at each price. If there is no drought, what is the new equilibrium and how does the market adjust to it? Solution to Practice Problem 4.3 This Practice Problem uses the idea of market equilibrium and puts to work all you learned in the previous checkpoints about changes in demand and supply. Quick Review Market equilibrium When the quantity demanded equals the quantity supplied. a. What is the market equilibrium in the milk market? Scan the table to find the row in which the quantity supplied and the quantity demanded are equal. The price that equates quantity demanded and quantity supplied is the equilibrium price and, in the table, is $1.50 per carton. The equilibrium quantity is 150 cartons per day. b. Describe the situation in the milk market if the price is $1.75 a carton. At prices that are higher than the equilibrium price, the quantity supplied will exceed the quantity demanded, so there is a surplus. At a price of $1.75 per carton, the surplus is 45 cartons (170 cartons minus 125 cartons). c. If the price is $1.75 a carton, explain how the market reaches equilibrium. The surplus means that sellers cannot sell all the milk they have for sale, 170 cartons. The price falls, which increases the quantity demanded and decreases the quantity supplied. The price falls to its equilibrium level. d. A drought decreases the quantity supplied by 45 cartons per day at each price. What is the new equilibrium and how does the market adjust to it? The new supply curve shifts leftward by 45 cartons a day at each price. At the old equilibrium price of $1.50 a carton, there now is a shortage of milk. The law of markets tells us that the price rises. The (new) equilibrium price is $1.75 a carton and the (new) equilibrium quantity is 125 cartons a day. e. Milk becomes more popular and the quantity demanded increases by 5 cartons a day at each price. Improved feeds for dairy cows increase the quantity of milk supplied by 50 cartons a day at each price. If there is no drought, what is the new equilibrium and how does the market adjust to it? The change in preferences shifts the demand curve rightward by 5 cartons a day at all prices and the advanced technology shifts the supply curve rightward by 50 cartons. Because the increase in supply exceeds the increase in demand, at the initial equilibrium price there is a surplus. The price falls until it reaches its new equilibrium of $1.25 a carton. At $1.25 a carton, the (new) quantity demanded equals the (new)

10 60 Part 1. INTRODUCTION quantity supplied at the equilibrium quantity of 180 cartons a day. Additional Practice Problem 4.3a The price of a hot dog bun falls and, simultaneously, the number of hot dog producers increases. The effect of the fall in the price of a hot dog bun is less than the effect of the increase in the number of producers. What happens to the equilibrium price and quantity of hot dogs? Solution to Additional Practice Problem 4.3a The fall in the price of a complement, Price (dollars per hot dog) S 0 hot dog S 1 buns, increases P 0 the demand for P 1 hot dogs and the demand curve for hot dogs shifts D 1 D 0 Q 0 Q 1 (hot dogs per month) rightward. The increase in the number of producers increases the supply of hot dogs and the supply curve shifts rightward. Because the increase in supply exceeds the increase in demand, the price of a hot dog falls and the quantity increases, as shown in the figure. Self Test 4.3 Fill in the blanks The price at which the quantity demanded equals the quantity supplied is the. In a diagram, the is determined where the supply and demand curves intersect. If the price exceeds the equilibrium price, the price (rises; falls). An increase in demand (raises; lowers) the equilibrium price and (increases; decreases) the equilibrium quantity. An increase in supply (raises; lowers) the equilibrium price and (increases; decreases) the equilibrium quantity. If both the demand and supply increase, definitely the equilibrium increases but the effect on the equilibrium is ambiguous. True or false 1. If the price of asparagus is below the equilibrium price, there is a shortage of asparagus and the price of asparagus will rise until the shortage disappears. 2. When the demand for skateboards decreases and the supply of skateboards remains unchanged, the quantity supplied of skateboards decreases as the price rises. 3. As summer comes to an end and winter sets in, the demand for and supply of hamburger buns decrease. The price of a hamburger bun will definitely remain the same. 4. The number of buyers of grapefruit juice increases and at the same time severe frost decreases the supply of grapefruit juice. The price of grapefruit juice will rise. Multiple choice 1. The equilibrium price of a good occurs when the a. quantity of the good demanded equals the quantity of the good supplied. b. quantity of the good demanded is greater than the quantity of the good supplied. c. quantity of the good demanded is less than the quantity of the good supplied. d. demand for the good is equal to the supply of the good. 2. Which of the following is correct? a. A surplus puts downward pressure on the price of a good. b. A shortage puts upward pressure on the price of a good. c. There is no surplus or shortage at equilibrium. d. All of the above answers are correct.

11 Chapter 4. Demand and Supply Which of the following is the best explanation for why the price of gasoline rises and the quantity increases during the summer months? a. Oil producers have higher costs of production in the summer. b. Sellers have to earn profits during the summer to cover losses in the winter. c. There is increased driving by families going on vacation. d. There is less competition among oil refineries in the summer. 4. Suppose that the price of lettuce used to produce tacos increases. As a result, the equilibrium price of a taco and the equilibrium quantity. a. rises; increases b. rises; decreases c. falls; increases d. falls; decreases 5. The technology associated with manufacturing computers has advanced enormously. This change has led to the equilibrium price of a computer and the equilibrium quantity. a. rising; increasing b. rising; decreasing c. falling; increasing d. falling; decreasing 6. During 2003 the supply of petroleum decreased while at the same time the demand for petroleum increased. If the magnitude of the increase in demand was greater than the magnitude of the decrease in supply, which of the following occurred? a. The equilibrium price of gasoline increased and the equilibrium quantity increased. b. The equilibrium price of gasoline increased and the equilibrium quantity decreased. c. The equilibrium price of gasoline increased and the equilibrium quantity did not change. d. The equilibrium price of gasoline decreased and the equilibrium quantity did not change. Complete the graph 1. In Checkpoint 4.1 you drew a demand curve in Figure 4.3; in Checkpoint 4.2, you drew a supply curve in that figure. Return to Figure 4.3 and answer the following questions. a. If the price of cotton candy is $1 a bundle, what is the situation in the market? b. If the price of cotton candy is $3 a bundle, what is the situation in the market? c. What is the equilibrium price and equilibrium quantity of cotton candy? Short answer and numeric questions 1. How is a shortage different from a surplus? Price (dollars per sweatshirt) demanded (sweatshirts per season) supplied (sweatshirts per season) The table gives the demand and supply schedules for sweatshirts. At what price will the quantity demanded be equal to the quantity supplied? What is the equilibrium quantity? 3. People read that drinking orange juice helps prevent heart disease. What is the effect on the equilibrium price and quantity of orange juice? 4. The cost of memory chips used in computers falls. What is the effect on the equilibrium price and quantity of computers? 5. The demand for Japanese yen (the currency of Japan) increases while simultaneously the Japanese government decreases the supply of yen. What is the effect on the price of yen?

12 62 Part 1. INTRODUCTION CHECKPOINT 4.4 Explain how price ceilings, price floors, and sticky prices cause shortages, surpluses, and unemployment. Practice Problems The figure shows the rental market for apartments in Corsicana, Texas. a. What is the rent and how many apartments are rented? b. If the city government Rent (dollars per month) 1,200 1, (thousands of apartments) imposes a rent ceiling of $900 a month, what is the rent and how many apartments are rented? c. If the city government imposes a rent ceiling of $600 a month, what is the rent and how many apartments are rented? 2. The figure shows Wage rate (dollars per hour) the market for 10 tomato pickers in southern California: 6 8 S a. What is the 4 equilibrium D wage rate of 2 tomato pickers and what 3,000 4,000 5,000 is the equilibrium quantity (pickers) of tomato pickers employed? b. If California introduces a minimum wage for tomato pickers of $4 an hour, how many tomato pickers are employed and how many are unemployed? c. If California introduces a minimum wage for tomato pickers of $8 an hour, how many tomato pickers are employed and how many are unemployed? S D Solution to Practice Problems 4.4 These problems study cases in which markets cannot adjust to their equilibrium. In later chapters we use these ideas to help explain unemployment and the overall level of production in the economy. Quick Review Price ceiling The highest price at which it is legal to trade a good, service, or factor of production. An interest rate ceiling is a price ceiling. Price floor The lowest price at which it is legal to trade a good, service, or factor of production. The minimum wage is a price floor. 1a. What is the rent and how many apartments are rented? At equilibrium, the quantity supplied equals the quantity demanded. The equilibrium rent is $800 a month and the equilibrium quantity of apartments rented is 3,000. 1b. If the city government imposes a rent ceiling of $900 a month, what is the rent and how many apartments are rented? With a rent ceiling of $900 a month, apartments cannot be rented for more than $900. Because the equilibrium rent is below $900, this requirement has no effect. The rent remains at $800 a month and 3,000 apartment are rented. 1c. If the city government imposes a rent ceiling of $600 a month, what is the rent and how many apartments are rented? The rent ceiling is Rent (dollars per month) below the equilibrium rent. The rent 1,200 cannot adjust to 1,000 the equilibrium amount, $800. The 800 rent will be $600 a month, equal to 600 Ceiling the ceiling rate, and the quantity of apartments rented is 1,000, determined from the supply curve. D (thousands of apartments)

13 Chapter 4. Demand and Supply 63 2a. What is the equilibrium wage rate of tomato pickers and what is the equilibrium quantity of tomato pickers employed? The quantity supplied equals the quantity demanded at a wage rate of $6 an hour. $6 an hour is the equilibrium wage rate. The equilibrium quantity of tomato pickers employed is 4,000. 2b. If California introduces a minimum wage for tomato pickers of $4 an hour, how many tomato pickers are employed and how many are unemployed? The minimum wage of $4 an hour is less than the equilibrium wage, so the minimum wage has no effect. The wage rate remains equal to $6 an hour. Zero pickers are unemployed and 4,000 pickers are employed. 2c. If California introduces a minimum wage for tomato pickers of $8 an hour, how many tomato pickers are employed and how many are unemployed? The minimum wage is above the equilibrium wage of $6 an hour, so the wage cannot adjust to its equilibrium. The figure shows that at the minimum wage, the quantity demanded is 3,000 pickers, so 3,000 pickers will be Wage rate (dollars per hour) 10 Minimum 8 wage S employed. But 5,000 people would like to work, so 2,000 pickers (5,000 3,000) are unemployed. 3,000 4,000 5,000 (pickers) Additional Practice Problem 4.4a What is a sticky price and how can a sticky price in the labor market create unemployment? Solution to Additional Practice Problem 4.4a A sticky price occurs when buyers and sellers agree on a price for a fixed period of time or a seller sets a price that changes infrequently. Many workers have contracts with their employers in which the wage rate to be paid for D several years is specified. This wage rate can create unemployment when the demand for labor decreases. The wage rate cannot fall to its new equilibrium value. At the relatively high sticky wage, the quantity of labor demanded is less than the quantity of labor supplied. The surplus of workers are unemployed. Self Test 4.4 Fill in the blanks A price (ceiling; floor) is the highest price at which it is legal to trade a particular good, service, or factor of production. In order to affect the market price and quantity, a price floor must be set (above; below) the equilibrium price. A minimum wage is an example of a price (ceiling; floor). A minimum wage creates unemployment when it is set (above; below) the equilibrium wage rate. Sticky prices (can; cannot) create unemployment. True or false 1. A rent ceiling always lowers the rent paid. 2. A minimum wage is an example of a price ceiling. 3. Firms hire labor, so they determine how much labor to supply in a market. 4. When firms enter into long-term contracts with labor unions that fix wage rates for several years, the wage rate is sticky. Multiple choice 1. Price ceilings a. prevent the market price from going above a certain value. b. prevent the market price from going below a certain value. c. keep the market prices higher than would otherwise be the case. d. match the quantity demanded with the quantity supplied of any given good or service.

14 64 Part 1. INTRODUCTION 2. When the government imposes a price ceiling on a product below the equilibrium price, the government creates a. a shortage. b. a surplus. c. equilibrium in the market. d. None of the above answers is correct. 3. To affect the market s price and quantity, a price floor must be set a. above the equilibrium price. b. below the equilibrium price. c. at the equilibrium price. d. None of the above answers are correct. 4. The minimum wage is an example of a. an equilibrium price. b. a price floor. c. a price ceiling. d. None of the above answers is correct. 5. A two-year labor contract is an example of a a. price ceiling. b. price floor. c. sticky price. d. shortage. 6. The result of sticky prices in a market is a. quicker adjustment of prices. b. no adjustment of prices. c. a slower adjustment of prices. d. to change the price but not the quantity bought and sold. Short answer and numeric questions Price (cents per kilowatt-hour) demanded (kilowatt-hours) supplied (kilowatt-hours) 17 2,700 2, ,900 2, ,100 2, ,300 2, ,500 2, ,700 2, The table gives the demand and supply schedules for electricity. At what price will the quantity demanded be equal to the quantity supplied? Suppose the government tries to keep the price of electricity low by setting a price ceiling of 7 per kilowatt. What is the impact of this price ceiling? 2. What is the effect of a minimum wage set below the equilibrium wage rate? Set above the equilibrium wage rate? Explain why your answers to the two questions differ. Complete the graph 1. In Checkpoint 4.1 you drew a demand curve in Figure 4.3; in Checkpoint 4.2, you drew a supply curve in that figure. Return to Figure 4.3 and answer the following questions. a. Suppose the government imposes a price ceiling for cotton candy of $1. What is the situation in the market? b. Suppose the government imposes a price floor for cotton candy of $3. What is the situation in the market? c. How do your answers to parts (a) and (b) compare with your answers to Checkpoint 4.3 complete the graph question parts (a) and (b)?

15 Chapter 4. Demand and Supply 65 SELF TEST ANSWERS CHECKPOINT 4.1 Fill in the blanks The law of demand states that other things remaining the same, if the price of a good rises, the quantity demanded of that good decreases. A demand curve is a graph of the relationship between the quantity demanded of a good and its price. Demand curves are downward sloping. An increase in demand shifts the demand curve rightward. Factors that change demand lead to a shift of the demand curve. Factors that change demand are prices of related goods, income, expectations, number of buyers, and preferences. True or false 1. False; page False; page True; page False; page 85 Multiple choice 1. b; page d; page a; page d; page d; page d; page 86 Complete the graph 1. Figure 4.8 (above) illustrates the demand curve, labeled D in the diagram. a. 8,000 bundles per month b. 7,000 bundles per month c. The demand curve slopes downward. Short answer and numeric questions 1. A change in the quantity demanded occurs when the price of the good changes. A change in demand occurs when any other influence on buying plans other than the price of the good changes; page A movement along a demand curve reflects a change in the quantity demanded and is the result of a change in the price of the good. FIGURE 4.8 Price (dollars per bundle of cotton candy) ,000 4,000 6,000 8,000 10,000 12,000 (bundles of cotton candy per month) A shift of a demand curve reflects a change in demand and is the result of a change in any influence on buying plans other than the price of the good; page 83. CHECKPOINT 4.2 Fill in the blanks The quantity supplied of a good is the amount people are willing and able to sell during a specified period at a specified price. The law of supply states that other things remaining the same, if the price of a good rises, the quantity supplied increases. A supply curve is upward sloping. A change in the price of a good changes the quantity supplied and is illustrated by a movement along the supply curve. Factors that change supply are prices of related goods, prices of resources and other inputs, expectations, number of sellers, and productivity. True or false 1. True; page False; page True; page True; page 91 Multiple choice 1. c; page a; page a; page b; page 90 D S

16 66 Part 1. INTRODUCTION 5. b; page d; page 91 Complete the graph 1. The supply curve is illustrated in Figure 4.8, labeled S in the diagram. a. 8,000 bundles per month b. 10,000 bundles per month c. The supply curve slopes upward. FIGURE 4.9 Price (dollars per box of rubber bands) S 0 S 1 (boxes of rubber bands per year) 2. An advance in technology increases the supply. Figure 4.9 illustrates the shift of the supply curve; page 90. FIGURE 4.10 Price (dollars per ton of copper) S 1 S 0 (tons of copper per year) 3. A rise in the price of a resource decreases the supply. Figure 4.10 illustrates the leftward shift of the supply curve; page 90. Short answer and numeric questions 1. If other things remain the same, when the price of a good falls (rises), the quantity supplied of that good decreases (increases); page Change in the price of the good; page Changes in: prices of related goods; prices of resources and other inputs; expectations; number of sellers; and productivity; page 90. CHECKPOINT 4.3 Fill in the blanks The price at which the quantity demanded equals the quantity supplied is the equilibrium price. In a diagram, the equilibrium price is determined where the supply and demand curves intersect. If the price exceeds the equilibrium price, the price falls. An increase in demand raises the equilibrium price and increases the equilibrium quantity. An increase in supply lowers the equilibrium price and increases the equilibrium quantity. If both the demand and supply increase, definitely the equilibrium quantity increases but the effect on the equilibrium price is ambiguous. True or false 1. True; page False; page False; page True; page 99 Multiple choice 1. a; page d; page c; page b; page c; page a; page 99 Complete the graph 1. a. A shortage of 6,000 bundles a day; page 94. b. A surplus of 3,000 bundles a day; page 94. c. The equilibrium price is $2 a bundle of cotton candy and the equilibrium quantity is 8,000 bundles a day; page 94.

17 Chapter 4. Demand and Supply 67 Short answer and numeric questions 1. When a shortage exists, the price of the good is below the equilibrium price. The quantity demanded is greater than the quantity supplied. When a surplus exists, the price of the good is above the equilibrium price. The quantity demanded is less than the quantity supplied; page The quantity demanded equals the quantity supplied when the price is $25. The equilibrium quantity is 19 sweatshirts; page The increase in preferences increases the demand for orange juice and the demand curve shifts rightward. The price of orange juice rises and the quantity increases; page The fall in cost increases the supply of computers. The supply curve of computers shifts rightward. The price falls and the quantity increases; page The increase in demand shifts the demand curve for yen rightward. The decrease in supply shifts the supply curve of yen leftward. The price of a yen rises; page 98. CHECKPOINT 4.4 Fill in the blanks A price ceiling is the highest price at which it is legal to trade a particular good, service, or factor of production. In order to affect the market price and quantity, a price floor must be set above the equilibrium price. A minimum wage is an example of a price floor. A minimum wage creates unemployment when it is set above the equilibrium wage rate. Sticky prices can create unemployment. True or false 1. False; page False; page False; page True; pages Multiple choice 1. a; page a; page a; pages b; page c; pages c; page 105 Complete the graph 1. a. With a price ceiling of $1, there is a shortage of 6,000 bundles; page 102. b. With a price floor of $3, there is a surplus of 3,000 bundles; page 104. c. The shortages and surpluses in the answers above are the same as the shortages and surpluses in the answers to questions in Checkpoint 4.3. Government-imposed price ceilings and floors create shortages and surpluses exactly the same way that non-equilibrium prices create shortages and surpluses, though government created shortages and surpluses persist as long as the policies persist; pages 102, 104. Short answer and numeric questions 1. The quantity demanded equals quantity supplied at the equilibrium price of 17 per kilowatt-hour. A price ceiling of 7 per kilowatt is below the equilibrium price. At the price ceiling, the quantity demanded is 3,700 kilowatt-hours and the quantity supplied is 2,100 kilowatt-hours, so a shortage of 1,600 kilowatt-hours exists; page A minimum wage set below the equilibrium wage rate has no effect. The minimum wage is the lowest legal wage. When set below the equilibrium wage rate, the equilibrium wage remains legal. Nothing is changed because the market wage remains equal to the equilibrium wage. When the minimum wage is set above the equilibrium wage, the equilibrium wage becomes illegal. The wage becomes the minimum wage. At the higher minimum wage, the quantity of labor demanded is less than the quantity of labor supplied and unemployment results; page 104.

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