04 markets in action

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Chapter 4Markets in Action

• Key Concepts• Summary• Practice Quiz• Internet Exercises

©2000 South-Western College Publishing

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In this chapter, you will learn to solve these economic puzzles:

How does the spotted owl affect the price

of homes?

Why might government warehouses overflow with

cheese and milk?

What do ticket scalping and rent controls have

in common?

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What can cause a shift in a Demand Curve?

1. Number of buyers in the market2. Tastes and preferences3. Income4. Expectations of consumers5. Prices of related goods* Return to previous slide while in slide show

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$1200

$600

$300

4 8 12 16

D1

The Effects of Shift in Demand on Market Equilibrium

D2

Shortage$900

SP

Q

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$40

$30

$10

10 20 30 40D2

S

D1

Surplus$20


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Increase in Demand

Increase in Equilibrium

Price

Increase in Quantity Supplied

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Decrease in Demand

Decrease in Equilibrium

Price

Decrease in Quantity Supplied

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What can cause a shift in a Supply Curve?

1. Number of sellers in the market2. Technology3. Resource prices4. Taxes and subsidies5. Expectations of producers

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$4

$1

20 40 60 80D

Surplus$3

$2

S1

The Effects of Shift in Supply on Market Equilibrium

S2

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$800

$200

2 4 6 8D

Shortage$600 S1

S2

$400

The Effects of Shift in Supply on Market Equilibrium

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Increase in Supply

Decrease in Equilibrium

Price

Increase in Quantity

Demanded

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Decrease in Supply

Increase in Equilibrium

Price

Decrease in Quantity

Demanded

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Can the Laws of Demand and Supply be repealed?

In some markets, the objective of politicians is to prevent prices from reaching the equilibrium price

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What are the two types of price controls?

Price ceilingsPrice floors

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What is a Price Ceiling?A legally established

maximum price a seller can charge

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$800

$600

$400

$200

2 4 6 8

D

SRent Control Results in a Shortage of Rental Units

ShortageRent ceiling

P

Q

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Rent Ceiling

Quantity Demanded exceeds the

quantity supplied

Shortage

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What is the purpose of Price Ceilings on Rent?

So needy people will pay lower rent than the equilibrium rent

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Why may Rent Controls be counterproductive?

• Shortages• Illegal markets• Less maintenance• Discrimination

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What are other examples of Price Ceilings?

Wage and price controlsUsury laws

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What is a Price Floor?A legally established

minimum price a seller can be paid

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Wm

We

QD QE QS

D

S

A Minimum Wage Results in a Surplus of Labor

UnemploymentMinimum wage

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Minimum wage

Unemployment

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What are examples of Price Floors?

Minimum wage lawAgricultural price supports

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Why do we have Price Ceilings and Floors?

Because of failures in the free market

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What is Market Failure?A situation in which the

price system creates a problem for society or fails to achieve society’s goals

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Who was Adam Smith?The father of modern

economics who wrote The Wealth of Nations, published in 1776

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What did Adam Smith say about Competition?

There must be competition for markets to function properly

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What happens when Competition is lacking?

Market failure results

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$2000

$500

50 100 200

Rigging the Personal Computer Market

D

$1500

S1S2

$1000

250

$2500

300150

Inefficient equilibrium

Efficient equilibrium

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What is an example of another Market Failure?

Externalities

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What is an Externality?A cost or benefit imposed

on people other than the consumers and producers of a good or service

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What is aNegative Externality?

An externality that is detrimental to third parties

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What is an example of a Negative Externality?

Pollution

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P2

Q1

External Cost of Pollution

P1

S1S2

Q2

Includes external costs of pollution

Excludes external costs of pollution

D

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What is aPositive Externality?

An externality that is beneficial to third parties

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What is an example of a Positive Externality?

Vaccinations

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$10

Q1 Q2

D1

S

External Benefits of AIDS Vaccinations

D2P1

Excludes Vaccination benefits

Includes Vaccination benefits

P2

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External costs


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External benefits


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What is another example of a Positive Externality?

Public Goods

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What is a Public Good?A good that, once produced,

has two properties: (1) users collectively

consume benefits (2) no one can be excluded

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What are examples of Public Goods?

• National defense• Public education• Roads

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What is another example of Market Failure?

Income inequality

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Key Concepts

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Key Concepts• What can cause a shift in a Demand Curve?• What can cause a shift in a Supply Curve?• What are the two types of price controls?• What is a Price Ceiling?• What is a Price Floor?• Why do we have Price Ceilings and Floors?• What is Market Failure?

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Key Concepts cont.• What happens when Competition is lacking?• What is an Externality?• What is a Negative Externality?• What is a Positive Externality?• What is a Public Good?• What is another example of Market Failure?

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Summary

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Price ceilings and price floors are maximum and minimum prices enacted by law, rather than allowing the forces of supply and demand to determine prices. A price ceiling is a maximum price mandated by government, and a price floor is a minimum legal price.

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$800

$600

$400

$200

2 4 6 8

D

SIf a price ceiling is set below the

equilibrium price, a shortage will persist

ShortageRent ceiling

P

Q

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Wm

We

QD QE QS

D

S

If a price floor is set above the equilibrium price, a surplus will persist

UnemploymentMinimum wage

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Market failure means that the market mechanism does not achieve desirable results. Sources of market failure include lack of competition, externalities, public goods, and income inequality. Although controversial, government intervention is a possible way to correct market failure.

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An externality is a cost or benefit of a good imposed on people who are not buyers or sellers of that good. Pollution is an example of an external cost, which means too many resources are used to produce the product responsible for the pollution. Two basic approaches to solve this market failure are taxes (like in pollution taxes) and regulation (like in vaccinations).

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P2

Q1

External Cost of Pollution

P1

S1S2

Q2

Includes external costs of pollution

Excludes external costs of pollution

D

55Q1 Q2

D1

S

External Benefits of AIDS Vaccinations

D2P1

Excludes Vaccination benefits

Includes Vaccination benefits

P2

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Public goods are goods that are consumed by everyone regardless of whether they pay or not. National defense, air traffic control, and other public goods can benefit many individuals simultaneously and are provided by the government.

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Chapter 4 Quiz

©2000 South-Western College Publishing

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1. Suppose prices for new homes have risen, yet sales of new homes have also risen. We can conclude that a. the demand for new homes has risen.b. the law of demand has been violated.c. new firms have entered the construction

industry.d. construction firms must be facing higher

costs.A. The demand for new homes has risen

causing the price to increase and the quantity of new homes to increase as illustrated on the next page.

59Q1 Q2

D1

S

An increase in demand for new homes

D2P1

P2

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2. Which of the following statements if true of a market? a. An increase in demand, with no change in

supply, will increase the equilibrium price and quantity.

b. An increase in supply, with no change in demand, will decrease the equilibrium price and the equilibrium quantity.

c. A decrease in supply, with no change in demand, will decrease the equilibrium price and increase the equilibrium quantity.

d. all of the above are true.

A. See previous graph.

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3. Consider the market for chicken. An increase in the price of beef willa. decrease the demand for chicken, creating a

lower price and a smaller amount of chicken purchased in the market.

b. decrease the supply of chicken, creating a higher price a and a smaller amount of chicken purchased in the market.

c. increase the demand for chicken, creating a higher price and a greater amount of chicken purchased in the market.

d. increase the supply of chicken, creating a lower price and a greater amount of chicken purchased in the market.

C. An increase in the price of beef will cause an increase in the demand for chicken because beef and chicken are substitutes.

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4. An increase in consumer income increases the demand for oranges. As a result of the adjustment to a new equilibrium, there is a (an) a. leftward shift of the supply curve.b. downward movement along the supply

curve.c. rightward shift of the supple curve.d. upward movement along the supply curve.

D. As the demand curve shifts to the right along the upward sloping supply curve, there is a movement along the supply curve as illustrated on the next page.

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$1200

$600

$300

4 8 12 16

D1


D2

Shortage$900

SP

Q

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5. An increase in the wage paid to grape pickers will cause the a. demand curve for grapes to shift to the

right, resulting in higher prices for grapes.b. demand curve for grapes to shift to the

left, resulting in lower prices for grapes.c. supply curve for grapes to shift to the left,

resulting in lower prices for grapes.d. supply curve for grapes to shift to the left,

resulting in higher prices for grapes.D. An increase in costs is one factor that will

cause the supply curve to shift to the left as production becomes more expensive as illustrated on the next page.

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$800

$200

2 4 6 8D

Shortage$600 S1

S2

$400

The Effects of Shift in Supply on Market EquilibriumP

Q

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6. If the federal government wants to raise the price of cheese, it willa. take cheese from government storage and

sell it.b. encourage farmers to research ways to

produce more cheese.c. subsidize purchases of farm equipment.d. encourage farmers to produce less cheese.

D. As the supply curve for cheese shifts to the left and moves along a downward sloping demand curve, equilibrium price will increase as illustrated on the next page.

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$800

$200

2 4 6 8D

Shortage$600 S1

S2

$400

The Effects of Shift in Supply on Market EquilibriumP

Q

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7. Which of the following is least likely to result from rent controls set below the equilibrium price for rental housing?a. Shortages and black markets.b. Deterioration of existing rental housing.c. The supply of rental housing will increase

rapidly.d. People will demand more apartments

than are available.C. The supply curve will shift to the left, not

to the right, as suppliers produce fewer rental units due to the lower price and lower profits.

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8. Suppose the equilibrium price set by supply and demand is lower than the price ceiling set by the government. The result will bea. a shortage.b. that quantity demanded is equal to

quantity supplied.c. a surplus.d. a black market.

B. The purpose of price ceilings is to set a maximum price by law. If it is set lower than the equilibrium price, it will have no effect on the equilibrium price as illustrated on the next page.

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$800

$600

$400

$200

2 4 6 8

D

SRent Control Results in a Shortage of Rental Units

ShortagePrice ceiling

P

Q

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9. A good that provides external benefits to society hasa. too few resources devoted to production.b. too many resources devoted to its production.c. the optimal resources devoted to its

production.d. not provided profits to producers of the good.

A. An external benefit is an unintentional byproduct of the market.

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10. Pollution from cars is an example of a (an)a. harmful opportunity cost.b. negative externality.c. production dislocation.d. none of the above.

B. A negative externality imposes costs on third parties when drivers discharge pollution into the air, they erode the quality of life of others.

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11. Which of the following is the best example of a public good?a. Pencils.b. Education.c. Defense. d. Trucks.

C. None of the other answers fit the definition of a public good. A public good is something from which everyone benefits and no one can be excluded.

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12. A public good may be defined as any good or service thata. allows users to collectively consume

benefits.b. must be distributed equally to all

citizens in equal shares.c. is never produced by government.d. answers a and c above.

A. Once a public good is provided, for instance a road, everyone collectively benefits from it.

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Internet ExercisesClick on the picture of the book,

choose updates by chapter for the latest internet exercises

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END

04 markets in action

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