Fluent Essays

DUE IN 24 HOURS INSTRUCTIONS ARE ATTACHED Chapter 1 Discussion Chapter 1 discusses how economists use the standard  scientific method  to answer who, what, and how questions in studying economics. How have you applied the scientific method, or a similar process, in your school or work life? Post your response on the Discussion Board, citing evidence from research articles or periodicals found in the library’s research databases, such as The Wall Street Journal, Barron’s, or Fortune, and/or from government sources. Be sure to include enough details so that your classmates can understand the findings, and be sure to include the titles and URLs of articles in support of your position. Chapter 2 Discussion What is meant by the term "creative destruction"? How does the emergence of self driving cars relate to this idea? Post your response on the Discussion Board, citing evidence from research articles or periodicals found in the library’s research databases, such as The Wall Street Journal, Barron’s, or Fortune, and/or from government sources. Be sure to include enough details so that your classmates can understand the findings, and be sure to include the titles and URLs of articles in support of your position. Chapter 3 Discussion This chapter discusses the  paradox of thrift  . A paradox is a statement that seems to be a contradiction. In the paradox of thrift cycle, each individual's prudent action(s) have unintended consequences. The paradox of thrift is an example of a concept that the whole is greater than the sum of its parts. What has happened in your personal life that illustrates the paradox of thrift? Post your response on the Discussion Board, citing evidence from research articles or periodicals found in the library’s research databases, such as The Wall Street Journal, Barron’s, or Fortune, and/or from government sources. Be sure to include enough details so that your classmates can understand the findings, and be sure to include the titles and URLs of articles in support of your position. Chapter 2 The Market System and the Circular Flow Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. This chapter begins with a brief comparison of command and laissez-faire systems, then transitions to a discussion of the characteristics of a market system. The five fundamental questions faced by every economy are presented along with how a market economy answers each one. A discussion of Adam Smith’s “invisible hand” leads into an explanation of why command systems have failed. The circular flow model provides an overview of how resources and goods move through a market system. The chapter includes a discussion of how a market system deals with risk. The Last Word provides a look at the vast number of ways resources could be arranged and why this doesn’t result in randomness. * 2-* Economic Systems Economic systems Set of institutionalized arrangements Coordinating mechanism Differences in systems exist by Degree of decentralized use of markets and prices in decision-making Degree of centralized government control LO1 Economic systems are a set of institutional arrangements and a coordinating mechanism to solve economic problems. Economic systems differ in how much decentralized decision-making is enjoyed in the country versus how much centralized government command and control is used to direct economic activity in that country. * 2-* Laissez-Faire Capitalism Ideal economy “Keep the government from interfering with the economy” Power of government just needed to Protect private property from theft Provide a legal environment for contract enforcement People interact in markets to buy and sell LO1 Laissez-faire capitalism is the ideal economic system that Adam Smith envisioned in his book “The Wealth of Nations”. There is no need for government interference in markets because the system is a self-correcting one. In laissez-faire systems, the role of government is limited to providing a legal environment for protection of private property and to enforcement of private contracts. * 2-* The Command System The command system is known as socialism or communism Government ownership of resources Decisions made by a central planning board North Korea, Cuba, Myanmar LO1 Resources are owned by the government and economic activity is coordinated by a central planning board. This means that what is produced, how much is produced and the prices that are charged for the output are determined by the central planning board. Many countries formerly under communist or socialist control have begun reducing their reliance on central planning and implementing more market-oriented systems. However, there are still some mainly communist countries like North Korea, Cuba, and Myanmar. * 2-* The Market System The market system is a mix of decentralized decision making with some government control Systems found in much of the world Private markets are dominant force Private ownership of resources Self-interested behavior LO1 With a market system, resources are owned by private individuals and institutions. Markets and prices coordinate and direct economic activity. Each participant acts in his or her own self-interest. Monetary rewards are possible but not without some degree of financial risk. In the U.S. version of capitalism, the government plays a substantial role. * 2-* Characteristics of the Market System Private property Freedom of enterprise Freedom of choice Self-interest Competition Market and prices LO2 Private individuals and firms own most of the private property resources of land and capital. Private property, coupled with the freedom to negotiate binding legal contracts, enables individuals and businesses to obtain, control, use, and dispose of this property. Private property rights encourage investment, innovation, exchange of assets, maintenance of property, and economic growth. Property rights extend to intellectual property through patents, copyrights, and trademarks. Freedom of enterprise means that entrepreneurs and businesses have the freedom to obtain and use resources, to produce products of their choice, and to sell these products in the markets of their preference. Freedom of choice means that owners of property and money resources can use resources as they choose, workers can choose the training, occupations, and job of their choice, consumers are free to spend their income in such a way as to best satisfy their wants. Self interest is one of the driving forces in a market system. Entrepreneurs try to maximize profits or minimize losses; resource suppliers try to maximize income; consumers maximize satisfaction. As each tries to maximize profits, income, and satisfaction, the economy will benefit if competition is present. Competition requires two or more independently acting buyers and sellers. This serves to decentralize economic power. Also, it requires freedom to enter or leave the markets. Markets and prices is the characteristic that reflects the decisions made on each side of the market and determines the set of product and resource prices that guide owners, entrepreneurs and consumers as they all make choices based on their respective self-interests. * 2-* Global Perspective LO2 The Index of Economic Freedom measures economic freedom using 10 economic freedoms such as trade policy, property rights, and government intervention. The index then ranked 179 economies according to their degree of economic freedom. A few selected rankings for 2012 are listed here. * 2-* Technology and Capital Goods Advanced technology and capital goods are encouraged Specialization Division of labor Geographic specialization LO2 Market systems reward individuals and businesses for development of new technologies thereby encouraging their development and implementation. Specialization allows economies to take better advantage of their resources and their capabilities. Division of labor or human specialization increases productivity by making use of differences in abilities, fostering learning by doing, and saving time. Geographic specialization can be regional or it can be international. * 2-* Use of Money Money makes trade easier Medium of exchange Without money, people would have to barter LO2 It is much easier to sell what you produce for money and then buy what you want. Otherwise, you would have to barter for what you want which means that you not only have to find someone that has what you want, but also wants what you have. Money is socially defined, whatever society accepts as a medium of exchange is money. * 2-* Active, but Limited Government Government may be needed to alleviate market failures Government can increase effectiveness of a market system Possible government failure LO2 Although the market system promotes efficiency, it has certain shortcomings. There can be an over production of goods that have social costs and an underproduction of goods that have social benefits. There are tendencies for businesses to increase monopoly power. Though, governments also have shortcomings that lead to misallocation of resources. * 2-* The Five Fundamental Questions What goods and services will be produced? How will the goods and services be produced? Who will get the goods and services? How will the system accommodate change? How will the system promote progress? LO3 These five questions highlight the economic choices underlying the production possibilities model. All economies whether a market system, or otherwise, must address these questions. * 2-* What Will Be Produced? Goods and services that create a profit Consumer sovereignty “Dollar votes” Method for consumers to determine which goods will be produced Determines which products and industries survive or fail LO3 Profit is the difference in total revenues and total costs. In a market system, the consumer ultimately decides what will be produced through their dollar votes for a product. If there are not enough “votes” for a product, the firm will cease production of that product. Businesses must match their production choices with consumer choices or else face losses and bankruptcy. * 2-* How Will the Goods Be Produced? Minimize the cost per unit by using the most efficient techniques Technology Prices of the necessary resources LO3 When firms face competition, the market forces the producers to use the most efficient production techniques, otherwise the firm will be driven out of business. The combination of technology and the prices of the required resources determines the most efficient production technique. * 2-* How Will the Goods Be Produced? LO3 Three Techniques for Producing $15 Worth of Bar Soap Price per unit of Resource Units of Resource Technique 1 Technique 2 Technique 3 Resource Units Cost Units Cost Units Cost Labor $2 4 $ 8 2 $ 4 1 $ 2 Land $1 1 1 3 3 4 4 Capital $3 1 3 1 3 2 6 Entrepreneur $3 1 3 1 3 1 3 $ 15 $ 13 $ 15 The producer will rationally choose the least costly method because it is this method that leads to the greatest profit (or to loss minimization). Total Revenue – Total Cost = Economic Profit or Loss. Here $15 – 13 = $2 economic profit. * 2-* Who Will Get the Output? Consumers with the ability and willingness to pay will get the product Ability to pay depends on income LO3 A market system is based on the willingness to pay principle which means if the consumer is willing and able to pay, the consumer gets the product. The ability to pay depends on income which depends on the amount of resources the person has and the price those resources obtain in the market. * 2-* How Will the System Change? Changes in consumer tastes Changes in technology Changes in resource prices LO4 A market system is a dynamic environment and is able to quickly adapt to changes in consumer tastes and preferences. The business firm will find it in their best interest to make the changes reflected in the consumer choices. The market system acts like a giant communications system. The consumers communicate their preferences through their dollar votes, the business then responds to this by producing more, or less, or none of the product. This will soon be reflected in the demand for the resources employed in the production of the product. When technology and resource prices change, this affects the costs the producer faces when producing the good, changing the amount of the good that will be produced and the price of the good. * 2-* How Will the System Progress? Technological advance Creative destruction Capital accumulation LO4 The market system promotes technological improvements and capital accumulation. An entrepreneur or firm that introduces a popular new product will be rewarded with increased revenue and profits. New technologies that reduce production costs, and thus product price, will spread rapidly throughout the industry as a result of competition. Creative destruction occurs when new products and production methods destroy the market positions of firms that are not able or willing to adjust. The market system leads to even greater capital accumulation as it provides the resources necessary to produce more capital goods through the increased dollar votes for capital goods. The entrepreneurs and business owners are able to purchase more capital goods as they become more and more profitable. * 2-* The Invisible Hand The “invisible hand” 1776 Wealth of Nations by Adam Smith Unity of private and social interest Virtues of the market system Efficiency Incentives Freedom LO4 Adam Smith is often referred to as the “father of economics.” His emphasis on the role of self‑interest in motivating economic activity is especially important. Self-interested behavior of both the business and the suppliers of resources result in the greatest amount of economic efficiency possible. The market system guides resources into the production of the goods and services most desired by society. It enforces use of the most efficient production techniques while encouraging new production techniques. The market system encourages skill acquisition and hard work because you will be rewarded for your efforts. Entrepreneurs and workers are free to make choices based on their own self-interest. * 2-* The Demise of Command Systems Command system was a failure Soviet Union, Eastern Europe, and China The coordination problem Set output targets for all goods The incentive problem No adjustments for surplus or shortage LO4 Failures along the supply chain were common because one factory’s output was another factory’s input. A failure at any step along the way would cause a chain reaction. This became more difficult as the economies grew. There were no indicators of success like in a market system where we have profit or loss to indicate how successful the business firm is. There were no price signals to indicate more or less of a product was desired resulting in surpluses and shortages. * 2-* The Circular Flow Model The circular flow diagram Households Businesses Sole proprietorship Partnership Corporation Product market and the resource market The real flow and the money flow LO5 The circular flow diagram is a simple economic model showing a private closed economy in which there is only a private sector consisting of households and businesses who interact with each other in the markets. The real flow consists of resources flowing from households and used in producing products that flow from businesses. The money flow facilitates the workings of the economic system. Households are housing units occupied by one or more persons. Businesses combine resources and attempt to earn profits for the owners by offering goods and services for sale. Businesses are generally one of three basic types. The sole proprietorship is a business owned and managed by a single person. A partnership is a business owned and managed by two or more persons and a corporation is an independent legal entity that can engage in any legal business activity. * 2-* The Circular Flow Model RESOURCE MARKET Households sell Businesses buy PRODUCT MARKET Businesses sell Households buy BUSINESSES buy resources sell products HOUSEHOLDS sell resources buy products LO5 A simplified dynamic economy of continuous flows of goods and services, resources, and money. This simple economy consists of households and businesses and there is no government. Households are the owners of the resources (selling their resources in the resource market) and income flows into the households. Households are the ones who buy the goods and services in the products market. The prices that are paid in the products market are determined by supply and demand. Businesses buy the resources providing income to the households. Businesses buy the resources to produce goods and services that are then sold in the products market to households. When firms sell their products, the money that they receive is called revenue. The counterclockwise flow of economic resources and finished products that is illustrated by the red arrows is paid for by the clockwise flow of money income and consumption expenditures illustrated by the blue arrows. * 2-* How the System Deals with Risk Business owners and investors face risk Losses due to input shortages Changes in consumer tastes Natural disasters that affect the supply chain Employees and suppliers have security Paid whether the firm makes a profit or not LO6 In a market system, businesses all face risks. Profitability of the firm will depend on how well risk is managed. Profits flow to the owners as their reward for bearing the risk of losses. On the other hand, employees and suppliers to the firm do not face any risk, they get paid regardless of how well the firm is doing. * 2-* How the System Deals with Risk Business risks are restricted to owners Attracts needed inputs Inputs easier to obtain since many dislike risk Focuses attention Owners personally responsible for outcome Will encourage prudent decisions Manage risk well and the owners will prosper LO6 The market system will experience better economic outcomes over time since owners bear responsibility for their own management decisions. Compare this to the command and control system where no one bears any responsibility for bad management and do not lose any money if they make bad decisions. They receive the same salary regardless. * 2-* Shuffling the Deck Extremely large number of ways to arrange a deck of cards Arrangement of economy’s resources is even larger Avoid random outcomes in market due to Private property Rational decisions about property Shuffling the deck illustrates how many different arrangements can be obtained with 52 items, like a deck of cards, and then how many different arrangements could be made with the vast number of resources available to make goods and services. The number of possible ways to arrange a deck of cards is so large that it is incomprehensible; imagine the number of ways to allocate resources. The reason we do not have random outcomes is because of private property and people’s abilities to make decisions about their own property that will make themselves better off, not worse off. * Chapter 1 Limits, Alternatives, and Choices Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. This chapter introduces many of the fundamental concepts in economics and covers a wide variety of concepts. It begins with the definition of economics; then the economic perspective is discussed. After that, the discussion moves to the development of economic theory. The individual’s and society’s economizing problems are examined using a budget line and production possibilities curves where economic growth is addressed. The Last Word deals with common mistakes students make when thinking about economics. * 1-* Economics Economics A social science concerned with making optimal choices under conditions of scarcity Economic wants exceed society’s productive capacity LO1 If wants didn’t exceed our productive capacity, everyone could have everything that they ever wanted and this class wouldn’t exist. Since we can’t get everything that we want, we have to make choices. The choices that we make are the best options available given the circumstances. Every choice that is made has an impact on the economy. Being in this class right now impacts the economy. * 1-* The Economic Perspective Economic perspective Scarcity and choice Opportunity cost Purposeful behavior to increase utility Marginal analysis LO1 The economic perspective is the way economists view the world. This includes considering scarcity of resources, the opportunity costs of economic decisions, and how consumers and businesses exhibit purposeful behavior in order to increase their utility. Often economists use marginal analysis, which is weighing the marginal benefits and the marginal costs of some activity, in their work. * 1-* Scarcity and Choice Resources are scarce Choices must be made Opportunity cost There’s no free lunch LO1 If resources weren’t scarce, we wouldn’t have to make choices. Because we have to make choices, there is a cost to every choice and that’s called “opportunity cost.” This is where the phrase “There’s no such thing as a free lunch” comes from. What did you give up to be in this class? What would you be doing if you weren’t in class right now? It’s important to note that everyone’s opportunity cost will be different. * 1-* Purposeful Behavior Rational self-interest Individuals and utility Firms and profit Desired outcome LO1 Individuals and businesses make rational decisions; decisions that will make them better off, not worse off. With rational self-interest, the goal is to maximize utility or satisfaction. This does not mean that we are completely selfish or that we can’t make wrong decisions. We can derive utility by helping others and often when we make decisions, we don’t have all of the information, so wrong decisions can be made. Firms are rational when they make choices about which products to produce in an attempt to maximize their profits. People make decisions with some desired outcome in mind. * 1-* Marginal Analysis Marginal benefit Marginal cost Marginal means “extra” Comparison between marginal benefit and marginal cost LO1 Every time we make a choice, we are weighing the marginal benefit and cost. We will choose to do something if the marginal benefit is greater than the marginal cost because that is rational and will help to maximize utility. If a person says, “That’s not worth it,” then they are saying the marginal cost is greater than the marginal benefit. * 1-* Theories, Principles, and Models The scientific method Observe Formulate a hypothesis Test the hypothesis Accept, reject, or modify the hypothesis Continue to test the hypothesis, if necessary LO2 Based on the scientific method, economic principles and theories are created. Observing real world behavior, formulating a possible explanation or hypothesis, testing this, and deciding to accept, reject, or modify the explanation. Continue to test the hypothesis again real-world facts. * 1-* Economic Principle Generalizations Other-things-equal assumption Ceteris paribus Graphical expression LO2 Economic principles are generalizations about economic behavior that are true for the average person. The other-things-equal assumption is the ceteris paribus assumption which means that all variables other than those under consideration are held constant or is assumed to not change for a particular analysis. In economics, graphs are often used to illustrate the relationship between variables. * 1-* Micro and Macro Microeconomics The study of the individual consumer, firm, or market Macroeconomics The study of the entire economy or a major aggregate of the economy LO3 In microeconomics an individual consumer, household, or industry is examined. Examining the price of a particular product or demand or supply of a particular products’ market is studied in microeconomics. In macroeconomics the entire economy is examined. Macroeconomics also looks at the basic groups in the economy such as all households, all businesses, all of the government, or the foreign sector. All goods and services produced in the economy, or the unemployment rate for the entire labor force, or the inflation rate are all macroeconomics topics. * 1-* Positive and Normative Economics Positive economics Economic statements that are factual Normative economics Economic statements that involve value judgments LO3 Positive economics can be supported or disproved with data. There isn’t any subjectivity. Normative economics is what “ought to be.” This is subjective since everybody has different opinions about what is desirable. * 1-* The Economizing Problem The economizing problem Limited income and unlimited wants The budget line Attainable and unattainable combinations Trade-offs and opportunity costs LO4 The individual’s economizing problem exists because of the combination of a limited income and unlimited wants. A budget line is used to illustrate the greatest combinations of two goods that can be purchased with a certain amount of income. It reflects the greatest amount of these two goods that can be purchased. A budget line is created for a specific level of income so that when income changes, the budget line will shift to show the higher or lower incomes. * 1-* The Consumer’s Budget Line 12 10 8 6 4 2 0 2 4 6 8 10 12 14 LO4 The Budget Line: Combinations of DVDs and Books Attainable with $120 Units of DVDs (Price = $20) Units of Books (Price=$10) Total Expenditure 6 0 $120 5 2 $120 4 4 $120 3 6 $120 2 8 $120 1 10 $120 0 12 $120 Income = $120 Pdvd = $20 = 6 Income = $120 Pb = $10 = 12 Attainable Unattainable Any combination of goods inside the budget line can be purchased, but that combination of goods is not representative of the maximum that could be purchased. Since the blue budget line represents the maximum of goods that can be purchased, any point outside (to the right) of the budget line represents a combination whose price exceeds the available income and therefore can’t be purchased. A budget line clearly illustrates how much of one good must be sacrificed to get more of another good (opportunity costs). If income increases, the budget line will shift to the right to show that now more books and DVDs can be purchased. If income falls, the budget line shifts to the left to show that fewer books and DVDs can be purchased. * 1-* Global Perspective LO4 This global perspective shows how average incomes vary greatly among countries. If average incomes vary, so will the budget constraints for these nations. * 1-* Society’s Economizing Problem 4 categories of economic resources Land Labor Capital Investment Entrepreneurial ability LO5 For the economy as a whole, the economizing problem exists because resources are scarce. Resources refers to inputs that are used in the production of other goods and services. Land refers to all natural resources. Labor is one of the human resources and refers to all physical and mental talents used in the production of a good or service. Capital refers to anything man-made and used to produce goods and services. Capital is an investment good; it is not the same as money. Money isn’t even considered a resource. Entrepreneurs are another type of human resource but is different from labor mainly because entrepreneurs are risk-takers. * 1-* Society’s Economizing Problem Entrepreneurs Employs the other factors of production Takes initiative Makes strategic business decisions Innovates Takes risk LO5 Entrepreneurs are the driving force behind production and the agent that combines the other factors of production or inputs in a business venture. They risk their time, effort, ability and money because not all ideas or new products will be profitable. * 1-* Production Possibilities Model Economic model that shows different combinations of two goods that an economy can produce Full employment Fixed resources Fixed technology 2-good economy Consumer goods and capital goods LO6 The production possibilities model is an economic model that shows different combinations of goods and services that society can produce in a fully employed economy, assuming a fixed available of supplies of resources and fixed technology. * 1-* Production Possibilities Model Type of Product Pizzas (in hundred thousands) Industrial Robots (in thousands) Production Alternatives A B C D E 10 9 7 4 0 0 1 2 3 4 Plot the points to create the graph… LO6 The production possibilities table shows the combinations of pizzas and robots that can be produced with the resources available. At point A, the economy can produce 10,000 robots by using all of the resources to produce those robots. At point B, the economy is able to produce 100,000 pizzas, but they have to give up some robots to get these pizzas. This is because some resources are re-allocated to producing pizzas instead of robots. As the economy continues to move towards point E, the number of pizzas increases while the number of robots decreases, illustrating that the opportunity cost of more pizzas is fewer robots. * 1-* Production Possibilities Graph 0 1 2 3 4 5 6 7 8 9 Unattainable 14 13 12 11 10 9 8 7 6 5 4 3 2 1 A B C D E Attainable W Q Q LO6 Pizzas Industrial robots Producing anywhere along the blue PPC line means that the economy is producing the maximum amount of pizzas and robots, and this implies that the economy is efficient. The economy can produce at any point inside the PPC, but doing so means that the economy is inefficient. This means that the economy has idle resources and/or resources are not being used to their capacity. When inside the PPC, it is possible to get more of both goods by utilizing idle resources, or using resources to their capacity. Just like with the budget line, any point to the right of the PPC represents a combination of robots and pizzas that is impossible to create with the current resources. * 1-* Increasing Opportunity Costs Law of increasing opportunity costs As more of a particular good is produced, its marginal opportunity costs increase Production possibilities curve Concave shape Economic rationale LO6 The PPC is concave because of the increasing opportunity costs. If the opportunity costs were constant, the PPC would be a straight line. When the economy is efficient and operating on the PPC, the only way to get more of one good is to give up some of the other because all resources are already being utilized. There is no way to allocate the resources differently without giving up some of another good. * 1-* Optimal Output Marginal benefit & marginal cost Quantity of pizza 15 10 5 0 1 2 3 MC MB MB = MC e a b c d LO6 The economy decides how much pizza to produce similarly to how a person makes their decisions. The economy must compare the marginal benefit to the marginal cost of producing pizza. The optimal amount of pizza is where the marginal benefit is equal to the marginal cost of producing another unit of pizza. * 1-* A Growing Economy Type of Product Pizzas (in hundred thousands) Industrial Robots (in thousands) Production Alternatives A' B' C' D' E' 14 12 9 5 0 0 2 4 6 8 LO7 An increase in the supplies of resources, improvements in resource quality, and/or technological advance move the production possibilities curve outward and to the right, allowing the economy to have larger quantities of both types of goods. * 1-* Unemployment, Growth, & the Future Economic growth Pizzas Industrial robots Attainable 0 1 2 3 4 5 6 7 8 9 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C D E Now attainable A’ B’ C’ D’ E’ LO7 Graphically, economic growth is shown as a shift to the right of the PPC. Shifting the PPC to the right shows that more robots and pizzas can now be produced at every point on the PPC. Points that used to be unattainable are now attainable. This means that the economy can now have a higher standard of living. * 1-* Present Choices, Future Possibilities Goods for the present Goods for the future Goods for the future Goods for the present P F Current curve Current curve Future Curve Future Curve Presentville Futureville LO7 Where the economy chooses to produce on the PPC today largely determines the amount of economic growth that they will experience in the future. Goods for the future include goods like capital, education, and research and development. When we produce those kinds of goods today, they don’t do anything to satisfy needs and wants today, but they will help to better satisfy future wants and needs by enabling the economy to produce a greater amount of present goods in the future. Present goods are goods that satisfy needs today and do nothing for us in the future; most of the goods that we buy are present goods. * 1-* International Trade Specialization Increased production possibilities LO7 International trade enables countries to specialize in the production of goods which they produce more efficiently than other countries. With international trade, resources are allocated more efficiently, and it essentially is the equivalent of an increase in resources. Now a country can not only use its own resources, but it can also take advantage of foreign resources through trade. This leads to a rightward shift of the production possibilities curve. * 1-* Pitfalls to Sound Economic Reasoning Biases Loaded terminology Fallacy of composition Post hoc fallacy Correlation not causation It’s often difficult to put aside biases, but it is important to put aside your preconceived notions about things for an objective evaluation of the economy. The news often uses loaded terminology to catch the audience’s interest, but we have to be careful of the exaggerations that this often implies. Fallacy of composition often occurs when we assume that what benefits one person will also benefit others. When there is a traffic jam on the highway, it will benefit me to take the back roads if I am the only one who does that. If everyone gets off of the highway and tries to take the back roads, then the back roads will become very congested and it could actually take longer. It is important to not draw conclusions about cause and effect relationships. Superstitions are great examples of the post hoc fallacy. Often events are related (correlated), but it doesn’t mean that one actually caused the other. * Grading Rubric for Discussions Total Possible Points: 20 points per discussion question   Exemplary Proficient Partially Proficient or Incomplete Presentation of Major Discussion Posting Up to 10 points Well-thought-out, very clearly presented persuasive posting that responds to the question Incorporated and cited the textbook or other sources, such as current events, articles, Web resources (do not simply copy and paste information from a Website; instead, summarize the information and properly cite the source in your posting) Up to 7 points A reasonably well thought out and somewhat clearly presented posting with a citation 0 points Posting is vague or lacks clear point of view Did not cite supporting information from the textbook or outside sources Writing Mechanics Up to 5 points Discussion posting contains minimal grammar, punctuation, or spelling errors. Up to 3 points  Discussion posting contains some grammar, punctuation, or spelling errors. 0 points Grammar, punctuation and/or spelling errors affected the readability and/or effectiveness of the discussion. Replies to Other Students' Postings Up to 5 points Clearly and politely provided a counter perspective or identified additional points to support another student's perspective,  Motivated discussion with further questions Up to 3 points Replied to another student's posting but did not provide reasons for either challenging or agreeing with the posting 0 points Did not reply to another student's posting OR used belligerent or attacking language when responding to another student's perspective   Chapter 3 Demand, Supply, and Market Equilibrium Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. This chapter provides an introduction to demand and supply concepts. Both demand and supply are defined and illustrated; determinants of demand and supply are listed and explained. The concept of equilibrium and the effects of changes in demand and supply on equilibrium price and quantity are explained and illustrated. The chapter also includes brief discussions of efficiency (productive and allocative) and price controls (floors and ceilings). In the Last Word, you can read how creation of a legal market for human organs could reduce the shortages of kidneys, lungs, and other needed organs available for transplant. * 3-* Markets Interaction between buyers and sellers Markets may be Local National International Price is discovered in the interactions of buyers and sellers LO1 In this chapter, the focus is on markets that are competitive. This requires large numbers of buyers and sellers acting independently. An example of a local market is the farmer’s market that brings together buyers and sellers of produce in the summer. An example of a national market is the US real estate market and the New York Stock Exchange is an international market. * 3-* Demand Demand Demand schedule or demand curve Amount consumers are willing and able to purchase at a given price Other things equal Individual demand Market demand LO2 To be part of the demand for a good, consumers have to be willing and able to purchase the good. When deriving demand, we are assuming that the only factor that causes consumers to buy more or less is the price of the good. It is assumed that all other factors that influence the amount that consumers will buy are constant. Market demand is derived by summing the individuals’ demand curves. * 3-* Law of Demand Law of demand Other things equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls Explanations Price acts as an obstacle to buyers Law of diminishing marginal utility Income effect and substitution effect LO2 An inverse relationship exists between price and quantity demanded. Prices act as obstacles for buyers and keep them from being able to buy everything that they want. So, it makes sense that with a limited income, consumers will buy more at lower prices. Diminishing marginal utility refers to the decrease in added satisfaction that results as one consumes additional units of a good or service, i.e., the second “Big Mac” yields less extra satisfaction (or utility) than the first. Because additional units yield less utility, the price has to be lower to make up for less utility. The income effect occurs as a lower price increases the purchasing power of money income; this enables the consumer to buy more at a lower price (or less at a higher price) without having to reduce consumption of other goods. The substitution effect is when a lower price gives an incentive to substitute the lower-priced good for the now relatively higher-priced goods. * 3-* The Demand Curve LO2 P Qd $5 4 3 2 1 10 20 35 55 80 P Q D 6 5 4 3 2 1 0 10 20 30 40 50 60 70 80 Quantity demanded (bushels per week) Price (per bushel) The demand curve illustrates the inverse relationship between price and quantity. The downward slope indicates a lower quantity (horizontal axis) at a higher price (vertical axis), and a higher quantity at a lower price, reflecting the law of demand. * 3-* Market Demand LO2 Market Demand for Corn, Three Buyers Price per bushel Quantity Demanded Total Qd per week Joe Jen Jay $5 10 12 8 30 4 20 23 17 60 3 35 39 26 100 2 55 60 39 154 1 80 87 54 221 There are three buyers in the market for corn. The market demand is the horizontal summation of the individual demand curves of all of the consumers in the market. At a price of $3, for example, the three individual curves yield a total quantity demanded of 100 bushels. * 3-* Changes in Demand 6 5 4 3 2 1 0 Quantity demanded (thousands of bushels per week) Price (per bushel) P Q D1 2 4 6 8 10 12 14 16 18 D2 D3 LO2 P Qd $5 4 3 2 1 2000 4000 7000 11,000 16,000 Decrease in demand Increase in demand Changes in the demand for corn will be brought about by a change in one or more of the determinants of demand. An increase in demand is shown as a shift of the demand curve to the right, as from D1 to D2. A decrease in demand is shown as a shift of the demand curve to the left, as from D1 to D3. * 3-* Changes in Demand LO2 6 5 4 3 2 1 0 Quantity demanded (thousands of bushels per week) Price (per bushel) P Q D1 2 4 6 8 10 12 14 16 18 D2 D3 Change in demand Change in quantity demanded These changes in demand are to be distinguished from a change in quantity demanded, which is caused by a change in the price of the product and is shown by a movement from one point to another point on a fixed demand curve. * 3-* Determinants of Demand Determinants of demand Change in consumer tastes and preferences Change in the number of buyers Change in income Normal goods Inferior goods LO2 Determinants are those things that can shift the entire demand curve causing demand to change. When most consumers experience the same change in tastes for a particular good, the demand for the good will change. If there is a preferable change in tastes, demand will increase. On the other hand, if there is an unfavorable change in tastes, demand will fall. If there are more buyers in the market for a good, demand will increase, whereas when there are fewer buyers in the market for a good, demand will decrease. Normal goods are goods that we buy more of as our incomes increase. Most of the goods that we buy are normal goods. We buy fewer normal goods when our income decreases. Inferior goods are goods we buy more of as our income decreases. We buy fewer inferior goods if our income increases. * 3-* Determinants of Demand Change in prices of related goods Complementary good Substitute good Change in consumer expectations Future prices Future income LO2 Complementary goods are goods that we consume jointly. It isn’t beneficial to have one without its complement. When the price of one complement increases, the demand for the other complement decreases. When the price of one complement decreases, the demand for the other complement increases. Some examples are cell phones and cell phone service, tuition and textbooks. Substitute goods are goods that we use in place of another. A perfect substitute is a good that we use in place of the other without any loss of satisfaction. If the price of one good increases, the demand for its substitute increases. If the price of one good decreases, the demand for the other substitute decreases. Some examples are Colgate and Crest toothpaste, Nike and Reebok shoes. If consumers expect the future price of a product to be higher, they increase their current demand for the product. If consumers expect the future price of a product to be lower, they decrease their current demand for the product. If consumers expect their future income to rise, they increase purchases now. If consumers believe their future income will be less, they reduce their demand for some products. * 3-* Determinants of Demand Determinants of Demand: Factors That Shift the Demand Curve Determinant Examples Change in buyers’ tastes Physical fitness rises in popularity, increasing the demand for jogging shoes and bicycles; cell phone popularity rises, reducing the demand for land-line phones. Change in the number of buyers A decline in the birthrate reduces the demand for children’s toys. Change in income A rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as cabbage, turnips, and inexpensive wine. Change in the prices of related goods A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of DVD players increases the demand for DVD movies (complementary goods). Change in consumer expectations Inclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today’s demand for coffee beans. A change in one or more of these determinants will change demand and shift the demand curve. * 3-* Supply Supply Supply schedule or a supply curve Amount producers are willing and able to sell at a given price Individual supply Market supply LO3 To be part of the supply of a good, producers have to be willing and able to produce the good. When creating supply, we are assuming that the only factor that causes firms to produce more or less is the price of the good. It is assumed that all other factors that influence the amount that firms will produce are constant. Market supply is created by summing the individual firms’ supply curves. * 3-* Law of Supply Law of supply Other things equal, as the price rises, the quantity supplied rises and as the price falls, the quantity supplied falls Explanation Price acts as an incentive to producers At some point, costs will rise LO3 Producers are willing to produce and sell more of their product at a high price than at a low price. There is a direct relationship between price and quantity supplied. Given product costs, a higher price means greater profits and thus an incentive to increase the quantity supplied. Beyond some level of output, producers usually encounter increasing costs per added unit of output. * 3-* The Supply Curve LO3 5 4 3 2 1 0 Price (per bushel) Quantity supplied (bushels per week) S1 10 20 30 40 50 60 70 P Q P Qs $5 4 3 2 1 60 50 35 20 5 Because price and quantity supplied are directly related, the supply curve graphs as an upsloping curve. Other things equal, producers will offer more of a product for sale as its price rises and less of the product for sale as its price falls. * 3-* Changes in Supply LO3 S1 P Q S2 S3 Increase in supply Decrease in supply P Qs $5 4 3 2 1 12,000 10,000 7000 4000 1000 $6 5 4 3 2 1 0 Price (per bushel) Quantity supplied (thousands of bushels per week) 2 4 6 8 10 12 14 16 A change in one or more of the determinants of supply causes a change in supply. An increase in supply is shown as a rightward shift of the supply curve, as from S1 to S2. A decrease in supply is depicted as a leftward shift of the curve, as from S1 to S3. * 3-* Changes in Supply S1 P Q S2 S3 Change in quantity supplied Change in supply LO3 $6 5 4 3 2 1 0 Price (per bushel) Quantity supplied (thousands of bushels per week) 2 4 6 8 10 12 14 16 These changes in supply are to be distinguished from a change in quantity supplied, which is caused by a change in the price of the product and is shown by a movement from one point to another point on a fixed supply curve. * 3-* Determinants of Supply Determinants of supply A change in resource prices A change in technology A change in the number of sellers A change in taxes and subsidies A change in prices of other goods A change in producer expectations LO3 If resource prices (input prices) go up, supply decreases. If resource prices (input prices) go down, supply increases. If technology increases, supply increases. If we adopt, or use, less efficient technology, supply decreases. If the number of sellers increases, supply increases. Economic profits in the market draw producers from less profitable markets into this market. If the number of sellers decreases, supply decreases. Economic losses in the market cause producers to leave market. If taxes are increased on a specific product, supply decreases. If taxes are decreased, or eliminated on a specific product, supply increases. If subsidies are increased on a specific product, supply increases. If subsidies are decreased on a specific product, supply decreases. If the price of another good that the producer could produce with the same resources rises, the supply decreases for the product the producers are currently producing. If the price of another good that the producer could produce with the same resources falls, the supply increases for the product the producers are currently producing. If producers expect that the price of the product they are producing will be higher in the future, they cut back on current supply and supply will decrease. If producers expect the price of the product they are producing will be lower in the future, they increase current supply to take advantage of the currently higher price. * 3-* Determinants of Supply Determinants of Supply: Factors That Shift the Supply Curve Determinant Examples Change in resource prices A decrease in the price of microchips increases the supply of computers; an increase in the price of crude oil reduces the supply of gasoline. Change in technology The development of more effective wireless technology increases the supply of cell phones. Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to state universities reduces the supply of higher education. Change in prices of other goods An increase in the price of cucumbers decreases the supply of watermelons. Change in producer expectations An expectation of a substantial rise in future log prices decreases the supply of logs today. Change in the number of suppliers An increase in the number of tattoo parlors increases the supply of tattoos; the formation of women’s professional basketball leagues increases the supply of women’s professional basketball games. A change in one or more of these determinants will change supply and shift the curve. * 3-* Market Equilibrium Equilibrium occurs where the demand curve and supply curve intersect Equilibrium price and equilibrium quantity Surplus and shortage Rationing function of prices Efficient allocation LO4 The equilibrium price is also known as the market-clearing price. Graphically, note that the equilibrium price and quantity are where the supply and demand curves intersect. It is important to note that it is not correct to say supply equals demand. The rationing function of prices is the ability of competitive forces of supply and demand to establish a price where buying and selling decisions are coordinated. At prices above this equilibrium, note that there is an excess quantity supplied, or a surplus. At prices below this equilibrium, note that there is an excess quantity demanded, or shortage. At equilibrium the markets are economically efficient. * 3-* Efficient Allocation Productive efficiency Producing goods in the least costly way Using the best technology Using the right mix of resources Allocative efficiency Producing the right mix of goods The combination of goods most highly valued by society LO4 Competitive markets generate productive efficiency that is the production of any particular good in the least costly way. Sellers that don’t achieve the least-cost combination of inputs will be unprofitable and have difficulty competing in the market. The competitive process also generates allocative efficiency which is producing the combination of goods and services most valued by society. Allocative efficiency requires that there be productive efficiency. Productive efficiency can occur without allocative efficiency. Goods can be produced in the least costly method without being the most wanted by society. Allocative and productive efficiency occur at the equilibrium price and quantity in a competitive market. Resources are neither over-allocated nor under-allocated based on society’s wants. * 3-* Market Equilibrium 6 5 4 3 2 1 0 2 4 6 8 10 12 14 16 18 Bushels of corn (thousands per week) Price (per bushel) P Qd $5 4 3 2 1 2000 4000 7000 11,000 16,000 P Qs $5 4 3 2 1 12,000 10,000 7000 4000 1000 7 3 D S 6,000 bushel surplus 7,000 bushel shortage LO4 The intersection of the downsloping demand curve, D, and the upsloping supply curve, S, indicates the equilibrium price of $3 and equilibrium quantity of 7,000 bushels of corn per week. The shortages of corn at below-equilibrium prices (for example, 7000 bushels at $2) drive up the price. The higher prices increase the quantity supplied and reduce the quantity demanded until equilibrium is achieved. The surpluses caused by above-equilibrium prices (for example, 6000 bushels at $4) push the price down. As price drops, the quantity demanded rises and the quantity supplied falls until equilibrium is established. At the equilibrium price and quantity, there are neither shortages nor surpluses of corn. * 3-* Rationing Function of Prices The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent LO4 Prices automatically rise and fall and bring a market closer to equilibrium. Prices are the best tool for eliminating market shortages and surpluses. * 3-* Changes in Demand and Equilibrium LO5 0 P D4 D3 0 P D1 D2 S Increase in demand D increase: P, Q D decrease: P, Q Decrease in demand S An increase in demand results in an increase in price and an increase in quantity exchanged. A decrease in demand results in a decrease in price and a decrease in the quantity exchanged. * 3-* Changes in Supply and Equilibrium 0 P D S4 S3 0 P D S2 S1 Increase in supply S increase: P, Q S decrease: P, Q Decrease in supply LO5 An increase in supply results in a decrease in price and an increase in the quantity exchanged. A decrease in supply results in an increase in price and a decrease in the quantity exchanged. * 3-* Complex Cases LO5 Effects of Changes in Both Supply and Demand Change in Supply Change in Demand Effect on Equilibrium Price Effect on Equilibrium Quantity 1. Increase Decrease Decrease Indeterminate 2. Decrease Increase Increase Indeterminate 3. Increase Increase Indeterminate Increase 4. Decrease Decrease Indeterminate Decrease These cases demonstrate what happens to equilibrium price and equilibrium quantity when supply and demand shifts occur simultaneously. If supply increases and demand decreases, price declines, but the new equilibrium quantity depends on the relative sizes of shifts in demand and supply. If supply decreases and demand increases, price rises, but the new equilibrium quantity depends on the relative sizes of shifts in demand and supply. If supply and demand change in the same direction (both increase or both decrease), the change in equilibrium quantity will be in the direction of the shift but the change in equilibrium price now depends on the relative shifts in demand and supply. * 3-* Government Set Prices Price ceiling Set below equilibrium price Rationing problem Black markets Example is rent control LO6 Price ceilings are maximum prices that can be charged on a good. Price ceilings are set on goods that are considered to be necessities, but the equilibrium price is so high that many people are unable to purchase the item. To be effective, the price ceiling must be set below the equilibrium price. When price ceilings are placed on a good, this creates a chronic shortage which makes it difficult to determine how to ration the limited output for all of the consumers who are willing and able to buy the good. The shortages often lead to black markets where the good is sold at a higher price than the price ceiling. Price ceilings distort the efficient allocation of resources. * 3-* Government Set Prices S P Q D P0 PC Q0 Shortage Qd Qs Ceiling $3.50 3.00 LO6 A price ceiling is a maximum legal price such as Pc. When the ceiling price is below the equilibrium price, a persistent product shortage results. Here that shortage is shown by the horizontal distance between Qd and Qs. * 3-* Government Set Prices Price floor Prices are set above the market price Chronic surpluses Example is the minimum wage law LO6 A price floor is a minimum price fixed by the government. A price at or above the price floor is legal; a price below it is not. * 3-* Government Set Prices LO6 S P Q D P0 Pf Q0 Surplus Qs Qd Floor 2.00 $3.00 A price floor is a minimum legal price such as Pf. When the price floor is above the equilibrium price, a persistent product surplus results. Here that surplus is shown by the horizontal distance between Qs and Qd. * 3-* Legal Market for Human Organs What if we created a legal market for human organs? Positive effects Increase the incentive to donate Eliminate the persistent shortage of eyes, livers, hearts, kidneys, etc. Organ transplants have become increasingly common, but not everyone who needs a transplant can get one. In 2012, there were 116,000 Americans on the waiting list for transplants. It is estimated that there are 6,900 deaths per year in the U.S. because not enough organs are available. Why shortages? No market exists for human organs. The demand curve for human organs would resemble others in that a greater quantity would be demanded at low prices than at higher prices. Donated organs that are rationed by a waiting list have a zero price. The existing supply is perfectly inelastic, and there is a fixed quantity offered by willing donors. There is a shortage of human organs because at a zero price the quantity demanded exceeds the quantity supplied. * 3-* Legal Market for Human Organs Negative effects Diminishes the special nature of life by commercializing it The market would leave out the poor and uninsured Increases the cost of medical care Prohibition on market solution has resulted in a $1 billion illegal market The first negative effect is a moral objection that turning human organs into commodities commercializes human beings and diminishes the special nature of human life. An analytical critique based on the elasticity of supply suggests that the likely increase in the actual number of usable organs for transplants would not be great. A health cost concern suggests that a market for body organs would greatly increase the cost of health care. Prohibitions on a human organ market have given rise to a worldwide, $1 billion-per-year illegal market. There is concern that those willing to participate in an illegal market such as this may also be willing to take extreme measures to solicit organs from unwilling donors. Supporters of legalizing the market for organs argue that it would increase the supply of legal organs, drive down the price of organs, and reduce the harvesting of organs from unwilling sellers (the lower price would make it less profitable). * Chapter 3A Additional Examples of Supply and Demand Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. This appendix provides additional examples of demand and supply analysis using real-world economic occurrences. This is helpful for those trying to understand or explain current events. * 3A-* Lettuce Supply shifts left for lettuce Weather destroys part of the crop Demand doesn’t change Consumers still want as much lettuce as before Equilibrium price rises which will reduce the quantity demanded LO7 As a result of bad weather, the supply of lettuce decreases and shifts to the left, but demand has not changed because there haven’t been any changes in any of the determinants of demand. When supply decreases, equilibrium price increases and quantity falls. * 3A-* Lettuce LO7 D1 S1 Q1 P1 Quantity (pounds) Price (per pound) S2 Q2 P2 0 This market represents the demand and supply of lettuce. Freezing weather decreases the supply of lettuce reflecting lower quantities supplied at every price. The demand for lettuce remains the same after the freeze. The price of lettuce rises and the quantity available in the market is reduced. * 3A-* Exchange Rates Exchange rates are the price of one country’s currency in terms of another country’s currency Currency appreciation Currency depreciation LO7 Currency appreciation means the value of one of the currencies, in terms of the other, has increased. Currency depreciation means the value of one of the currencies, in terms of the other, has decreased. * 3A-* Exchange Rates LO7 D1 S1 Q1 $1.25 Quantity of euros Dollar price of 1 euro D2 0 $1.50 Q2 Currency appreciation can occur as the demand for a country’s product increases around the world, the demand for that country’s currency will increase. This increases the value of that country’s currency. Currency depreciation can occur as the home country sells more of the home country’s currency to buy the other currency; this has increased the supply of the home currency which decreases the value of the home currency. In this graph, the demand for euros is increasing causing the euro to appreciate and the US dollar is depreciate. * 3A-* Pink Salmon Supply shifts right for pink salmon New technology New fishers enter the industry Demand shifts left for pink salmon Increases in consumers’ income Reductions in the price of substitutes LO7 Supply shifts due to new technology which increases the catch and lowers the cost of fishing. High profits encourage new fishers to enter the industry. Demand shifts due to increases in consumers’ income causing them to shift away from canned fish such as pink salmon. Reductions in the price of substitutes for pink salmon, such as fresh salmon from the Atlantic, cause the demand for pink salmon to fall. * 3A-* Pink Salmon LO7 D1 S1 Q1 P1 Quantity (in pounds) Price (per pound) S2 D2 P2 Q2 0 As a result of the changes in the pink salmon market, supply shifts to the right and demand shifts to the left. In this example, the supply shift was greater than the shift in demand therefore the result is a lower price and higher quantity. * 3A-* Gasoline Supply of gasoline decreases Refinery breakdowns Mideast politics and warfare Rising price of oil Demand for gasoline increases Consumers’ incomes increased Low mileage SUVs popular LO7 The supply curve for gasoline shifts left due to a decrease in the number of producers, and increases in input costs (oil). The demand curve shifts to the right due to increases in consumers’ income which causes an increase in the demand for the normal good (gasoline) and increased use of automobiles that do not get very good gasoline mileage. * 3A-* Gasoline LO7 D2 S2 Q1 P2 Quantity (in gallons) Price (per gallon) S1 D1 P1 Q2 0 An increase in the demand for gasoline, as shown by the shift from D1 to D2, coupled with a decrease in supply, as shown by the shift from S1 to S2, boosts equilibrium price (here from P1 to P2). In this case, equilibrium quantity increases from Q1 to Q2 because the increase in demand outweighs the decrease in supply. * 3A-* Sushi Supply shifts right Increase in the number of sushi bars Demand shifts right Consumers’ tastes for sushi increases LO7 With the increase in the number of sushi bars, there is an increase in the number of sellers; this increases the supply of sushi and shifts the supply curve to the right. A preferable change in tastes for sushi causes demand to increase and the demand curve to shift to the right. * 3A-* Sushi LO7 D2 S2 Q1 Quantity (pounds) Price (per pound) S1 D1 P1 Q2 0 Equal increases in the demand for sushi, as from D1 to D2, and in the supply of sushi, as from S1 to S2, expand the equilibrium quantity of sushi (here from Q1 to Q2) while leaving the price of sushi unchanged at P1. * 3A-* Land in San Francisco Vertical supply curve Quantity supplied fixed and unresponsive to price changes Demand increase causes price to rise but quantity stays the same Demand decrease causes price to fall but quantity stays the same Explains high real estate prices in cities LO7 When a supply curve is upsloping, any change in demand is tempered by a change in quantity supplied. However, when the supply curve is vertical and fixed, any change in demand only results in changes in price; the quantity supplied stays the same no matter what the price is. There is only so much land available in major cities, like San Francisco, therefore when demand increases, the only market response is an increase in price. * 3A-* Land in San Francisco D1 S1 Q0 P1 Quantity of land (acres) Price (per acre) D2 0 P2 LO7 Because the quantity of land in San Francisco is fixed, the supply curve is vertical and parallel to the vertical axis. Therefore, when demand changes the only market response is a change in price. In this graph, the demand for land in San Francisco increases from D1 to D2 and causing price to rise from P1 to P2. The supply is the same no matter what the price is. * 3A-* Preset Prices Preset prices can cause market imbalances Olympics figure skating finals Preset price results in a shortage of tickets Olympics curling preliminaries Preset prices result in a surplus of tickets LO7 Due to the shortage of tickets in the formal market, a secondary market develops and tickets sell for higher prices. It is safe to assume that the shortage was caused by the original price being set too low. Contrast this to the surplus of tickets to the curling preliminaries. Demand is low for this event and tickets were priced too high causing the stands to be relatively empty. Event officials should lower the price to sell more tickets. * 3A-* Preset Prices LO7 D S P1 P2 Q1 Q2 D S P1 P2 Q1 Q2 a b a b 0 P Figure Skating Quantity (tickets) Price (per ticket) 0 P Curling Quantity (tickets) Price (per ticket) Shortage Surplus In the market for tickets to the Olympic women’s figure skating finals the demand curve, D, and supply curve, S, produce an equilibrium price that is above the P1 price printed on the ticket. At price P1 the quantity of tickets demanded, Q2, greatly exceeds the quantity of tickets available (Q1). The resulting shortage of ab (= Q2-Q1) gives rise to a legal, or illegal, secondary market. In the market for tickets to the Olympic curling preliminaries the demand curve, D, and supply curve, S, produce an equilibrium price below the P1 price printed on the ticket. At price P1 the quantity of tickets demanded is less than the quantity of tickets available. The resulting surplus of ba (= Q1-Q2) means the event is not sold out. *