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Ch. 4: Supply and Ch. 4: Supply and Demand: PracticeDemand: Practice

James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts UniversityUniversity©2005 Thomson Business & Professional Publishing, A Division of Thomson ©2005 Thomson Business & Professional Publishing, A Division of Thomson LearningLearning

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Application 1: Why Do Application 1: Why Do Colleges Use GPAs, ACTs, Colleges Use GPAs, ACTs, and SATs for Purposes of and SATs for Purposes of Admission?Admission? The tuition that students pay to The tuition that students pay to

attend college is usually less than attend college is usually less than the equilibrium tuition.the equilibrium tuition.

The college is likely to ration its The college is likely to ration its available space by a combination of available space by a combination of money price and some other non-money price and some other non-price rationing device, such as GPA, price rationing device, such as GPA, SAT, TASP, and ACT.SAT, TASP, and ACT.

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Exhibit 1: College and University Admissions

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Self-TestSelf-Test

Suppose the demand rises for admission to a Suppose the demand rises for admission to a university but both the tuition and the number university but both the tuition and the number of openings in the entering class remain the of openings in the entering class remain the same. Will this affect the admission same. Will this affect the admission standards of the university? Explain.standards of the university? Explain.

Administrators and faculty at state colleges Administrators and faculty at state colleges and universities often say that their standards and universities often say that their standards of admission are independent of whether of admission are independent of whether there is a shortage or surplus of openings at there is a shortage or surplus of openings at the university. Do you think this is true? the university. Do you think this is true? Explain.Explain.

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Application 2: What Would Application 2: What Would Happen If Marijuana Were Happen If Marijuana Were Legalized?Legalized? What would happen to equilibrium price? What would happen to equilibrium price?

What would happen to the equilibrium What would happen to the equilibrium quantity?quantity?

Supply would increase, as farmers began Supply would increase, as farmers began to grow marijuana instead of corn or other to grow marijuana instead of corn or other products.products.

Demand would increase, as the number of Demand would increase, as the number of people who want to buy and consume people who want to buy and consume marijuana increases.marijuana increases.

Equilibrium price is dependent on whether Equilibrium price is dependent on whether supply or demand increases the most.supply or demand increases the most.

Equilibrium quantity would increase.Equilibrium quantity would increase.

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Application 3: Where Did Application 3: Where Did You Get That Music?You Get That Music?Too many people are downloading music Too many people are downloading music

from the internet instead of purchasing from the internet instead of purchasing CDs.CDs.Possible solutions:Possible solutions:

1.1. Higher Price: Recording industry Higher Price: Recording industry threatened to sue scores of people who threatened to sue scores of people who download music.download music.

2.2. Lower Demand: Recording industry Lower Demand: Recording industry aired television commercials to lower aired television commercials to lower demand.demand.

3.3. Lower Supply: Recording industry sued Lower Supply: Recording industry sued certain companies such as Napster.certain companies such as Napster.

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Self-TestSelf-Test

On January 21, 2004 the recording On January 21, 2004 the recording industry filed lawsuits against 532 industry filed lawsuits against 532 people it accused of illegally people it accused of illegally swapping copyrighted music on the swapping copyrighted music on the internet. What does this have to do internet. What does this have to do with supply, demand, or price?with supply, demand, or price?

If the recording industry puts few TV If the recording industry puts few TV commercials trying to lower demand commercials trying to lower demand for downloading music, but instead for downloading music, but instead continues to sue, what does this say?continues to sue, what does this say?

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Application 4: The Application 4: The Minimum Wage LawMinimum Wage Law

At a higher minimum wage, At a higher minimum wage, more unskilled workers want more unskilled workers want to work, but only a few are to work, but only a few are hired.hired.

Additionally, fewer workers Additionally, fewer workers are paid at the higher are paid at the higher minimum wage than at the minimum wage than at the previous equilibrium wage.previous equilibrium wage.

In a competitive market In a competitive market setting, the forces of supply setting, the forces of supply and demand determine and demand determine equilibrium wages.equilibrium wages.

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The Minimum Wage The Minimum Wage LawLaw If labor markets are competitive and the If labor markets are competitive and the

demand for labor is downward-sloping, a demand for labor is downward-sloping, a minimum wage (above equilibrium minimum wage (above equilibrium wage) will reduce employment.wage) will reduce employment.

The important question is: How much The important question is: How much will it reduce employment? A $1 raise at will it reduce employment? A $1 raise at the expense of 1 labor hour is different the expense of 1 labor hour is different than a $1 raise at the expense of than a $1 raise at the expense of 1,000,000 labor hours.1,000,000 labor hours.

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Exhibit 2: Effects of the Minimum Wage

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Self-TestSelf-Test

When the labor supply is upward-When the labor supply is upward-sloping, an effective minimum sloping, an effective minimum wage law creates a surplus of wage law creates a surplus of labor. If the labor supply is labor. If the labor supply is vertical, does a surplus of labor vertical, does a surplus of labor still occur? Explain.still occur? Explain.

Someone says that an increase in Someone says that an increase in the minimum wage will not cause the minimum wage will not cause firms to hire fewer workers. What firms to hire fewer workers. What is this person assuming?is this person assuming?

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Application 5: Price Application 5: Price Ceiling In The Kidney Ceiling In The Kidney MarketMarket Kidneys are currently donated as there is Kidneys are currently donated as there is

no free market for kidneys.no free market for kidneys. Assuming that some people are unwilling Assuming that some people are unwilling

to donate a kidney for $0 but would for to donate a kidney for $0 but would for some other amount of money, the kidney some other amount of money, the kidney market could be analyzed using a standard market could be analyzed using a standard supply and demand curve.supply and demand curve.

At $0 compensation, there is a larger At $0 compensation, there is a larger quantity demanded than supplied, exactly quantity demanded than supplied, exactly the case we see today in the United States.the case we see today in the United States.

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Exhibit 3: The Market for Kidneys

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Self-TestSelf-Test

A shortage of kidneys is a A shortage of kidneys is a consequence of the price of a kidney consequence of the price of a kidney being below equilibrium price. Do being below equilibrium price. Do you agree or disagree? Explain.you agree or disagree? Explain.

Suppose the price ceiling in the Suppose the price ceiling in the kidney market is $0. Will there be a kidney market is $0. Will there be a shortage of kidneys? Explain.shortage of kidneys? Explain.

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Application 6: Health Care Application 6: Health Care and the Right to Sue Your and the Right to Sue Your HMOHMO Some people argue you should be Some people argue you should be

able to sue your HMO.able to sue your HMO. Consider two settings: one where Consider two settings: one where

you can sue your HMO, and one you can sue your HMO, and one where you cannot.where you cannot.– An HMO’s liability costs are lower if An HMO’s liability costs are lower if

patients cannot sue. These costs will be patients cannot sue. These costs will be passed on to consumers, raising HMO passed on to consumers, raising HMO rates for everyone.rates for everyone.

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Exhibit 4: Apartment Rent and the Law

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Self-TestSelf-Test Economists often say, “There is no Economists often say, “There is no

such thing as a free lunch.” How is such thing as a free lunch.” How is this saying related to patients moving this saying related to patients moving from a system when they cannot sue from a system when they cannot sue their HMOs to one where they can.their HMOs to one where they can.

A professor tells her students that they A professor tells her students that they can have an extra week to complete can have an extra week to complete their research papers. Under what their research papers. Under what conditions are the students made conditions are the students made better off? Can you think of a case better off? Can you think of a case where the students would actually be where the students would actually be made worse off.made worse off.

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Application 7: If Gold Prices Application 7: If Gold Prices Are The Same Everywhere, Are The Same Everywhere, Then Why Aren’t House Prices?Then Why Aren’t House Prices?

If gold prices were different, sellers would If gold prices were different, sellers would buy in one area, and sell in another.buy in one area, and sell in another.

As time went on, the lack of gold would As time went on, the lack of gold would drive up prices in some areas, while the drive up prices in some areas, while the deluge of gold would drive down prices in deluge of gold would drive down prices in other areas until the prices of gold is fixed other areas until the prices of gold is fixed across the world.across the world.

However, since we can not pick up a house However, since we can not pick up a house and land and transplant them in a new and land and transplant them in a new area, house prices vary across the country.area, house prices vary across the country.

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Self-TestSelf-Test

What causes the price of gold to be What causes the price of gold to be the same in New York and London?the same in New York and London?

The price of a Honda Pilot is nearly The price of a Honda Pilot is nearly the same in Miami as it is in Dallas. the same in Miami as it is in Dallas. Why?Why?

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Application 8: Do You Application 8: Do You Pay For Good Weather?Pay For Good Weather? There is no weather market.There is no weather market. But to enjoy the weather in San But to enjoy the weather in San

Diego, CA, you must be there, Diego, CA, you must be there, either living there or visiting.either living there or visiting.

If there were only bad weather in If there were only bad weather in San Diego, the demand to live San Diego, the demand to live there would be lower and the cost there would be lower and the cost of living would be lower.of living would be lower.

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Self-TestSelf-Test

Give an example to illustrate that Give an example to illustrate that someone may “pay” for clean air someone may “pay” for clean air in much the same way that she in much the same way that she “pays” for good weather.“pays” for good weather.

If people pay for good weather, If people pay for good weather, who ultimately receives the who ultimately receives the “good-weather payment” ?“good-weather payment” ?

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Application 9: Paying All Application 9: Paying All Professors The Same Professors The Same SalarySalary

Professors have different salaries. Professors have different salaries. Should they all have the same Should they all have the same salary?salary?

Market conditions are different for Market conditions are different for history and accounting professors.history and accounting professors.

Same salary would create surpluses Same salary would create surpluses and shortages.and shortages.

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Exhibit 5: Paying Professors the Same Salary

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Self-TestSelf-Test

Suppose the supply of biology and Suppose the supply of biology and computer science professors is the computer science professors is the same but the demand for computer same but the demand for computer scientists is greater. If a shortage scientists is greater. If a shortage exists in both fields, in which field is exists in both fields, in which field is the shortage greater? Explain.the shortage greater? Explain.

Under what condition might an Under what condition might an economist propose that all college economist propose that all college professors be paid the same?professors be paid the same?

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Application 10: Price Application 10: Price Floors and Winners and Floors and Winners and LosersLosersSuppose an agricultural foodstuff Suppose an agricultural foodstuff

receives a price floor. Who gains receives a price floor. Who gains and who loses?and who loses?

Consumers lose.Consumers lose. Producers gain.Producers gain. Society loses (consumers lose Society loses (consumers lose

more than producers gain).more than producers gain).

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Exhibit 6: Agricultural Price Floors

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Self-TestSelf-Test Look at the area equal to areas 3 + 5 in Look at the area equal to areas 3 + 5 in

Exhibit 6. If there is a price floor, this Exhibit 6. If there is a price floor, this area ends up being a deadweight loss. area ends up being a deadweight loss. It is the loss to society of not producing It is the loss to society of not producing Q1. Are there mutually beneficial Q1. Are there mutually beneficial trades that exist between Q2 and Q1, trades that exist between Q2 and Q1, and if so, how do you know this?and if so, how do you know this?

Why might producers argue for a price Why might producers argue for a price floor if it ends up making society worse floor if it ends up making society worse off?off?

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Application 11: Application 11: College Super-AthletesCollege Super-Athletes Assume a super-athlete receives a Assume a super-athlete receives a

full ride scholarship at a university. full ride scholarship at a university. NCAA rules limit payment to the NCAA rules limit payment to the athlete to the amount of the athlete to the amount of the scholarship even if the athlete is scholarship even if the athlete is worth more to the university.worth more to the university.

Because of a perfectly inelastic Because of a perfectly inelastic supply curve, NCAA rules result in supply curve, NCAA rules result in a transfer from the athlete to the a transfer from the athlete to the university.university.

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Exhibit 7: The College Athlete

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Self-TestSelf-Test University X is a large university with a University X is a large university with a

major football team. A new field major football team. A new field house and track was just added to the house and track was just added to the university. What might this have to do university. What might this have to do with our discussion?with our discussion?

Sometimes it is argued that if colleges Sometimes it is argued that if colleges paid student athletes, the demand for paid student athletes, the demand for college sports would decline. How college sports would decline. How would this change the analysis?would this change the analysis?

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Application 12: Supply Application 12: Supply and Demand on the and Demand on the FreewayFreeway

The supply of freeway space The supply of freeway space remains the same, but the remains the same, but the demand for space fluctuates.demand for space fluctuates.

Some people have proposed Some people have proposed tolls to control the demand tolls to control the demand for freeway space.for freeway space.

If the driving population If the driving population increases in an area, and the increases in an area, and the supply of freeway space supply of freeway space remains the same, what will remains the same, what will happen to freeway happen to freeway congestion?congestion?

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Exhibit 8: Freeway Congestion and Supply and Demand

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Self-TestSelf-Test

In Exhibit 9, at what price is there a In Exhibit 9, at what price is there a surplus of freeway space at 8 A.M.?surplus of freeway space at 8 A.M.?

If the driving population increases If the driving population increases in an area and the supply of in an area and the supply of freeway space remains constant, freeway space remains constant, what will happen to freeway what will happen to freeway congestion? Explain.congestion? Explain.

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Application 13: What Does Application 13: What Does Price Have to do with Getting Price Have to do with Getting to Class on Time?to Class on Time? Price and parking places conspire to Price and parking places conspire to

delay students.delay students. Students pay money or time to get Students pay money or time to get

to classes.to classes. Some suggest auctioning off Some suggest auctioning off

parking spaces on a yearly basis.parking spaces on a yearly basis. Just because someone doesn’t pay Just because someone doesn’t pay

the price doesn’t mean there isn’t a the price doesn’t mean there isn’t a price to pay.price to pay.

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Self-TestSelf-Test

If a person pays for something in If a person pays for something in terms of time, he or she is really terms of time, he or she is really paying in terms of money. Do paying in terms of money. Do you agree or disagree? Explain.you agree or disagree? Explain.

Suppose a price of $1/day is the Suppose a price of $1/day is the equilibrium price. What happens equilibrium price. What happens if demand rises more than supply if demand rises more than supply and the price is kept at $1?and the price is kept at $1?

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Application 14: Aisle Application 14: Aisle Seats on Commercial Seats on Commercial AirlinesAirlines The supply curve for The supply curve for

aisle seats and aisle seats and middle seats are middle seats are equal straight lines, equal straight lines, while the demand is while the demand is anything but equal.anything but equal.

Airlines charge the Airlines charge the same price for middle same price for middle and aisle seats.and aisle seats.

Late comers get the Late comers get the middle seats.middle seats.

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Application 15: 10 Application 15: 10 O’Clock Classes in O’Clock Classes in CollegeCollege

Supply for classes is Supply for classes is fixed, but are offered fixed, but are offered at different times. at different times.

Demand varies based Demand varies based an times.an times.

There is a set of There is a set of prices that will make prices that will make the quantity the quantity demanded of each demanded of each class the same.class the same.

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Exhibit 9: The Supply and Demand for College Classes at Different Times

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Application 16: What Application 16: What is the price of an “A”?is the price of an “A”? Assume Professor Lawson is a slightly Assume Professor Lawson is a slightly

better teacher that Professor Brown.better teacher that Professor Brown. Will Professor Brown have fewer Will Professor Brown have fewer

students?students? Not necessarily. Professor Brown may Not necessarily. Professor Brown may

lower the cost to students.lower the cost to students.– Less work.Less work.– Easier tests.Easier tests.– Higher GPA.Higher GPA.– Etc.Etc.

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Exhibit 10: The Price of an A

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Self-TestSelf-Test

If more people want to read romance If more people want to read romance novels than classic novels, it holds novels than classic novels, it holds that the demand for romance novels that the demand for romance novels is greater than the demand for is greater than the demand for classic novels. Agree or disagree? classic novels. Agree or disagree? Explain.Explain.

Popularity is a function of demand, Popularity is a function of demand, not price. Agree or disagree? not price. Agree or disagree? Explain.Explain.

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Coming Up (Ch. 5): Macroeconomic Coming Up (Ch. 5): Macroeconomic Measurements, Part I: Prices & Measurements, Part I: Prices & UnemploymentUnemployment