Economic Examples1. Cyclone Larry in Australia

•Destroyed 80% of the banana crop.•Prices went from $1.00 to $2.00 per pound•Supply or Demand problem??

BananaMarket

Quantity

$2.00

DR

S1

Price

Q1Q2

S2

$1.00

Sales of SUVs in the U.S.

P0

Q1

P1

Increasing gas costs causes the demand curve to shift

left

Average price fell 10%

Price for SUVs fell from

P0 to P1 where

Q demanded = Q supplied

S0

D0

P

QQ0

SUVs

D1

Supply or Demand problem?

Coffee Beans• fell from $2.00/pound in 1997 to $.50 in 2002

Supply or Demand problem?

Price

Coffee BeanMarket

Q1

Dc

Q2

S1

Quantity

S2

$2.00

$0.50

New growing techniques and the entry of new growers shifted the supply curve.

2. Increase in the Demand for Loanable Funds

r2

Q1

r1

Q2

Interestrate

Quantity of loanable funds

• At the interest rate r the quantity of loanable funds demanded by borrowers into equals quantity supplied by lenders.

• An increase in demand will move D1 to D2

• Higher interest rates encourage additional savings, making it possible to fund more borrowing.

the interest rises to r2 and increasing borrowing to Q2

S

D1

D2

Lending

Borrowing

• Foreign exchange market is where currency of one country is traded for another.• The exchange rate is measured as the

dollar price of foreign currency.

The Price of Foreign Currency

• Changes in exchange rates will alter the prices of internationally traded goods/services and assets• A lower dollar price of foreign currency

will have two effects:•It will lower the price of foreign goods

to U.S. residents and raise imports.•It will raise the price of U.S. goods to

foreigners and lower exports.

Examples of exchange rates

Country currency In US$ Per US$US$ vs. YTD change (%)

Mexico peso 0.0738 13.5520 - 1.3

China yuan 0.1463 6.8348 0.2

United Kingdom pound 1.4828 0.6744 - 1.6

Poland zloty 0.3032 3.2982 11.1

Israel shekel 0.2400 4.1667 10.3

Kuwait dinar 3.4376 0.2909 5.3

Increase in the Demand for Foreign Exchange

0.20

Q1 Q2

Exchange rate($ per quetzal)

Quantity of quetzal exchange

S

D1

U.S. sales toGuatemala

U.S. purchasesfrom Guatemala

D20.10

• Beginning equilibrium exchange rate: (10 cents = 1quetzal).

• An increase in American demand for Guatemalan coffee will also increase the demand for quetzals

• Equilibrium occurs where the new demand for quetzals D2 just equals the supply S – at $.20 per quetzal with Q2 > Q1 quetzals clearing the market.

Government Intervention

in the Market

• It stops the price from rising to the equilibrium level.

• Example: rent control• The direct effect of a price ceiling is

a shortage: quantity demanded exceeds quantity supplied.

1. Price Ceilings• Price ceiling is a legally established

maximum price that sellers may charge.

• In the rental housing market the price (rent) P0 would bring the quantity of rental units demanded into balance with the quantity supplied.

• A price ceiling like P1sets a price below equilibrium …

quantity demanded QD …

exceeds quantity supplied QS … resulting in a shortage.

The Impact of a Price CeilingPrice(rent)

Quantity of housing units

Priceceiling

D

QS QD

P0

S

P1

Shortage

Rental housing market

• The future supply of housing will decline.

• The quality of housing will deteriorate.• Non-price methods of rationing will

increase in importance.

Effects of Rent Control

• Long-term renters will benefit at the expense of newcomers.

• Price floor is a legally established minimum price that buyers must pay.

• It stops the price from dropping down to equilibrium level.

• Example: minimum wage• The direct effect of a price floor above the

equilibrium price is a surplus: quantity supplied exceeds quantity demanded.

2. Price Floors

• A price floor like P1 sets a price above market equilibriumcausing quantity supplied

QD …

•Non-price factors will become more important than

prices in determining where scarce

goods go.

to exceed quantity demanded

QS … resulting in a surplus.

The Impact of a Price FloorPrice

Quantity

Pricefloor

D

QD QS

P0

SP1

Surplus

• Direct effect: • Reduces employment of low-skilled

labor.• Indirect effects:

• Reduction in non-wage component of compensation.

• Less on-the-job training.• May encourage students to drop out of

school• A higher minimum wage does little to

help the poor.

Minimum Wage Effects

Employment and the Minimum WagePrice (wage)

Quantity(employment)

Minimum wage level

D

E1 E0

S

$ 5.15

Excesssupply

$ 4.00

• If a price (wage) of $4.00 could bring equilibrium.

• A minimum wage (price floor) of $5.15 would increase the earnings of those who stayed employed (E1), but would reduce the employment of others.

• Those who lose their job (E0 to E1) would be pushed into either unemployment or some other less preferred form of employment.

Excise Taxes

• An excise tax is a tax that is levied on a specific good

• A tariff is an excise tax on an imported good

• The result of taxes and tariffs is an increase in equilibrium prices and reduce equilibrium quantities

• Government impacts markets through taxation

5-16

The price of boats rises by less than the

tax to $70,000

The Effect of an Excise Tax

S0

D0

P

Q

$65,000

510420

The supply curve shifts up by the amount of the tax

Government imposes a $10,000 luxury tax on the suppliers of boats

S1

Tax = $10,000

Luxury Boats

$60,000

$70,000

Quantity Restrictions• Government regulates markets with licenses,

which limit entry into a market

• Many professions require licenses, such as doctors, financial planners, cosmetologists, electricians, or taxi cab drivers

• The results of limited number of licenses in a market are increases in wages and an increases in the price of obtaining the license

5-18

The Effect of a Quantity Restriction

QR

D0

12,000

When the demand for taxi services increased, because the

number of taxi licenses was limited, wages increased

Successful lobbying by taxi cab drivers in NYC resulted in quantity

restrictions (medallions)

NYC Taxi Drivers

$15

P(wage)

Q(of drivers)

D1

Application: The Effect of a Quantity Restriction

QR

D0

12,000

The demand for taxi medallions also increased

because wages were increasing. But because the number of taxi licenses was

limited, the price of a medallion also increased

NYC Taxis Medallions

$400,000

P

Q(of medallions)

D1Initial Fee

Third-Party-Payer Markets

• In third-party-payer markets, the person who receives the good differs from the person paying for the good

• Equilibrium quantity and total spending can be much higher in third-party-payer markets

• Under a third-party-payer system, the person who chooses how much to purchase doesn’t pay the entire cost

• Goods from a third-party-payer system will be rationed through social and political means

5-21

Third-Party-Payer Markets

D0

10

Health Care

$25

P

Q

$45

$5

S0

18

The consumer pays the entire

cost

Total expenditures for 18 units of health

care

With a co-payment of $5, consumers demand 18 unitsSellers require $45 per unit for that quantity

…are greater than when…