Principles of Microeconomics Scarcity and Social Provisioning Chapter 4 Demand and Supply

CHAPTER . DEMAND AND SUPPLY INTRODUCTION TO DEMAND AND SUPPLY Figure . Farmer Market . Organic vegetables and fruits that are grown and sold within a specific geographical region should , in theory , cost less than conventional produce because the transportation costs are less . That is not , however , usually the case . Credit modification of work by Natalie Creative Commons ) WHY CAN WE NOT GET ENOUGH OF ORGANIC ?

Organic food is increasingly popular , not just in the United States , but worldwide . At one time , consumers had to go to specialty stores or farmer markets to find organic produce . Now it is available in most grocery stores . In short , organic is part of the mainstream . Ever wonder why organic food costs more than conventional food ?

Why , say , does an organic Fuji apple cost a pound , while its conventional counterpart costs a pound ?

The same price relationship is true for just about every organic product on the market . If many organic foods are locally grown , would they not take less time to get to market and fore be cheaper ?

What are the forces that keep those prices from coming down ?

Turns out those forces have a lot to do with this chapter topic demand and supply .

PRINCIPLES or ECONOMICS 77 CHAPTER OBJECTIVES Introduction to Demand and Supply In this chapter , you will learn about Demand , Supply , and Equilibrium in Markets for Goods and Services Shifts in Demand and Supply for Goods and Services Changes in Equilibrium Price and Quantity The Process Price Ceilings and Price Floors auction bidder pays thousands of dollars for a dress Whitney Houston wore . A collector spends a small fortune for a few drawings Lennon . People usually react to purchases like these in two ways their jaw drops because they think these are high prices to pay for such goods or they think these are rare , desirable items and the amount paid seems right . Visit this website to read a list of bizarre items that have been purchased for their ties to celebrities . These examples sent an interesting facet of demand and supply . El cones , El . When economists talk about prices , they are less interested in making judgments than in gaining a practical understanding of what determines prices and why prices change . Consider a price most of us contend with weekly that of a gallon of gas . Why was the average price of gasoline in the United States per gallon in June 2014 ?

Why did the price for gasoline fall sharply to per gallon by January 2015 ?

To explain these price movements , economists focus on the of what gasoline buyers are willing to pay and what gasoline sellers are willing to accept . As it turns out , the price of gasoline in June of any given year is nearly always higher than the price of that same year over recent decades , gasoline prices in midsummer have averaged about 10 cents per gallon more than their midwinter low . The likely reason is that people drive more in the summer , and are also willing to pay more for gas , but that does not explain how steeply gas prices fell . Other factors were at work during those six months , such as increases in supply and decreases in the demand for crude oil . This chapter introduces the economic model of demand and of the most powerful els in all of economics . The discussion here begins by examining how demand and supply determine

78 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER the price and the quantity sold in markets for goods and services , and how changes in demand and supply lead to changes in prices and quantities .

DEMAND , SUPPLY , AND EQUILIBRIUM IN MARKETS FOR GOODS AND SERVICES LEARNING By the end of this section , you will be able to Explain demand , quantity demanded , and the law of demand Identify a demand curve and a supply curve Explain supply , quantity supply , and the law of supply Explain equilibrium , equilibrium price , and equilibrium quantity irst let first focus on what economists mean by demand , what they mean by supply , and then how demand and supply interact in a market . DEMAND FOR GOODS AND SERVICES Economists use the term demand to refer to the amount of some good or service consumers are ing and able to purchase at each price . Demand is based on needs and consumer may be able to differentiate between a need and a want , but from an economist perspective they are the same thing . Demand is also based on ability to pay . If you can not pay for it , you have no effective demand . What a buyer pays for a unit of the specific good or service is called price . The total number of units purchased at that price is called the quantity demanded . A rise in price of a good or service almost always decreases the quantity demanded of that good or service . Conversely , a fall in price will increase the quantity demanded . When the price of a gallon of gasoline goes up , for example , people look for ways to reduce their consumption by combining several errands , commuting by carpool or mass transit , or taking weekend or vacation trips closer to home . Economists call this inverse between price and quantity demanded the law of demand . The law of demand assumes that all other variables that affect demand ( to be explained in the next module ) are held constant . An example from the market for gasoline can be shown in the form of a table or a graph . A table that shows the quantity demanded at each price , such as Table , is called a demand schedule . Price in this case is measured in dollars per gallon of gasoline . The quantity demanded is measured in millions of gallons over some time period ( for example , per day or per year ) and over some geographic area ( like a state or a country ) A demand curve shows the relationship between price and quantity demanded on a graph like Figure , with quantity on the horizontal axis and the price per gallon on the vertical axis . Note that this is an exception to the normal rule in mathematics that the independent variable

80 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER ( goes on the horizontal axis and the dependent variable ( goes on the vertical . Economics is not math . The demand schedule shown by Table and the demand curve shown by the graph in Figure are two ways of describing the same relationship between price and quantity demanded . 5220 . per gallon , 420 gallons ) 52700 ( 00 per gallon , 460 gallons ) 80 ( per gallon . 500 gallons ) 60 per gallon , 550 gallons ) 40 ( per gallon , 600 gallons ) per gallon , 700 gallons ) II II II . per ga on mI Ion ga ons ) 300 400 500 600 700 800 900 Quantity of Gasoline ( millions of gallons ) Figure . A Demand Curve for Gasoline . The demand schedule shows that as price rises , quantity demanded decreases , and vice versa . These points are then , and the line connecting them is the demand curve ( The downward slope of the demand curve again illustrates the law of inverse relationship between prices and quantity demanded . Price ( per gallon ) Quantity Demanded ( millions of gallons ) 800 700 600 550 500 460 420 Table . Price and Quantity Demanded of Gasoline Demand curves will appear somewhat different for each product . They may appear relatively steep or , or they may be straight or curved . Nearly all demand curves share the fundamental similarity that they slope down from left to right . So demand curves embody the law of demand As the price increases , the quantity demanded decreases , and conversely , as the price decreases , the quantity demanded increases . Confused about these different types of demand ?

Read the next Clear It Up feature .

PRINCIPLES or ECONOMICS 81 IS DEMAND THE SAME AS QUANTITY DEMANDED ?

In economic terminology , demand is not the same as quantity demanded . When economists talk about demand , they mean the relationship between a range of prices and the quantities demanded at those prices , as illustrated by a demand curve or a demand schedule . When economists talk about quantity demanded , they mean only a certain point on the demand curve , or one quantity on the demand schedule . In short , demand refers to the curve and quantity demanded refers to the ( specific ) point on the curve . SUPPLY OF GOODS AND SERVICES When economists talk about supply , they mean the amount of some good or service a producer is willing to supply at each price . Price is what the producer receives for selling one unit of a good or service . A rise in price almost always leads to an increase in the quantity supplied of that good or service , while a fall in price will decrease the quantity supplied . When the price of gasoline rises , for example , it encourages firms to take several actions expand exploration for oil reserves drill for more oil invest in more pipelines and oil tankers to bring the oil to plants where it can be refined into gasoline build new oil refineries purchase additional pipelines and trucks to ship the gasoline to gas stations and open more gas stations or keep existing gas stations open longer hours . Economists call this positive relationship between price and quantity a higher price leads to a higher quantity supplied and a lower price leads to a lower quantity law of supply . The law of supply assumes that all other variables that affect supply ( to be explained in the next module ) are held constant . Still unsure about the different types of supply ?

See the following Clear It Up feature . IS SUPPLY THE SAME AS QUANTITY SUPPLIED ?

In economic terminology , supply is not the same as quantity supplied . When economists refer to supply , they mean the relationship between a range of prices and the quantities supplied at those prices , a relationship that can be illustrated with a supply curve or a supply schedule . When economists refer to quantity supplied , they mean only a certain point on the supply curve , or one quantity on the supply schedule . In short , supply refers to the curve and quantity supplied refers to the ( specific ) point on the curve . Figure illustrates the law of supply , again using the market for gasoline as an example . Like demand , supply can be illustrated using a table or a graph . A supply schedule is a table , like Table , that shows the quantity supplied at a range of different prices . Again , price is measured in dollars per gallon of gasoline and quantity supplied is measured in millions of gallons . A supply curve is a graphic of the relationship between price , shown on the vertical axis , and quantity , shown on the axis . The supply schedule and the supply curve are just two different ways of showing the same information . Notice that the horizontal and vertical axes on the graph for the supply curve are the same as for the demand curve .

82 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER 220 I ( per gallon , 720 gallons ) 5200 A ( 00 per gallon , 700 gallons ) A ( per gallon , 680 million gallons ) per gallon , 640 gallons ) 40 ( per gallon . 600 gallons ) 20 A ( per gallon , 550 gallons ) 00 I ( per 500 gallons ) I I I 300 400 500 600 700 800 900 Quantity of Gasoline ( millions of gallons ) Figure . A Supply Curve for Gasoline . The supply schedule is the table that shows quantity supplied of gasoline at each price . As price rises , quantity supplied also increases , and vice versa . The supply curve ( is created by graphing the points from the supply schedule and then connecting them . The upward slope of the supply curve illustrates the law of a higher price leads to a higher quantity supplied , and vice versa . Price ( per gallon ) Quantity Supplied ( millions of gallons ) 500 550 600 640 680 700 720 Table . Price and Supply of Gasoline The shape of supply curves will vary somewhat according to the product steeper , straighter , or curved . Nearly all supply curves , however , share a basic similarity they slope up from left to right and illustrate the law of supply as the price rises , say , from per gallon to per gallon , the quantity supplied increases from 500 gallons to 720 gallons . Conversely , as the price falls , the quantity supplied decreases . DEMAND AND SUPPLY INTERSECT Because the graphs for demand and supply curves both have price on the vertical axis and quantity on the horizontal axis , the demand curve and supply curve for a particular good or service can appear on the same graph . Together , demand and supply determine the price and the quantity that will be bought and sold in a market .

PRINCIPLES OF ECONOMICS 83 Figure illustrates the interaction of demand and supply in the market for gasoline . The demand curve ( is identical to Figure . The supply curve ( is identical to Figure . Table contains the same information in tabular form . 20 Excess supply i or surplus i 351 80 An prIce . 140 price 120 ' 00 Excess demand ' or , 300 400 500 600 700 800 900 Quantity of Gasoline ( millions of gallons ) Figure . Demand and Supply for Gasoline . The demand curve ( and the supply curve ( intersect at the equilibrium point , with a price of and a quantity of 600 . The equilibrium is the only price where quantity demanded is equal to quantity supplied . At a price above equilibrium like , quantity supplied exceeds the quantity demanded , so there is excess supply . At a price below equilibrium such as , quantity demanded exceeds quantity supplied , so there is excess demand . Price ( per gallon ) Quantity demanded ( millions of gallons ) Quantity supplied ( millions of gallons ) 800 500 700 550 600 600 550 640 500 680 460 700 420 720 Table . Price , Quantity Demanded , and Quantity Supplied Remember this When two lines on a diagram cross , this intersection usually means something . The point where the supply curve ( and the demand curve ( cross , designated by point in Figure , is called the equilibrium . The equilibrium price is the only price Where the plans of consumers and the plans of producers is , where the amount of the product consumers want to buy ( demanded ) is equal to the amount producers Want to sell ( quantity supplied ) This common is called the equilibrium quantity . At any other price , the quantity demanded does not equal the quantity supplied , so the market is not in equilibrium at that price .

84 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER In Figure , the equilibrium price is per gallon of gasoline and the equilibrium quantity is 600 million gallons . If you had only the demand and supply schedules , and not the graph , you could find the equilibrium by looking for the price level on the tables where the quantity demanded and the quantity supplied are equal . The word equilibrium means If a market is at its equilibrium price and quantity , then it has no reason to move away from that point . However , if a market is not at equilibrium , then nomic pressures arise to move the market toward the equilibrium price and the equilibrium quantity . Imagine , for example , that the price of a gallon of gasoline was above the equilibrium is , instead of per gallon , the price is per gallon . This price is illustrated by the dashed horizontal line at the price of in Figure . At this higher price , the quantity demanded drops from 600 to 500 . This decline in quantity reflects how consumers react to the higher price by finding ways to use less gasoline . Moreover , at this higher price of , the quantity of gasoline supplied rises from the 600 to 680 , as the higher price makes it more profitable for gasoline producers to expand their output . Now , consider how quantity demanded and quantity supplied are related at this price . Quantity demanded has fallen to 500 gallons , while quantity supplied has risen to 680 gallons . In fact , at any price , the quantity supplied exceeds the quantity demanded . We call this an excess supply or a surplus . With a surplus , gasoline accumulates at gas stations , in tanker trucks , in pipelines , and at oil refineries . This accumulation puts pressure on gasoline sellers . If a surplus remains unsold , those firms involved in making and selling gasoline are not receiving enough cash to pay their workers and to cover their expenses . In this situation , some producers and sellers will want to cut prices , because it is better to sell at a lower price than not to sell at all . Once some sellers start cutting prices , others will follow to avoid losing sales . These price reductions in turn will stimulate a higher quantity demanded . So , if the price is above the equilibrium level , incentives built into the structure of demand and supply will create pressures for the price to fall toward the equilibrium . Now suppose that the price is below its equilibrium level at per gallon , as the dashed horizontal line at this price in Figure shows . At this lower price , the quantity demanded increases from 600 to 700 as drivers take longer trips , spend more minutes warming up the car in the driveway in time , stop sharing rides to work , and buy larger cars that get fewer miles to the gallon . However , the price reduces gasoline producers incentives to produce and sell gasoline , and the quantity supplied falls from 600 to 550 . When the price is below equilibrium , there is excess demand , or a is , at the given price the quantity demanded , which has been stimulated by the lower price , now exceeds the quantity supplied , which had been depressed by the lower price . In this situation , eager gasoline buyers mob the gas stations , only to find many stations running short of fuel . Oil companies and gas stations that they have an opportunity to make higher profits by selling what gasoline they have at a higher price . As a result , the price rises toward the equilibrium level . Read Demand , Supply , and for more discussion on the importance of the demand and supply model . KEY CONCEPTS AND SUMMARY A demand schedule is a table that shows the quantity demanded at different prices in the market . A

PRINCIPLES OF ECONOMICS 85 demand curve shows the relationship between quantity demanded and price in a given market on a graph . The law of demand states that a higher price typically leads to a lower quantity demanded . A supply schedule is a table that shows the quantity supplied at different prices in the market . A supply curve shows the relationship between quantity supplied and price on a graph . The law of supply says that a higher price typically leads to a higher quantity supplied . The equilibrium price and equilibrium quantity occur where the supply and demand curves cross . The equilibrium occurs where the quantity demanded is equal to the quantity supplied . If the price is below the equilibrium level , then the quantity demanded will exceed the quantity supplied . Excess demand or a shortage will exist . If the price is above the equilibrium level , then the quantity supplied will exceed the quantity demanded . Excess supply or a surplus will exist . In either case , economic pressures will push the price toward the equilibrium level . SELF CHECK QUESTIONS Review Figure . Suppose the price of gasoline is per gallon . Is the quantity demanded higher or lower than at the equilibrium price of per gallon ?

And what about the quantity supplied ?

Is there a shortage or a surplus in the market ?

If so , of how much ?

REVIEW QUESTIONS . determines the level of prices in a market ?

does a demand curve mean about how buyers in a market will react to a higher price ?

Will demand curves have the same exact shape in all markets ?

If not , how will they differ ?

Will supply curves have the same shape in all markets ?

If not , how will they differ ?

rat is the relationship between quantity demanded and quantity supplied at equilibrium ?

What is the re when there is a shortage ?

What is the relationship when there is a surplus ?

How can you locate the equilibrium point on a demand and supply graph ?

If the price is above the equilibrium level , would you predict a surplus or a shortage ?

If the price is below the equilibrium level , would you predict a surplus or a shortage ?

Why ?

Jen the price is above the equilibrium , explain how market forces move the market price to equilibrium . Do the same when the price is below the equilibrium . rat is the difference between the demand and the quantity demanded of a product , say milk ?

Explain in Words and show the difference on a graph with a demand curve for milk . rat is the difference between the supply and the quantity supplied of a product , say milk ?

Explain in Words and show the difference on a graph with the supply curve for milk .

85 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER CRITICAL THINKING QUESTIONS I Review Figure . Suppose the government decided that , since gasoline is a necessity , its price should be legally capped at per gallon . What do you anticipate would be the outcome in the gasoline market ?

I Explain why the following statement is false In the goods market , no buyer would be willing to pay more than the equilibrium price . I Explain why the following statement is false In the goods market , no seller would be willing to sell for less than the equilibrium price . PROBLEMS Review Figure again . Suppose the price of gasoline is Will the quantity demanded be lower or higher than at the equilibrium price of per gallon ?

Will the quantity supplied be lower or higher ?

Is there a shortage or a surplus in the market ?

If so , of how much ?

REFERENCES , Robert , and Lisa . No Accounting For Nature How Conventional Economics torts the Value of The Washington Post . September , 1990 . European Commission Agriculture and Rural Development . 2013 . Overview of the CAP Reform Accessed April 13 , A . The Economic Organisation of a . no . 48 ( 1945 ) demand curve a graphic representation of the relationship between price and quantity demanded of a certain good or service , with quantity on the horizontal axis and the price on the vertical axis demand schedule a table that shows a range of prices for a certain good or service and the quantity demanded at each price demand the relationship between price and the quantity demanded of a certain good or service equilibrium price the price where quantity demanded is equal to quantity supplied equilibrium quantity the quantity at which quantity demanded and quantity supplied are equal for a certain price level equilibrium the situation where quantity demanded is equal to the quantity supplied the combination of price and quantity where there is no economic pressure from surpluses or shortages that would cause price or quantity to change excess demand at the existing price , the quantity demanded exceeds the quantity supplied also called a shortage excess supply at the existing price , quantity supplied exceeds the quantity demanded also called a surplus law of demand the common relationship that a higher price leads to a lower quantity demanded of a

PRINCIPLES or ECONOMICS 87 certain good or service and a lower price leads to a higher quantity demanded , while all other variables are held constant law of supply the common relationship that a higher price leads to a greater quantity supplied and a lower price leads to a lower quantity supplied , while all other variables are held constant price what a buyer pays for a unit of the specific good or service quantity demanded the total number of units of a good or service consumers are willing to purchase at a given price quantity supplied the total number of units of a good or service producers are willing to sell at a given price shortage at the existing price , the quantity demanded exceeds the quantity supplied also called excess demand supply curve a line that shows the relationship between price and quantity supplied on a graph , with quantity supplied on the horizontal axis and price on the vertical axis supply schedule a table that shows a range of prices for a good or service and the quantity supplied at each price supply the relationship between price and the quantity supplied of a certain good or service surplus at the existing price , quantity supplied exceeds the quantity demanded also called excess supply SOLUTIONS Answers to Questions Since per gallon is above the equilibrium price , the quantity demanded would be lower at 550 gallons and the quantity supplied would be higher at 640 gallons . These results are due to the laws of demand and supply , respectively . The outcome of lower and higher would be a surplus in the gasoline market of 640 550 90 gallons .

SHIFTS IN DEMAND AND SUPPLY FOR GOODS AND SERVICES LEARNING By the end of this section , you will be able to Identify factors that affect demand Graph demand curves and demand shifts Identify factors that affect supply Graph supply curves and supply shifts he previous module explored how price affects the quantity demanded and the quantity plied . The result was the demand curve and the supply curve . Price , however , is not the only thing that demand . Nor is it the only thing that supply . For example , how is demand for vegetarian food affected if , say , health concerns cause more consumers to avoid eating meat ?

Or how is the supply of diamonds affected if diamond producers discover several new diamond mines ?

What are the major factors , in addition to the price , that demand or supply ?

Visit this website to read a brief note on how marketing strategies can supply and demand of products . cones WHAT FACTORS AFFECT DEMAND ?

We defined demand as the amount of some product a consumer is willing and able to purchase at each price . That suggests at least two factors in addition to price that affect demand . Willingness to purchase suggests a desire , based on what economists call tastes and preferences . If you neither need nor want something , you will not buy it . Ability to purchase suggests that income is important . are usually able to afford better housing and transportation than students , because they have

PRINCIPLES or ECONOMICS 89 more income . Prices of related goods can affect demand also . If you need a new car , the price of a Honda may affect your demand for a Ford . Finally , the size or composition of the population can affect demand . The more children a family has , the greater their demand for clothing . The more children a family has , the greater their demand for car insurance , and the less for diapers and baby formula . These factors matter both for demand by an individual and demand by the market as a whole . Exactly how do these various factors affect demand , and how do we show the effects graphically ?

To answer those questions , we need the assumption . THE ASSUMPTION A demand curve or a supply curve is a relationship between two , and only two , variables quantity on the horizontal axis and price on the vertical axis . The assumption behind a demand curve or a supply curve is that no relevant economic factors , other than the products price , are changing . Economists call this assumption , a Latin phrase meaning other things being Any given demand or supply curve is based on the assumption that all else is held equal . A demand curve or a supply curve is a relationship between two , and only two , variables when all other variables are kept constant . If all else is not held equal , then the laws of supply and demand will not necessarily hold , as the following Clear It Up feature shows . WHEN DOES APPLY ?

is typically applied when We look at how changes in price affect demand or supply , but can be applied more generally . In the real World , demand and supply depend on more factors than just price . For example , a consumer demand depends on income and a producer supply depends on the cost of producing the product . How can we analyze the effect on demand or supply if multiple factors are changing at the same price rises and income falls ?

The answer is that we examine the changes one at a time , assuming the other factors are held constant . For example , we can say that an increase in the price reduces the amount consumers will buy ( assuming income , and thing else that affects demand , is unchanged ) Additionally , a decrease in income reduces the amount consumers can afford to buy ( assuming price , and anything else that affects demand , is unchanged ) This is What the assumption really means . In this particular case , after we analyze each factor separately , we can combine the results . The amount buy falls for two reasons first because of the higher price and second because of the lower income . HOW DOES INCOME AFFECT DEMAND ?

Let use income as an example of how factors other than price affect demand . Figure shows the demand for automobiles as Do . At point , for example , if the price is per car , the of cars demanded is 18 million . Do also shows how the quantity of cars demanded would change as a result of a higher or lower price . For example , if the price of a car rose to , the quantity demanded would decrease to 17 million , at point The original demand curve Do , like every demand curve , is based on the assumption that no other economically relevant factors change . Now imagine that the economy expands in a way that raises the incomes of many people , making cars more affordable . How will this affect demand ?

How can we show this graphically ?

90 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Return to Figure . The price of cars is still , but with higher incomes , the quantity demanded has now increased to 20 million cars , shown at point As a result of the higher income levels , the demand curve shifts to the right to the new demand curve , indicating an increase in demand . Table shows clearly that this increased demand would occur at every price , not just the original one . 824000 A Don coco , on ( I A I I . 14000 A A 13 144 17 20 23 28 Quantity Figure . Shifts in Demand A Car Example . Increased demand means that at every given price , the quantity demanded is higher , so that the demand curve shifts to the right from Do to . Decreased demand means that at every given price , the quantity demanded is lower , so that the demand curve shifts to the left from Do to . Price Decrease to Original Quantity Demanded Do Increase to million million million million million million million million million million million million million million million million million million Table . Price and Demand Shifts A Car Example Now , imagine that the economy slows down so that many people lose their jobs or work fewer hours , reducing their incomes . In this case , the decrease in income would lead to a lower quantity of cars demanded at every given price , and the original demand curve Do would shift left to . The shift from Do to represents such a decrease in demand At any given price level , the quantity demanded is now lower . In this example , a price of means 18 million cars sold along the original demand curve , but only million sold after demand fell . When a demand curve shifts , it does not mean that the quantity demanded by every individual buyer

PRINCIPLES or ECONOMICS 91 changes by the same amount . In this example , not everyone would have higher or lower income and not everyone would buy or not buy an additional car . Instead , a shift in a demand curve captures an pattern for the market as a whole . In the previous section , we argued that higher income causes greater demand at every price . This is true for most goods and services . For cars , vacations in Europe , and fine effect of a rise in income can be especially pronounced . A product whose demand rises when income rises , and vice versa , is called a normal good . A few exceptions to this pattern do exist . As incomes rise , many people will buy fewer generic brand groceries and more name brand groceries . They are less likely to buy used cars and more likely to buy new cars . They will be less likely to rent an ment and more likely to own a home , and so on . A product whose demand falls when income rises , and vice versa , is called an inferior good . In other words , when income increases , the demand curve shifts to the left . OTHER FACTORS THAT SHIFT DEMAND CURVES Income is not the only factor that causes a shift in demand . Other things that change demand include tastes and preferences , the composition or size of the population , the prices of related goods , and even expectations . A change in any one of the underlying factors that determine what quantity people are willing to buy at a given price will cause a shift in demand . Graphically , the new demand curve lies either to the right ( an increase ) or to the left ( a decrease ) of the original demand curve . Let look at these factors . Changing Tastes or Preferences From 1980 to 2014 , the consumption of chicken by Americans rose from 48 pounds per year to 85 pounds per year , and consumption of beef fell from 77 pounds per year to 54 pounds per year , according to the Department of Agriculture ( Changes like these are largely due to movements in taste , which change the quantity of a good demanded at every price that is , they shift the demand curve for that good , rightward for chicken and leftward for beef . Changes in the Composition of the Population The proportion of elderly citizens in the United States population is rising . It rose from in 1970 to in 2000 , and will be a projected ( by the Census Bureau ) 20 of the population by 2030 . A society with relatively more children , like the United States in the , will have greater demand for goods and services like and day care facilities . A society with relatively more elderly sons , as the United States is projected to have by 2030 , has a higher demand for nursing homes and hearing aids . Similarly , changes in the size of the population can affect the demand for housing and many other goods . Each of these changes in demand will be shown as a shift in the demand curve . The demand for a product can also be affected by changes in the prices of related goods such as or complements . A substitute is a good or service that can be used in place of another good or service . As electronic books , like this one , become more available , you would expect to see a decrease in demand for traditional printed books . A lower price for a substitute decreases demand for the other product . For example , in recent years as the price of tablet computers has fallen , the quantity demanded has increased ( because of the law of demand ) Since people are purchasing tablets , there has been a decrease in demand for laptops , which can be shown graphically as a leftward shift in the demand curve for laptops . A higher price for a substitute good has the reverse effect .

92 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Other goods are complements for each other , meaning that the goods are often used together , because consumption of one good tends to enhance consumption of the other . Examples include breakfast cereal and milk notebooks and pens or pencils , golf balls and golf clubs gasoline and sport utility vehicles and the combination of bacon , lettuce , tomato , mayonnaise , and bread . If the price of golf clubs rises , since the quantity demanded of golf clubs falls ( because of the law of demand ) demand for a complement good like golf balls decreases , too . Similarly , a higher price for skis would shift the demand curve for a complement good like ski resort trips to the left , while a lower price for a complement has the reverse effect . Changes in Expectations about Future Prices or Other Factors that Affect Demand While it is clear that the price of a good affects the quantity demanded , it is also true that expectations about the future price ( or expectations about tastes and preferences , income , and so on ) can affect demand . For example , if people hear that a hurricane is coming , they may rush to the store to buy flashlight batteries and bottled water . If people learn that the price of a good like coffee is likely to rise in the future , they may head for the store to stock up on coffee now . These changes in demand are shown as shifts in the curve . Therefore , a shift in demand happens when a change in some nomic factor ( other than price ) causes a different quantity to be demanded at every price . The ing Work It Out feature shows how this happens . SHIFT IN DEMAND A shift in demand means that at any price ( and at every price ) the quantity demanded will be different than it was before . Following is an example of a shift in demand due to an income increase . Step . Draw the graph of a demand curve for a normal good like pizza . Pick a price ( like Po ) Identify the corresponding Qo . An example is shown in Figure . Price Quantity Demanded Figure . Demand Curve . The demand curve can be used to identify how much consumers would buy at any given price . Step . Suppose income increases . As a result of the change , are consumers going to buy more or less pizza ?

The answer is more . Draw a dotted horizontal line from the chosen price , through the original quantity demanded , to the new point with the new . Draw a dotted Vertical line down to the horizontal axis and label the new . An example is provided in Figure .

PRINCIPLES OF ECONOMICS 93 Price ' Quantity Demanded Figure . Demand Curve with Income Increase . With an increase in income , consumers will purchase larger quantities , pushing demand to the right . Step . Now , shift the curve through the new point . You will see that an increase in income causes an upward ( or rightward ) shift in the demand curve , so that at any price the quantities demanded will be higher , as shown in Figure . Quantity Demanded Figure . Demand Curve Shifted Right . With an increase in income , consumers will purchase larger quantities , pushing demand to the right , and causing the demand curve to shift right . SUMMING UP FACTORS THAT CHANGE DEMAND Six factors that can shift demand curves are summarized in Figure . The direction of the arrows indicates whether the demand curve shifts represent an increase in demand or a decrease in demand . Notice that a change in the price of the good or service itself is not listed among the factors that can shift a demand curve . A change in the price of a good or service causes a movement along a specific demand curve , and it typically leads to some change in the quantity demanded , but it does not shift the demand curve .

94 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Taste to greater Taste to lesser PopulatIon to buy to buy drops ( for a normal good ) Income drops ( for a normal good ) of PrIce of falls PrIce of complements falls of complements . Future Future expectations ' encourage ) Quantity Quantity ( a ) Factors that Increase demand ( Factors that decrease demand Figure . Factors That Shift Demand Curves . a ) A list of factors that can cause an increase in demand from Do to . The same factors , if their direction is reversed , can cause a decrease in demand from Do to . When a demand curve shifts , it will then intersect with a given supply curve at a different equilibrium price and quantity . We are , however , getting ahead of our story . Before discussing how changes in demand can affect equilibrium price and quantity , we first need to discuss shifts in supply curves . HOW PRODUCTION COSTS AFFECT SUPPLY A supply curve shows how quantity supplied will change as the price rises and falls , assuming so that no other economically relevant factors are changing . If other factors relevant to supply do change , then the entire supply curve will shift . Just as a shift in demand is represented by a change in the quantity demanded at every price , a shift in supply means a change in the quantity supplied at every price . In thinking about the factors that affect supply , remember what motivates firms profits , which are the difference between revenues and costs . Goods and services are produced using combinations of labor , materials , and machinery , or what we call inputs or factors of production . If a firm faces lower costs of production , while the prices for the good or service the firm produces remain unchanged , a firm profits go up . When a firm profits increase , it is more motivated to produce output , since the more it produces the more profit it will earn . So , when costs of production fall , a firm will tend to supply a larger quantity at any given price for its output . This can be shown by the supply curve shifting to the right . Take , for example , a messenger company that delivers packages around a city . The company may find that buying gasoline is one of its main costs . If the price of gasoline falls , then the company will find it can deliver messages more cheaply than before . Since lower costs correspond to higher profits , the messenger company may now supply more of its services at any given price . For example , given the lower gasoline prices , the company can now serve a greater area , and increase its supply . Conversely , if a firm faces higher costs of production , then it will earn lower profits at any given ing price for its products . As a result , a higher cost of production typically causes a firm to supply a smaller quantity at any given price . In this case , the supply curve shifts to the left . Consider the supply for cars , shown by curve So in Figure . Point indicates that if the price is , the quantity supplied will be 18 million cars . If the price rises to per car ,

PRINCIPLES OF ECONOMICS 95 , the quantity supplied will rise to 20 million cars , as point on the So curve shows . The same information can be shown in table form , as in Table . A . 24000 if I ! FI . 20000 I , 18000 16000 . if 14000 A , 13 165 18 23 Quantity Figure . Shifts in Supply A Car Example . Decreased supply means that at every given price , the quantity supplied is lower , so that the supply curve shifts to the left , from So to . Increased supply means that at every given price , the quantity supplied is higher , so that the supply curve shifts to the right , from So to . Price Decrease to Original Quantity Supplied So Increase to million million million million million million million million million million million million million million million million million million Table . Price and Shifts in Supply A Car Example Now , imagine that the price of steel , an important ingredient in manufacturing cars , rises , so that a car has become more expensive . At any given price for selling cars , car manufacturers will react by supplying a lower quantity . This can be shown graphically as a leftward shift of supply , from So to , which indicates that at any given price , the quantity supplied decreases . In this example , at a price of , the quantity supplied decreases from 18 million on the original supply curve ( So ) to million on the supply curve , which is labeled as point Conversely , if the price of steel decreases , producing a car becomes less expensive . At any given price for selling cars , car manufacturers can now expect to earn higher profits , so they will supply a higher

96 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER quantity . The shift of supply to the right , from So to , means that at all prices , the quantity supplied has increased . In this example , at a price of , the quantity supplied increases from 18 million on the original supply curve ( So ) to million on the supply curve , which is labeled OTHER FACTORS THAT AFFECT SUPPLY In the example above , we saw that changes in the prices of inputs in the production process will affect the cost of production and thus the supply . Several other things affect the cost of production , too , such as changes in weather or other natural conditions , new technologies for production , and some policies . The cost of production for many agricultural products will be affected by changes in natural . For example , in 2014 the Manchurian Plain in Northeastern China , which produces most of the country wheat , corn , and soybeans , experienced its most severe drought in 50 years . A drought decreases the supply of agricultural products , which means that at any given price , a lower quantity will be supplied conversely , especially good weather would shift the supply curve to the right . When a firm discovers a new technology that allows the firm to produce at a lower cost , the supply curve will shift to the right , as well . For instance , in the a major scientific effort nicknamed the Green Revolution focused on breeding improved seeds for basic crops like wheat and rice . By the early 19905 , more than of the wheat and rice in countries around the world was grown with these Green Revolution the harvest was twice as high per acre . A logical improvement that reduces costs of production will shift supply to the right , so that a greater quantity will be produced at any given price . Government policies can affect the cost of production and the supply curve through taxes , and subsidies . For example , the government imposes a tax on alcoholic beverages that about billion per year from producers . Taxes are treated as costs by businesses . Higher costs decrease supply for the reasons discussed above . Other examples of policy that can affect cost are the wide array of government regulations that require firms to spend money to provide a cleaner or a safer workplace complying with regulations increases costs . A government subsidy , on the other hand , is the opposite of a tax . A subsidy occurs when the ment pays a firm directly or reduces the firms taxes if the firm carries out certain actions . From the firms perspective , taxes or regulations are an additional cost of production that shifts supply to the left , leading the firm to produce a lower quantity at every given price . Government subsidies reduce the cost of production and increase supply at every given price , shifting supply to the right . The lowing Work It Out feature shows how this shift happens . SHIFT IN SUPPLY We know that a supply curve shows the minimum price a firm will accept to produce a given quantity of output . What happens to the supply curve when the cost of production goes up ?

Following is an example of a shift in supply due to a production cost increase . Step . Draw a graph of a supply curve for pizza . Pick a quantity ( like ) If you draw a vertical line up from to the supply curve , you will see the price the firm chooses . An example is shown in Figure . Step . Why did the firm choose that price and not some other ?

One way to think about this is that the price is composed PRINCIPLES OF ECONOMICS 97 Price ' 00 Quantity Supplied Figure . Supply Curve . The supply curve can be used to show the minimum price a firm will accept to produce a given quantity of output . of two parts . The first part is the average cost of production , in this case , the cost of the pizza ingredients ( dough , sauce , cheese , pepperoni , and so on ) the cost of the pizza oven , the rent on the shop , and the wages of the workers . The second part is the firm desired profit , which is determined , among other factors , by the profit margins in that particular business . If you add these two parts together , you get the price the firm wishes to charge . The quantity and associated price give you one point on the firm supply curve , as shown in Figure . Price ' Desired profit Cost of production Quantity Supplied Figure . Setting Prices . The cost of production and the desired profit equal the price a firm will set for a product . Step . Now , suppose that the cost of production goes up . Perhaps cheese has become more expensive by per pizza . If that is true , the firm will want to raise its price by the amount of the increase in cost ( Draw this point on the supply curve directly above the initial point on the curve , but higher , as shown in Figure . Step . Shift the supply curve through this point . You will see that an increase in cost causes an upward ( or a leftward ) shift of the supply curve so that at any price , the quantities supplied will be smaller , as shown in Figure 10 .

98 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER . Same I desIred , Price New DesIred hIgher Cost of productIon Quantity Supplied Figure . Increasing Costs Leads to Increasing Price . Because the cost of production and the desired profit equal the price a firm will set for a product , if the cost of production increases , the price for the product will also need to increase . if A Same . desired . a . New DesIred hIgher cos Cost of Quantity Supplied Figure 10 . Supply Curve Shifts . When the cost of production increases , the supply curve shifts upwardly to a new price level . SUMMING UP FACTORS THAT CHANGE SUPPLY Changes in the cost of inputs , natural disasters , new technologies , and the impact of government all affect the cost of production . In turn , these factors affect how much firms are willing to ply at any given price . Figure 11 summarizes factors that change the supply of goods and services . Notice that a change in the price of the product itself is not among the factors that shift the supply curve . Although a change in price of a good or service typically causes a change in quantity supplied or a movement along the supply curve for that specific good or service , it does not cause the supply curve itself to shift . Because demand and supply curves appear on a diagram with only price and on the axes , an unwary visitor to the land of economics might be fooled into believing that

Price PRINCIPLES OF ECONOMICS 99 Favorable natural for . A fall In Input Improved technology . Lower product , less costly , Poor natural condItIons for A In Input I A In technology I , not common ) product , more costly Quantity Quantity ( a ) Factors that Increase supply ( Factors that decrease supply Figure 11 . Factors That Shift Supply Curves . a ) A list of factors that can cause an increase in supply from So to . The same factors , if their direction is reversed , can cause a decrease in supply from So to . is about only four topics demand , supply , price , and quantity . However , demand and supply are really umbrella concepts demand covers all the factors that affect demand , and supply covers all the factors that affect supply . Factors other than price that affect demand and supply are included by using shifts in the demand or the supply curve . In this way , the demand and supply model becomes a powerful tool for analyzing a wide range of economic circumstances . KEY CONCEPTS AND SUMMARY Economists often use the or other things being equal assumption while examining the economic impact of one event , all other factors remain unchanged for the purpose of the analysis . Factors that can shift the demand curve for goods and services , causing a different quantity to be demanded at any given price , include changes in tastes , population , income , prices of substitute or complement goods , and expectations about future conditions and prices . Factors that can shift the supply curve for goods and services , causing a different quantity to be supplied at any given price , include input prices , natural conditions , changes in technology , and government taxes , regulations , or subsidies . SELF CHECK QUESTIONS . Why do economists use the assumption ?

In an analysis of the market for paint , an economist discovers the facts listed below . State whether each of these changes will affect supply or demand , and in what direction . There have recently been some important inventions in the technology for making paint . Paint is lasting longer , so that property owners need not repaint as often . Because of severe , many people need to repaint now . The damaged several factories that make paint , forcing them to close down for several months . Many changes are affecting the market for oil . Predict how each of the following events will affect the

100 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER equilibrium price and quantity in the market for oil . In each case , state how the event will affect the supply and demand diagram . Create a sketch of the diagram if necessary . Cars are becoming more fuel efficient , and therefore get more miles to the gallon . The winter is exceptionally cold . A major discovery of new oil is made off the coast of Norway . The economies of some major nations , like japan , slow down . in the Middle East disrupts schedules . Landlords install additional insulation in buildings . The price of solar energy falls dramatically . Chemical companies invent a new , popular kind of plastic made from oil . REVIEW QUESTIONS . When analyzing a market , how do economists deal with the problem that many factors that affect the market are changing at the same time ?

Name some factors that can cause a shift in the demand curve in markets for goods and services . Name some factors that can cause a shift in the supply curve in markets for goods and services . CRITICAL THINKING QUESTIONS Consider the demand for hamburgers . If the price of a substitute good ( for example , hot dogs ) increases and the price of a complement good ( for example , hamburger buns ) increases , can you tell for sure what will happen to the demand for hamburgers ?

Why or why not ?

Illustrate your answer with a graph . How do you suppose the demographics of an aging population of Baby Boomers in the United States will affect the demand for milk ?

Justify your answer . We know that a change in the price of a product causes a movement along the demand curve . Suppose consumers believe that prices will be rising in the future . How will that affect demand for the product in the present ?

Can you show this graphically ?

Suppose there is soda tax to curb obesity . What should a reduction in the soda tax do to the supply of sodas and to the equilibrium price and quantity ?

Can you show this graphically ?

Hint assume that the soda tax is collected from the sellers PROBLEMS . Table shows information on the demand and supply for bicycles , where the quantities of bicycles are measured in thousands .

PRINCIPLES or ECONOMICS 101 Price 120 50 36 150 40 40 180 32 48 210 28 56 240 24 70 Table . Demand and Supply for Bicycles . What is the quantity demanded and the quantity supplied at a price of 210 ?

At What price is the quantity supplied equal to ?

Graph the demand and supply curve for bicycles . How can you determine the equilibrium price and quantity from the graph ?

How can you determine the equilibrium price and quantity from the table ?

What are the equilibrium price and equilibrium quantity ?

If the price was 120 , what would the quantities demanded and supplied be ?

Would a shortage or surplus exist ?

If so , how large would the shortage or surplus be ?

The computer market in recent years has seen many more computers sell at much lower prices . What shift in demand or supply is most likely to explain this outcome ?

Sketch a demand and supply diagram and explain your reasoning for each . A rise in demand . A fall in demand . A rise in supply . A fall in supply REFERENCES , Steven The Armchair Economist Economics and Everyday Life . New York The Free Press . specifically Section IV How Markets Work . National Chicken Council . 2015 . Per Capita Consumption of Poultry and Livestock , 1965 to mated 2015 , in Accessed April 13 , David . Saudi Arabia Fears Oil , The Wall . May 27 , 2004 , other things being equal complements goods that are often used together so that consumption of one good tends to enhance consumption of the other factors of production the combination of labor , materials , and machinery that is used to produce goods and services also called inputs

102 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER inferior good a good in which the quantity demanded falls as income rises , and in which quantity demanded rises and income falls inputs the combination of labor , materials , and machinery that is used to produce goods and services also called factors of production normal good a good in which the quantity demanded rises as income rises , and in which quantity demanded falls as income falls shift in demand when a change in some economic factor ( other than price ) causes a different quantity to be demanded at every price shift in supply when a change in some economic factor ( other than price ) causes a different quantity to be supplied at every price substitute a good that can replace another to some extent , so that greater consumption of one good can mean less of the other SOLUTIONS Answers to Questions . To make it easier to analyze complex problems . allows you to look at the effect of one factor at a time on What it is you are trying to analyze . When you have analyzed all the factors individually , you add the results together to get the final answer . An improvement in technology that reduces the cost of production will cause an increase in supply . Alternatively , you can think of this as a reduction in price necessary for firms to supply any quantity . Either way , this can be shown as a rightward ( or downward ) shift in the supply curve . An improvement in product quality is treated as an increase in tastes or preferences , meaning consumers demand more paint at any price level , so demand increases or shifts to the right . If this seems counterintuitive , note that demand in the future for the paint will fall , since consumers are essentially shifting demand from the future to the present . An increase in need causes an increase in demand or a rightward shift in the demand curve . Factory damage means that firms are unable to supply as much in the present . Technically , this is an increase in the cost of production . Either Way you look at it , the supply curve shifts to the left . More cars means there is less need for gasoline . This causes a leftward shift in the demand for gasoline and thus oil . Since the demand curve is shifting down the supply curve , the equilibrium price and quantity both fall . Cold weather increases the need for heating oil . This causes a rightward shift in the demand for heating oil and thus oil . Since the demand curve is shifting up the supply curve , the equilibrium price and quantity both rise . A discovery of new oil will make oil more abundant . This can be shown as a rightward shift in the supply curve , which will cause a decrease in the equilibrium price along with an increase in the equilibrium quantity . The supply curve shifts down the demand curve so price and quantity follow the law of demand . If price goes down , then the quantity goes up . When an economy slows down , it produces less output and demands less input , including energy , which is used in the production of virtually everything . A decrease in demand for energy will be as a decrease in the demand for oil , or a leftward shift in demand for oil . Since the

PRINCIPLES OF ECONOMICS 103 demand curve is shifting down the supply curve , both the equilibrium price and quantity of oil will fall . Disruption of oil pumping will reduce the supply of oil . This leftward shift in the supply curve will show a movement up the demand curve , resulting in an increase in the equilibrium price of oil and a decrease in the equilibrium quantity . Increased insulation will decrease the demand for heating . This leftward shift in the demand for oil causes a movement down the supply curve , resulting in a decrease in the equilibrium price and quantity of oil . Solar energy is a substitute for energy . So if solar energy becomes cheaper , the demand for oil will decrease as consumers switch from oil to solar . The decrease in demand for oil will be shown as a leftward shift in the demand curve . As the demand curve shifts down the supply curve , both equilibrium price and quantity for oil will fall . A new , popular kind of plastic will increase the demand for oil . The increase in demand will be shown as a rightward shift in demand , raising the equilibrium price and quantity of oil .

CHANGES IN EQUILIBRIUM PRICE AND QUANTITY THE PROCESS LEARNING By the end of this section , you will be able to Identify equilibrium price and quantity through the process Graph equilibrium price and quantity Contrast shifts of demand or supply and movements along a demand or supply curve Graph demand and supply curves , including equilibrium price and quantity , based on examples et begin this discussion with a single economic event . It might be an event that affects demand , like a change in income , population , tastes , prices of substitutes or complements , or expectations about future prices . It might be an event that affects supply , like a change in natural conditions , input prices , or technology , or government policies that affect production . How does this economic event affect equilibrium price and quantity ?

We will analyze this question using a process . Step . Draw a demand and supply model before the economic change took place . To establish the model requires four standard pieces of information The law of demand , which tells us the slope of the demand curve the law of supply , which gives us the slope of the supply curve the shift variables for demand and the shift variables for supply . From this model , find the initial equilibrium values for price and quantity . Step . Decide whether the economic change being analyzed affects demand or supply . In other words , does the event refer to something in the list of demand factors or supply factors ?

Step . Decide whether the effect on demand or supply causes the curve to shift to the right or to the left , and sketch the new demand or supply curve on the diagram . In other words , does the event increase or decrease the amount consumers want to buy or producers want to sell ?

Step . Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity . Let consider one example that involves a shift in supply and one that involves a shift in demand . Then we will consider an example where both supply and demand shift .

PRINCIPLES OF ECONOMICS 105 GOOD WEATHER FOR SALMON FISHING In the summer of 2000 , weather conditions were excellent for commercial salmon fishing off the coast . Heavy rains meant higher than normal levels of water in the rivers , which helps the salmon to breed . Slightly cooler ocean temperatures stimulated the growth of plankton , the scopic organisms at the bottom of the ocean food chain , providing everything in the ocean with a hearty food supply . The ocean stayed calm during fishing season , so commercial fishing operations did not lose many days to bad weather . How did these climate conditions affect the quantity and price of salmon ?

Figure illustrates the approach , which is explained below , to work through this problem . Table provides the information to work the problem as well . EE ( 53 . 50 I 00 ' 5250 . I I Price ( per pound ) 00 I I ' I I I 200 400 600 800 1000 Quantity ( thousands of fish ) Figure . Good Weather for Salmon Fishing The Process . Unusually good weather leads to changes in the price and quantity of salmon . Price per Pound Quantity Supplied in 1999 Quantity Supplied in 2000 Quantity Demanded 80 400 840 120 480 680 160 550 550 200 600 450 230 640 350 250 670 250 270 700 200 Table . Salmon Fishing Step . Draw a demand and supply model to illustrate the market for salmon in the year before the good weather conditions began . The demand curve Do and the supply curve So show that the original

106 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER equilibrium price is per pound and the original equilibrium quantity is fish . This price per pound is what commercial buyers pay at the fishing docks what consumers pay at the grocery is higher . Step . Did the economic event affect supply or demand ?

Good weather is an example of a natural condition that affects supply . Step . Was the effect on supply an increase or a decrease ?

Good weather is a change in natural that increases the quantity supplied at any given price . The supply curve shifts to the right , moving from the original supply curve So to the new supply curve , which is shown in both the table and the figure . Step . Compare the new equilibrium price and quantity to the original equilibrium . At the new , the equilibrium price falls from to , but the equilibrium quantity increases from to salmon . Notice that the equilibrium quantity demanded increased , even though the demand curve did not move . In short , good weather conditions increased supply of the California commercial salmon . The result was a higher equilibrium quantity of salmon bought and sold in the market at a lower price . NEWSPAPERS AND THE INTERNET According to the Pew Research Center for People and the Press , more and more people , especially younger people , are getting their news from online and digital sources . The majority of adults now own smartphones or tablets , and most of those Americans say they use them in part to get the news . From 2004 to 2012 , the share of Americans who reported getting their news from digital sources increased from 24 to 39 . How has this affected consumption of print news media , and radio and television news ?

Figure and the text below illustrates using the analysis to answer this question . Step . Develop a demand and supply model to think about what the market looked like before the event . The demand curve Do and the supply curve So show the original relationships . In this case , the analysis is performed without specific numbers on the price and quantity axis . Step . Did the change described affect supply or demand ?

A change in tastes , from traditional news sources ( print , radio , and television ) to digital sources , caused a change in demand for the former . Step . Was the effect on demand positive or negative ?

A shift to digital news sources will tend to mean a lower quantity demanded of traditional news sources at every given price , causing the demand curve for print and other traditional news sources to shift to the left , from Do to . Step . Compare the new equilibrium price and quantity to the original equilibrium price . The new equilibrium ( occurs at a lower quantity and a lower price than the original equilibrium ( The decline in print news reading predates 2004 . Print newspaper circulation peaked in 1973 and has declined since then due to competition from television and radio news . In 1991 , 55 of Americans indicated they got their news from print sources , while only 29 did so in 2012 . Radio news has lowed a similar path in recent decades , with the share of Americans getting their news from radio

PRINCIPLES OF ECONOMICS 107 of , ii , Quantity Figure . The Print News Market A Analysis . A change in tastes from print news sources to digital sources results in a leftward shift in demand for the former . The result is a decrease in both equilibrium price and quantity . declining from 54 in 1991 to 33 in 2012 . Television news has held its own over the last 15 years , with a market share staying in the mid to upper fifties . What does this suggest for the future , given that of Americans under 30 years old say they do not get their news from television at all ?

THE AND SPEED OF ADJUSTMENT IN REAL MARKETS In the real world , many factors that affect demand and supply can change all at once . For example , the demand for cars might increase because of rising incomes and population , and it might decrease because of rising gasoline prices ( a complementary good ) Likewise , the supply of cars might increase because of innovative new technologies that reduce the cost of car production , and it might decrease as a result of new government regulations requiring the installation of costly . Moreover , rising incomes and population or changes in gasoline prices will affect many markets , not just cars . How can an economist sort out all these interconnected events ?

The answer lies in the assumption . Look at how each economic event affects each market , one event at a time , ing all else constant . Then combine the analyses to see the net effect . A COMBINED EXAMPLE The . Postal Service is facing difficult challenges . Compensation for postal workers tends to increase most years due to increases . At the same time , more and more people are using email , text , and other digital message forms such as Facebook and Twitter to communicate with

103 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER friends and others . What does this suggest about the continued viability of the Postal Service ?

Figure and the text below illustrates using the analysis to answer this question . El , I , Da . Quantity Quantity ( Shift In supply ( demand Figure . Higher Compensation for Postal Workers A Analysis . a ) Higher labor compensation causes a leftward shift in the supply curve , a decrease in the equilibrium quantity , and an increase in the equilibrium price . A change in tastes away from Postal Services causes a leftward shift in the demand curve , a decrease in the equilibrium quantity , and a decrease in the equilibrium price . Since this problem involves two disturbances , we need two analyses , the first to analyze the effects of higher compensation for postal workers , the second to analyze the effects of many people switching from to email and other digital messages . Figure ( a ) shows the shift in supply discussed in the following steps . Step . Draw a demand and supply model to illustrate what the market for the . Postal Service looked like before this scenario starts . The demand curve Do and the supply curve So show the original relationships . Step . Did the change described affect supply or demand ?

Labor compensation is a cost of tion . A change in production costs caused a change in supply for the Postal Service . Step . Was the effect on supply positive or negative ?

Higher labor compensation leads to a lower quantity supplied of postal services at every given price , causing the supply curve for postal services to shift to the left , from So to . Step . Compare the new equilibrium price and quantity to the original equilibrium price . The new equilibrium ( occurs at a lower quantity and a higher price than the original equilibrium ( Figure ( shows the shift in demand discussed in the following steps .

PRINCIPLES OF ECONOMICS 109 Step . Draw a demand and supply model to illustrate what the market for . Postal Services looked like before this scenario starts . The demand curve Do and the supply curve show the original . Note that this diagram is independent from the diagram in panel ( a ) Step . Did the change described affect supply or demand ?

A change in tastes away from toward digital messages will cause a change in demand for the Postal Service . Step . Was the effect on supply positive or negative ?

Higher labor compensation leads to a lower quantity supplied of postal services at every given price , causing the supply curve for postal services to shift to the left , from Do to . Step . Compare the new equilibrium price and quantity to the original equilibrium price . The new equilibrium ( occurs at a lower quantity and a lower price than the original equilibrium ( The final step in a scenario where both supply and demand shift is to combine the two individual analyses to determine what happens to the equilibrium quantity and price . Graphically , we pose the previous two diagrams one on top of the other , as in Figure . 80 , Eu , Quantity Figure . Combined Effect of Decreased Demand and Decreased Supply . Supply and demand shifts cause changes in equilibrium price and quantity . Following are the results Effect on Quantity The effect of higher labor compensation on Postal Services because it raises the cost of production is to decrease the equilibrium quantity . The effect of a change in tastes away from is to decrease the equilibrium quantity . Since both shifts are to the left , the overall impact is

110 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER a decrease in the equilibrium quantity of Postal Services ( This is easy to see graphically , since is to the left of . Effect on Price The overall effect on price is more complicated . The effect of higher labor on Postal Services , because it raises the cost of production , is to increase the equilibrium price . The effect of a change in tastes away from is to decrease the equilibrium price . Since the two effects are in opposite directions , unless we know the of the two effects , the overall effect is unclear . This is not unusual . When both curves shift , typically we can determine the overall effect on price or on quantity , but not on both . In this case , we determined the overall effect on the quantity , but not on the equilibrium price . In other cases , it might be the opposite . The next Clear It Up feature focuses on the difference between shifts of supply or demand and along a curve . WHAT IS THE DIFFERENCE BETWEEN SHIFTS OF DEMAND OR SUPPLY VERSUS MOVEMENTS ALONG A DEMAND OR SUPPLY CURVE ?

One common mistake in applying the demand and supply framework is to confuse the shift of a demand or a supply curve with movement along a demand or supply curve . As an example , consider a problem that asks Whether a drought will increase or decrease the equilibrium quantity and equilibrium price of wheat . Lee , a student in an introductory economics class , might reason Well , it is clear that a drought reduces supply , so Iwill shift back the supply curve , as in the shift from the original supply curve So to shown on the diagram ( called Shift ) So the equilibrium moves from to , the equilibrium quantity is lower and the equilibrium price is higher . Then , a higher price makes farmers more likely to supply the good , so the supply curve shifts right , as shown by the shift from to , on the diagram ( shown as Shift ) so that the equilibrium now moves from to . The higher price , however , also reduces demand and so causes demand to shift back , like the shift from the original demand curve , Do to on the diagram ( labeled Shift ) and the equilibrium moves from to . At about this point , Lee suspects that this answer is headed down the wrong path . Think about what might be wrong with Lee logic , and then read the answer that follows . Answer Lee first step is correct that is , a drought shifts back the supply curve of wheat and leads to a prediction of a lower equilibrium quantity and a higher equilibrium price . This corresponds to a movement along the original demand curve ( Do ) from to . The rest of Lee argument is wrong , because it mixes up shifts in supply with quantity supplied , and shifts in demand with quantity demanded . A higher or lower price never shifts the supply curve , as suggested by the shift in supply from to . Instead , a price change leads to a movement along a given supply curve . Similarly , a higher or lower price never shifts a demand curve , as suggested in the shift from Do to . Instead , a price change leads to a movement along a given demand curve . Remember , a change in the price of a good never causes the demand or supply curve for that good to shift . Think carefully about the timeline of events What happens first , what happens next ?

What is cause , what is effect ?

If you keep the order right , you are more likely to get the analysis correct . In the analysis of how economic events affect equilibrium price and quantity , the movement from the old to the new equilibrium seems immediate . As a practical matter , however , prices and quantities often do not zoom straight to equilibrium . More realistically , when an economic event causes demand or supply to shift , prices and quantities set off in the general direction of equilibrium . Indeed , even as they are moving toward one new equilibrium , prices are often then pushed by another change in demand or supply toward another equilibrium .

PRINCIPLES OF ECONOMICS 111 Price Quantity Figure . Shifts of Demand or Supply versus Movements along a Demand or Supply Curve . A shift in one curve never causes a shift in the other curve . Rather , a shift in one curve causes a movement along the second curve . KEY CONCEPTS AND SUMMARY When using the supply and demand framework to think about how an event will affect the price and quantity , proceed through four steps ( sketch a supply and demand diagram to think about what the market looked like before the event ( decide whether the event will affect supply or demand ( decide whether the effect on supply or demand is negative or positive , and draw the appropriate shifted supply or demand curve ( compare the new equilibrium price and quantity to the original ones . SELF ' QUESTIONS . Let think about the market for air travel . From August 2014 to January 2015 , the price of jet fuel decreased roughly 47 . Using the analysis , how do you think this fuel price decrease affected the equilibrium price and quantity of air travel ?

A tariff is a tax on imported goods . Suppose the government cuts the tariff on imported screen televisions . Using the analysis , how do you think the tariff reduction will affect the equilibrium price and quantity of screen ?

REVIEW QUESTIONS . How does one analyze a market where both demand and supply shift ?

What causes a movement along the demand curve ?

What causes a movement along the supply curve ?

112 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER CRITICAL THINKING QUESTIONS . Use the process to analyze the impact of the advent of the iPod ( or other portable digital music players ) on the equilibrium price and quantity of the Sony Walkman ( or other portable audio cassette players ) Use the process to analyze the impact of a reduction in tariffs on imports of iPods on the equilibrium price and quantity of Sony products . Suppose both of these events took place at the same time . Combine your analyses of the impacts of the iPod and the tariff reduction to determine the likely impact on the equilibrium price and quantity of Sony products . Show your answer graphically . PROBLEMS . Demand and supply in the market for cheddar cheese is illustrated in Table . Graph the data and find the equilibrium . Next , create a table showing the change in quantity demanded or quantity supplied , and a graph of the new equilibrium , in each of the following situations a . The price of milk , a key input for cheese production , rises , so that the supply decreases by 80 pounds at every price . A new study says that eating cheese is good for your health , so that demand increases by 20 at every price . Price per Pound 750 540 700 600 650 650 620 700 600 720 590 730 Table . Demand and supply in the market for cheddar cheese . Supply and demand for movie tickets in a city are shown in Table . Graph demand and supply and identify the equilibrium . Then calculate in a table and graph the effect of the following two changes . a . Three new nightclubs open . They offer decent bands and have no cover charge , but make their money by selling food and drink . As a result , demand for movie tickets falls by six units at every price . The city eliminates a tax that it had been placing on all local entertainment businesses . The result is that the quantity supplied of movies at any given price increases by 10 .

PRINCIPLES OF ECONOMICS 113 Price per Pound 26 24 22 20 21 21 20 22 Table . Demand and supply for movie tickets REFERENCES Pew Research Center . Pew Research Center for the People the . SOLUTIONS Answers to Questions . Step . Draw the graph with the initial supply and demand curves . Label the initial equilibrium price and quantity . Step . Did the economic event affect supply or demand ?

jet fuel is a cost of producing air travel , so an increase in jet fuel price affects supply . Step . An increase in the price of jet fuel caused a decrease in the cost of air travel . We show this as a Ward or rightward shift in supply . Step . A rightward shift in supply causes a movement down the demand curve , lowering the equilibrium price of air travel and increasing the equilibrium quantity . Step . Draw the graph with the initial supply and demand curves . Label the initial equilibrium price and quantity . Step . Did the economic event affect supply or demand ?

A tariff is treated like a cost of production , so this affects supply . Step . A tariff reduction is equivalent to a decrease in the cost of production , which we can show as a Ward ( or downward ) shift in supply . Step . A rightward shift in supply causes a movement down the demand curve , lowering the equilibrium price and raising the equilibrium quantity .

PRICE CEILINGS AND PRICE FLOORS LEARNING OBJECTIVES By the end of this section , you will be able to Explain price controls , price ceilings , and price Analyze demand and supply as a social adjustment mechanism sometimes surrounds the prices and quantities established by demand and supply , especially for products that are considered necessities . In some cases , discontent over prices turns into public pressure on politicians , who may then pass legislation to prevent a certain price from climbing too high or falling too The demand and supply model shows how people and firms will react to the incentives provided by these laws to control prices , in ways that will often lead to undesirable consequences . Alternative icy tools can often achieve the desired goals of price control laws , while avoiding at least some of their costs and . PRICE Laws that government enacts to regulate prices are called Price controls . Price controls come in two . A price ceiling keeps a price from rising above a certain level ( the ceiling ) while a price keeps a price from falling below a certain level ( the floor ) This section uses the demand and supply framework to analyze price ceilings . The next section discusses price . In many markets for goods and services , outnumber suppliers . Consumers , who are also potential voters , sometimes unite behind a political proposal to hold down a certain price . In some cities , such as Albany , renters have pressed political leaders to pass rent control laws , a price ceiling that usually works by stating that rents can be raised by only a certain maximum percentage each year . Rent control becomes a politically hot topic when rents begin to rise rapidly . Everyone needs an affordable place to live . Perhaps a change in tastes makes a certain suburb or town a more popular place to live . Perhaps businesses expand , bringing higher incomes and more people into the area . Changes of this sort can cause a change in the demand for rental housing , as Figure . The original equilibrium ( Eo ) lies at the intersection of supply curve So and demand curve Do , corresponding to an equilibrium price of 500 and an equilibrium quantity of units of rental housing . The effect of greater income or a change in tastes is to shift the demand curve for rental

PRINCIPLES OF ECONOMICS 115 housing to the right , as shown by the data in Table 10 and the shift from Do to on the graph . In this market , at the new equilibrium , the price of a rental unit would rise to 600 and the equilibrium quantity would increase to units . A 3900 800 I ( 3600 , PrIce . IE . set here 3500 400 I 3300 Excess demand It age I from prIce 3100 101112131415161718192021222324 Quantity ( thousands of rental units ) Figure . A Price Ceiling Control . The original intersection of demand and supply occurs at . If demand shifts from Do to , the new equilibrium would be at a price ceiling prevents the price from rising . If the price is not permitted to rise , the quantity supplied remains at . However , after the change in demand , the quantity demanded rises to , resulting in a shortage . Price Original Quantity Supplied Original Quantity Demanded New Quantity Demanded 400 500 600 700 800 Table 10 . Rent Control Suppose that a rent control law is passed to keep the price at the original equilibrium of 500 for a ical apartment . In Figure , the horizontal line at the price of 500 shows the legally fixed maximum price set by the rent control law . However , the underlying forces that shifted the demand curve to the right are still there . At that price ( 500 ) the quantity supplied remains at the same rental units , but the quantity demanded is rental units . In other words , the quantity demanded exceeds the quantity supplied , so there is a shortage of rental housing . One of the ironies of price ceilings is that while the price ceiling was intended to help renters , there are actually fewer apartments rented out under the price ceiling ( rental units ) than would be the case at the market rent of 600 ( rental units ) Price ceilings do not simply benefit renters at the expense of landlords . Rather , some renters ( or

116 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER potential renters ) lose their housing as landlords convert apartments to and condos . Even when the housing remains in the rental market , landlords tend to spend less on maintenance and on essentials like heating , cooling , hot water , and lighting . The first rule of economics is you do not get something for has an opportunity cost . So if renters get cheaper housing than the market requires , they tend to also end up with lower quality housing . Price ceilings have been proposed for other products . For example , price ceilings to limit what can charge have been proposed in recent years for prescription drugs , doctor and hospital fees , the charges made by some automatic teller bank machines , and auto insurance rates . Price ceilings are enacted in an attempt to keep prices low for those who demand the product . But when the market price is not allowed to rise to the equilibrium level , quantity demanded exceeds quantity supplied , and thus a shortage occurs . Those who manage to purchase the product at the lower price given by the price ceiling will benefit , but sellers of the product will suffer , along with those who are not able to purchase the product at all . Quality is also likely to deteriorate . PRICE FLOORS A price is the lowest legal price that can be paid in markets for goods and services , labor , or financial capital . Perhaps the example of a price floor is the minimum wage , which is based on the normative view that someone working full time ought to be able to afford a basic of living . The federal minimum wage at the end of 2014 was per hour , which yields an income for a single person slightly higher than the poverty line . As the cost of living rises over time , the Congress periodically raises the federal minimum wage . Price floors are sometimes called price supports , because they support a price by preventing it from falling below a certain level . Around the world , many countries have passed laws to create agricultural price supports . Farm prices and thus farm incomes , sometimes widely . So even if , on age , farm incomes are adequate , some years they can be quite low . The purpose of price supports is to prevent these swings . The most common way price supports work is that the government enters the market and buys up the product , adding to demand to keep prices higher than they otherwise would be . According to the Common Agricultural Policy reform passed in 2013 , the European Union ( EU ) will spend about 60 billion euros per year , or 67 billion dollars per year , or roughly 38 of the EU budget , on price ports for Europe farmers from 2014 to 2020 . Figure illustrates the effects of a government program that assures a price above the equilibrium by focusing on the market for wheat in Europe . In the absence of government intervention , the price would adjust so that the quantity supplied would equal the quantity demanded at the equilibrium point , with price Po and quantity . However , policies to keep prices high for farmers keeps the price above what would have been the market equilibrium price shown by the dashed horizontal line in the diagram . The result is a quantity supplied in excess of the quantity demanded ( When quantity supplied exceeds quantity demanded , a surplus exists . The areas of the world , including the United States , Europe , and Japan , are estimated to spend roughly billion per day in supporting their farmers . If the government is willing to purchase the excess supply ( or to provide payments for others to purchase it ) then farmers will benefit from the price , but taxpayers and consumers of food will pay the costs . Numerous proposals have been

PRINCIPLES OF ECONOMICS 117 offered for reducing farm subsidies . In many countries , however , political support for subsidies for farmers remains strong . Either because this is viewed by the population as supporting the traditional rural way of life or because of the lobbying power of the industry . For more detail on the effects price ceilings and have on demand and supply , see the following Clear It Up feature . Excess supply or surplus Price floor set here ' OD Quantity Figure . European Wheat Prices A Price Floor Example . The intersection of demand ( and supply ( would be at the equilibrium point . However , a price set at holds the price above and prevents it from falling . The result of the price is that the quantity supplied exceeds the quantity demanded . There is excess supply , also called a surplus . DO PRICE CEILINGS AND FLOORS CHANGE DEMAND OR SUPPLY ?

Neither price ceilings nor price floors cause demand or supply to change . They simply set a price that limits what can be legally charged in the market . Remember , changes in price do not cause demand or supply to change . Price ceilings and price can cause a different choice of quantity demanded along a demand curve , but they do not move the demand curve . Price controls can cause a different choice of quantity supplied along a supply curve , but they do not shift the supply . KEY CONCEPTS AND SUMMARY Price ceilings prevent a price from rising above a certain level . When a price ceiling is set below the equilibrium price , quantity demanded will exceed quantity supplied , and excess demand or shortages will result . Price floors prevent a price from falling below a certain level . When a price floor is set

113 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER above the equilibrium price , quantity supplied will exceed quantity demanded , and excess supply or surpluses will result . Price and price ceilings often lead to unintended consequences . SELF CHECK QUESTIONS . What is the effect of a price ceiling on the quantity demanded of the product ?

What is the effect of a price ceiling on the quantity supplied ?

Why exactly does a price ceiling cause a shortage ?

Does a price ceiling change the equilibrium price ?

What would be the impact of imposing a price below the equilibrium price ?

REVIEW QUESTIONS Does a price ceiling attempt to make a price higher or lower ?

How does a price ceiling set below the equilibrium level affect quantity demanded and quantity supplied ?

Does a price attempt to make a price higher or lower ?

How does a price set above the equilibrium level affect quantity demanded and quantity supplied ?

CRITICAL THINKING QUESTIONS . Most government policy decisions have winners and losers . What are the effects of raising the minimum wage ?

It is more complex than simply producers lose and workers gain . Who are the winners and who are the losers , and what exactly do they win and lose ?

To what extent does the policy change achieve its goals ?

Agricultural price supports result in governments holding large inventories of agricultural products . Why do you think the government can not simply give the products away to poor people ?

Can you propose a policy that would induce the market to supply more rental housing units ?

PROBLEMS A country decides to set a price ceiling on bread so it can make sure that bread is affordable to the poor . The conditions of demand and supply are given in Table 11 . What are the equilibrium price and equilibrium quantity before the price ceiling ?

What will the excess demand or the shortage ( that is , quantity demanded minus quantity plied ) be if the price ceiling is set at ?

At ?

At ?

PRINCIPLES OF ECONOMICS 119 Price Table 11 . Demand and Supply of Bread in Country price ceiling a legal maximum price price control government laws to regulate prices instead of letting market forces determine prices price a legal minimum price total surplus see social surplus SOLUTIONS Answers to Questions A price ceiling ( Which is below the equilibrium price ) will cause the quantity demanded to rise and the quantity supplied to fall . This is why a price ceiling creates a shortage . A price ceiling is just a legal restriction . Equilibrium is an economic condition . People may or may not obey the price ceiling , so the actual price may be at or above the price ceiling , but the price ceiling does not change the equilibrium price . A price ceiling is a legal maximum price , but a price is a legal minimum price and , consequently , it would leave room for the price to rise to its equilibrium level . In other Words , a price below equilibrium will not be binding and will have no effect .

DEMAND , SUPPLY , AND EFFICIENCY LEARNING OBJECT ES By the end of this section , you will be able to Contrast consumer surplus , producer surplus , and social surplus Explain why price floors and price ceilings can be inefficient Analyze demand and supply as a social adjustment mechanism he familiar demand and supply diagram holds within it the concept of economic efficiency . One typical way that economists define efficiency is when it is impossible to improve the ation of one party without imposing a cost on another . Conversely , if a situation is inefficient , it becomes possible to benefit at least one party without imposing costs on others . Efficiency in the demand and supply model has the same basic meaning The economy is getting as much benefit as possible from its scarce resources and all the possible gains from trade have been achieved . In other words , the optimal amount of each good and service is being produced and . CONSUMER SURPLUS , PRODUCER SURPLUS , SOCIAL SURPLUS Consider a market for tablet computers , as shown in Figure . The equilibrium price is 80 and the equilibrium quantity is 28 million . To see the benefits to consumers , look at the segment of the demand curve above the equilibrium point and to the left . This portion of the demand curve shows that at least some would have been willing to pay more than 80 for a tablet . For example , point shows that if the price was 90 , 20 million tablets would be sold . Those who would have been willing to pay 90 for a tablet based on the utility they expect to receive from it , but who were able to pay the equilibrium price of 80 , clearly received a benefit beyond what they had to pay for . Remember , the demand curve traces consumers willingness to pay for different quantities . The amount that individuals would have been willing to pay , minus the amount that they actually paid , is called consumer surplus . Consumer surplus is the area labeled is , the area above the market price and below the demand curve . The supply curve shows the quantity that firms are willing to supply at each price . For example , point in Figure illustrates that , at 45 , firms would still have been willing to supply a quantity of 14 million . Those producers who would have been willing to supply the tablets at 45 , but who were

PRINCIPLES OF ECONOMICS 121 A an 90 . 80 Consumer surplus Producer surplus 60 ' 40 . 20 A 10 14 20 28 30 Quantity ( in millions ) Figure . Consumer and Producer Surplus . The somewhat triangular area labeled by shows the area of consumer surplus , which shows that the equilibrium price in the market was less than what many of the consumers were willing to pay . Point on the demand curve shows that , even at the price of 90 , consumers would have been willing to purchase a quantity of 20 million . The somewhat triangular area labeled by shows the area of producer surplus , which shows that the equilibrium price received in the market was more than what many of the producers were willing to accept for their products . For example , point on the supply curve shows that at a price of 45 , firms would have been willing to supply a quantity of 14 million . instead able to charge the equilibrium price of 80 , clearly received an extra benefit beyond what they required to supply the product . The amount that a seller is paid for a good minus the sellers actual cost is called producer surplus . In Figure , producer surplus is the area labeled is , the area between the market price and the segment of the supply curve below the equilibrium . The sum of consumer surplus and producer surplus is social surplus , also referred to as economic surplus or total surplus . In Figure , social surplus would be shown as the area Social surplus is larger at equilibrium quantity and price than it would be at any other quantity . This demonstrates the economic efficiency of the market equilibrium . In addition , at the efficient level of output , it is impossible to produce greater consumer surplus without reducing producer surplus , and it is to produce greater producer surplus without reducing consumer surplus .

122 DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER INEFFICIENCY OF PRICE FLOORS AND PRICE CEILINGS The imposition of a price floor or a price ceiling will prevent a market from adjusting to its price and quantity , and thus will create an inefficient outcome . But there is an additional twist here . Along with creating inefficiency , price floors and ceilings will also transfer some consumer plus to producers , or some producer surplus to consumers . Imagine that several firms develop a promising but expensive new drug for treating back pain . If this therapy is left to the market , the equilibrium price will be 600 per month and people will use the drug , as shown in Figure ( a ) The original level of consumer surplus is and producer plus is . However , the government decides to impose a price ceiling of 400 to make the drug more affordable . At this price ceiling , firms in the market now produce only . As a result , two changes occur . First , an inefficient outcome occurs and the total surplus of society is reduced . The loss in social surplus that occurs when the economy produces at an inefficient quantity is called deadweight loss . In a very real sense , it is like money thrown away that benefits no one . In Figure ( a ) the deadweight loss is the area When deadweight loss exists , it is possible for both consumer and producer surplus to be higher , in this case because the price control is blocking some suppliers and from transactions they would both be willing to make . A second change from the price ceiling is that some of the producer surplus is transferred to . After the price ceiling is imposed , the new consumer surplus is , while the new producer surplus is . In other words , the price ceiling transfers the area of surplus ( from producers to . Note that the gain to consumers is less than the loss to producers , which is just another way of seeing the deadweight loss . 12 A i rice 8600 ' Price i , i , i i i , i . 1400 ( a ) Reduced surplus from a price ceiling ( Reduced social surplus from a price floor Figure . a ) Efficiency and Price Floors and Ceilings . The original equilibrium price is 600 with a quantity of . Consumer surplus is , and producer surplus is . A price ceiling is imposed at 400 , so firms in the market now produce only a quantity of . As a result , the new consumer surplus is , while the new producer surplus is . The original equilibrium is at a quantity of . Consumer surplus is , and producer surplus is I A price is imposed at 12 , which means that quantity demanded falls to . As a result , the new consumer surplus is , and the new producer surplus is I .

PRINCIPLES or ECONOMICS 123 Figure ( shows a price example using a string of struggling movie theaters , all in the same city . The current equilibrium is per movie ticket , with people attending movies . The original consumer surplus is , and producer surplus is I The city government is worried that movie theaters will go out of business , reducing the entertainment options available to citizens , so it decides to impose a price floor of 12 per ticket . As a result , the quantity demanded of movie tickets falls to . The new consumer surplus is , and the new producer surplus is I . In effect , the price causes the area to be transferred from consumer to producer surplus , but also causes a deadweight loss of This analysis shows that a price ceiling , like a law establishing rent controls , will transfer some surplus to helps to explain why consumers often favor them . Conversely , a price floor like a guarantee that farmers will receive a certain price for their crops will transfer some consumer surplus to producers , which explains why producers often favor them . However , both price floors and price ceilings block some transactions that buyers and sellers would have been willing to make , and creates deadweight loss . Removing such barriers , so that prices and quantities can adjust to their equilibrium level , will increase the economy social surplus . DEMAND AND SUPPLY AS A SOCIAL MECHANISM The demand and supply model emphasizes that prices are not set only by demand or only by supply , but by the interaction between the two . In 1890 , the famous economist Alfred Marshall wrote that asking whether supply or demand determined a price was like arguing whether it is the upper or the under blade of a pair of scissors that cuts a piece of The answer is that both blades of the demand and supply scissors are always involved . The adjustments of equilibrium price and quantity in a economy often occur without much government direction or oversight . If the coffee crop in Brazil suffers a terrible frost , then the supply curve of coffee shifts to the left and the price of coffee rises . Some them the coffee to drink coffee and pay the higher price . Others switch to tea or soft drinks . No government commission is needed to figure out how to adjust coffee prices , which companies will be allowed to process the remaining supply , which supermarkets in which cities will get how much coffee to sell , or which consumers will ultimately be allowed to drink the brew . Such adjustments in response to price changes happen all the time in a market economy , often so smoothly and rapidly that we barely notice them . Think for a moment of all the seasonal foods that are available and inexpensive at certain times of the year , like fresh corn in midsummer , but more expensive at other times of the year . People alter their diets and restaurants alter their menus in response to these in prices without fuss or fanfare . For both the economy and the world economy as a whole , is , demand and the primary social mechanism for answering the basic questions about what is produced , how it is produced , and for whom it is produced . WHY CAN WE NOT GET ENOUGH OF ORGANIC ?

Organic food is grown without synthetic pesticides , chemical fertilizers or genetically modified seeds . In recent decades , the demand for organic products has increased dramatically . The Organic Trade Association reported sales increased from billion in 1990 to billion in 2013 , more than 90 of which were sales of food products .

124 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Why , then , are organic foods more expensive than their conventional counterparts ?

The answer is a clear application of the theories of supply and demand . As people have learned more about the harmful effects of chemical fertilizers , growth hormones , pesticides and the like from factory farming , our tastes and preferences for safer , organic foods have increased . This change in tastes has been reinforced by increases in income , which allow people to purchase , and has made organic foods more mainstream . This has led to an increased demand for organic foods . Graphically , the demand curve has shifted right , and We have moved up the supply curve as producers have responded to the higher prices by supplying a greater quantity . In addition to the movement along the supply curve , we have also had an increase in the number of farmers converting to organic farming over time . This is represented by a shift to the right of the supply curve . Since both demand and supply have shifted to the right , the resulting equilibrium quantity of organic foods is definitely higher , but the price will only fall when the increase in supply is larger than the increase in demand . We may need more time before we see lower prices in organic foods . Since the production costs of these foods may remain higher than conventional farming , because organic fertilizers and pest management techniques are more expensive , they may never fully catch up with the lower prices of foods . As a final , specific example The Environmental Working Group Dirty Dozen list of fruits and Vegetables , which test high for pesticide residue even after Washing , was released in April 2013 . The inclusion of strawberries on the list has led to an increase in demand for organic strawberries , resulting in both a higher equilibrium price and quantity of sales . KEY CONCEPTS AND SUMMARY Consumer surplus is the gap between the price that consumers are willing to pay , based on their , and the market equilibrium price . Producer surplus is the gap between the price for which producers are willing to sell a product , based on their costs , and the market equilibrium price . Social surplus is the sum of consumer surplus and producer surplus . Total surplus is larger at the quantity and price than it will be at any other quantity and price . Deadweight loss is loss in total surplus that occurs when the economy produces at an inefficient quantity . SELF ' QUESTIONS . Does a price ceiling increase or decrease the number of transactions in a market ?

Why ?

What about a price ?

If a price benefits producers , Why does a price reduce social surplus ?

REVIEW QUESTIONS What is consumer surplus ?

How is it illustrated on a demand and supply diagram ?

What is producer surplus ?

How is it illustrated on a demand and supply diagram ?

What is total surplus ?

How is it illustrated on a demand and supply diagram ?

What is the relationship between total surplus and economic efficiency ?

What is deadweight loss ?

125 PRINCIPLES OF ECONOMICS CRITICAL THINKING QUESTIONS What term would an economist use to describe what happens when a shopper gets a good deal on a product ?

Explain why voluntary transactions improve social welfare . Why would a free market never operate at a quantity greater than the equilibrium quantity ?

Hint What would be required for a transaction to occur at that quantity ?

consumer surplus the extra benefit consumers receive from buying a good or service , measured by what the individuals would have been willing to pay minus the amount that they actually paid deadweight loss the loss in social surplus that occurs when a market produces an inefficient quantity economic surplus see social surplus producer surplus the extra benefit producers receive from selling a good or service , measured by the price the producer actually received minus the price the producer would have been willing to accept social surplus the sum of consumer surplus and producer surplus SOLUTIONS Answers to Questions Assuming that people obey the price ceiling , the market price will be below equilibrium , which means that will be more than . Buyers can only buy What is offered for sale , so the number of transactions will fall to . This is easy to see graphically . By analogous reasoning , with a price the market price will be above the equilibrium price , so will be less than . Since the limit on transactions here is demand , the number of transactions will fall to . Note that because both price and price ceilings reduce the number of transactions , social surplus is less . Because the losses to consumers are greater than the benefits to producers , so the net effect is negative . Since the lost consumer surplus is greater than the additional producer surplus , social surplus falls .