Principles of Microeconomics Scarcity and Social Provisioning Chapter 5 Labor and Financial Markets

CHAPTER . LABOR AND FINANCIAL MARKETS INTRODUCTION TO LABOR AND FINANCIAL MARKETS Figure . People often think of demand and supply in relation to goods , but labor markets , such as the nursing profession , can also apply to this analysis . Credit modification of work by Creative Commons ) BABY BOOMERS COME OF AGE The Census Bureau reports that as of 2013 , 20 of the US . population was over 60 years old , which means that almost 63 million people are reaching an age when they will need increased medical care . The baby boomer population , the group born between 1946 and 1964 , is comprised of approximately 74 million people who have just reached retirement age . As this population grows older , they will be faced with common healthcare issues such as heart conditions , arthritis , and that may require hospitalization , or nursing care . Aging baby boomers and advances in and technologies will increase the demand for healthcare and nursing . Additionally , the Affordable Care Act , which expands access to healthcare for millions of Americans , will increase the demand . According to the Bureau of Labor Statistics , registered nursing jobs are expected to increase by 19 between 2012 and

PRINCIPLES or ECONOMICS 129 2022 . The median annual wage of ( in 2012 ) is also expected to increase . The forecasts that new nurses will be needed by 2022 . One concern is the low rate of enrollment in nursing programs to help meet the growing demand . According to the American Association of Colleges of Nursing ( enrollment in 2011 increased by only due to a shortage of nursing educators and teaching facilities . These data tell us , as economists , that the market for healthcare professionals , and nurses in particular , will face several challenges . Our study of supply and demand will help us to analyze what might happen in the labor market for nursing and other healthcare professionals , as discussed in the second half of this case at the end of the chapter . OB ( Introduction to Labor and Financial Markets In this chapter , you will learn about Demand and Supply at Work in Labor Markets Demand and Supply in Financial Markets The Market System as an Efficient Mechanism for lnformation he theories of supply and demand do not apply just to markets for goods . They apply to any market , even markets for labor and financial services . Labor markets are markets for employees or jobs . Financial services markets are markets for saving or borrowing . When we think about demand and supply curves in goods and services markets , it is easy to picture who the and suppliers are businesses produce the products and households buy them . Who are the and suppliers in labor and financial service markets ?

In labor markets job seekers ( individuals ) are the suppliers of labor , while firms and other employers who hire labor are the for labor . In financial markets , any individual or firm who saves contributes to the supply of money , and any who borrows ( person , firm , or government ) contributes to the demand for money . As a college student , you most likely participate in both labor and financial markets . Employment is a fact of life for most college students In 201 , says the , 52 of undergraduates worked part time and another 20 worked full time . Most college students are also heavily involved in financial , primarily as borrowers . Among students , about half take out a loan to help finance their education each year , and those loans average about per year . Many students also borrow for other expenses , like purchasing a car . As this chapter will illustrate , we can analyze labor markets and financial markets with the same tools we use to analyze demand and supply in the goods markets .

DEMAND AND SUPPLY AT WORK IN LABOR MARKETS LEARNING OBJECTIVES By the end of this section , you will be able to Predict shifts in the demand and supply curves of the labor market Explain the impact of new technology on the demand and supply curves of the labor market Explain price floors in the labor market such as minimum wage or a living wage for labor have demand and supply curves , just like markets for goods . The law of demand applies in labor markets this way A higher salary or is , a higher price in the labor to a decrease in the quantity of labor demanded by employers , while a lower salary or wage leads to an increase in the quantity of labor demanded . The law of supply functions in labor markets , too A higher price for labor leads to a higher quantity of labor supplied a lower price leads to a lower quantity supplied . EQUILIBRIUM IN THE LABOR MARKET In 2013 , about registered nurses worked in the . metropolitan area , according to the . They worked for a Variety of employers hospitals , doctors offices , schools , health clinics , and nursing homes . Figure illustrates how demand and supply determine equilibrium in this labor market . The demand and supply schedules in Table list the quantity supplied and quantity demanded of nurses at different salaries . Annual Salary Quantity Demanded Quantity Supplied Table . Demand and Supply of Nurses in . The horizontal axis shows the quantity of nurses hired . In this example , labor is measured by number of workers , but another common way to measure the quantity of labor is by the number of hours

PRINCIPLES OF ECONOMICS 131 I ' i , I An above I . Il , I , LI sa aw ' I I I , I BU ) SCI Quantity of Nurses Figure . Labor Market Example Demand and Supply for Nurses in . The demand curve ( of those employers who want to hire nurses intersects with the supply curve ( of those who are qualified and willing to work as nurses at the equilibrium point ( The equilibrium salary is and the equilibrium quantity is nurses . At an salary of , quantity supplied increases to , but the quantity of nurses demanded at the higher pay declines to . At this salary , an excess supply or surplus of nurses would exist . At a salary of , quantity supplied declines to , while the quantity demanded at the lower wage increases to nurses . At this salary , excess demand or a surplus exists . worked . The vertical axis shows the price for nurses is , how much they are paid . In the real world , this price would be total labor compensation salary plus benefits . It is not obvious , but benefits are a significant part ( as high as 30 percent ) of labor compensation . In this example , the price of labor is measured by salary on an annual basis , although in other cases the price of labor could be measured by monthly or weekly pay , or even the wage paid per hour . As the salary for nurses rises , the quantity demanded will fall . Some hospitals and nursing homes may cut back on the number of nurses they hire , or they may lay off some of their existing nurses , rather than pay them higher salaries . Employers who face higher nurses salaries may also try to replace some nursing functions by ing in physical equipment , like computer monitoring and diagnostic systems to monitor patients , or by using health care aides to reduce the number of nurses they need . As the salary for nurses rises , the quantity supplied will rise . If nurses salaries in . are higher than in other cities , more nurses will move to . to find jobs , more people will be willing to train as nurses , and those currently trained as nurses will be more likely to pursue nursing as a job . In other words , there will be more nurses looking for jobs in the area . At equilibrium , the quantity supplied and the quantity demanded are equal . Thus , every employer who wants to hire a nurse at this equilibrium wage can find a willing worker , and every nurse who

132 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER wants to work at this equilibrium salary can find a job . In Figure , the supply curve ( and demand curve ( intersect at the equilibrium point ( The equilibrium quantity of nurses in the . area is , and the equilibrium salary is per year . This example simplifies the nursing market by focusing on the average nurse . In reality , of course , the market for nurses is actually made up of many smaller markets , like markets for nurses with varying degrees of experience and credentials . Many markets contain closely related products that differ in quality for instance , even a simple product like gasoline comes in regular , premium , and , each with a different price . Even in such cases , discussing the average price of gasoline , like the average salary for nurses , can still be useful because it reflects what is happening in most of the . When the price of labor is not at the equilibrium , economic incentives tend to move salaries toward the equilibrium . For example , if salaries for nurses in . were above the equilibrium at per year , then people want to work as nurses , but employers want to hire only nurses . At that salary , excess supply or a surplus results . In a situation of excess supply in the labor market , with many applicants for every job opening , employers will have an incentive to offer lower wages than they otherwise would have . Nurses salary will move down toward equilibrium . In contrast , if the salary is below the equilibrium at , say , per year , then a situation of excess demand or a shortage arises . In this case , employers encouraged by the relatively lower wage want to hire nurses , but only individuals want to work as nurses at that salary in . In response to the shortage , some employers will offer higher pay to attract the nurses . Other employers will have to match the higher pay to keep their own employees . The higher salaries will encourage more nurses to train or work in . Again , price and quantity in the labor market will move toward equilibrium . SHIFTS IN LABOR DEMAND The demand curve for labor shows the quantity of labor employers wish to hire at any given salary or wage rate , under the assumption . A change in the wage or salary will result in a change in the quantity demanded of labor . If the wage rate increases , employers will want to hire fewer employees . The quantity of labor demanded will decrease , and there will be a movement upward along the demand curve . If the wages and salaries decrease , employers are more likely to hire a greater number of workers . The quantity of labor demanded will increase , resulting in a downward ment along the demand curve . Shifts in the demand curve for labor occur for many reasons . One key reason is that the demand for labor is based on the demand for the good or service that is being produced . For example , the more new automobiles consumers demand , the greater the number of workers automakers will need to hire . Therefore the demand for labor is called a derived Here are some examples of derived demand for labor The demand for chefs is dependent on the demand for restaurant meals . The demand for pharmacists is dependent on the demand for prescription drugs . The demand for attorneys is dependent on the demand for legal services . As the demand for the goods and services increases , the demand for labor will increase , or shift to

133 PRINCIPLES or ECONOMICS the right , to meet employers production requirements . As the demand for the goods and services decreases , the demand for labor will decrease , or shift to the left . Table shows that in addition to the derived demand for labor , demand can also increase or decrease ( shift ) in response to several factors . Factors Demand for Output Education and Training Technology Number of Companies Government Regulations Price and Availability of Other Inputs Table . Factors That Can Shift Demand Results When the demand for the good produced ( output ) increases , both the output price and profitability increase . As a result , producers demand more labor to ramp up production . A and educated workforce causes an increase in the demand for that labor by employers . Increased levels of productivity within the workforce will cause the demand for labor to shift to the right . If the workforce is not or educated , employers will not hire from within that labor pool , since they will need to spend a significant amount of time and money training that workforce . Demand for such will shift to the left . Technology changes can act as either substitutes for or complements to labor . When technology acts as a substitute , it replaces the need for the number of workers an employer needs to hire . For example , Word processing decreased the number of typists needed in the workplace . This shifted the demand curve for typists left . An increase in the availability of certain technologies may increase the demand for labor . Technology that acts as a complement to labor will increase the demand for certain types of labor , resulting in a rightward shift of the demand curve . For example , the increased use of word processing and other software has increased the demand for information technology professionals who can resolve software and hardware issues related to a firm network . More and better technology will increase demand for skilled workers who know how to use technology to enhance workplace productivity . Those workers who do not adapt to changes in technology will experience a decrease in demand . An increase in the number of companies producing a given product will increase the demand for labor resulting in a shift to the right . A decrease in the number of companies producing a given product will decrease the demand for labor ting in a shift to the left . Complying with government regulations can increase or decrease the demand for labor at any given wage . In the healthcare industry , government rules may require that nurses be hired to carry out certain medical procedures . This will increase the for nurses . healthcare workers would be prohibited from carrying out these procedures , and the demand for these workers will shift to the left . Labor is not the only input into the production process . For example , a salesperson at a call center needs a telephone and a computer to enter data and record sales . The demand for at the call center will increase if the number of telephones and computer terminals available increases . This will cause a rightward shift of the demand curve . As the amount of inputs increases , the demand for labor will increase . If the terminal or the telephones mal unction , then the demand for that labor force will decrease . As the quantity of other inputs decreases , the demand for labor will decrease . Similarly , if prices of other inputs fall , production will become more profitable and suppliers will demand more labor to increase production . The opposite is also true . Higher input lower demand for labor Click here to read more about Trends and Chal for Work in the 215 Century . SHIFTS IN LABOR SUPPLY The supply of labor is and adheres to the law of supply The higher the price , the

134 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER greater the quantity supplied and the lower the price , the less quantity supplied . The supply curve models the tradeoff between supplying labor into the market or using time in leisure activities at every given price level . The higher the wage , the more labor is willing to work and forego leisure activities . Table lists some of the factors that will cause the supply to increase or decrease . Factors Results An increased number of workers will cause the supply curve to shift to the right . An increased number of workers can be due to several factors , such as immigration , increasing population , an aging population , and changing demographics . Policies that encourage immigration will increase the supply of labor , and vice versa . Number of Population grows when birth rates exceed death rates this eventually increases supply of labor when the Workers . former reach Working age . An aging and therefore retiring population will decrease the supply of labor . Another example of changing demographics is more women working outside of the home , which increases the supply of labor . Re The more required education , the lower the supply . There is a lower supply of mathematicians than of . high school mathematics teachers there is a lower supply of cardiologists than of primary care physicians and there is a lower supply of physicians than of nurses . Government policies can also affect the supply of labor for jobs . On the one hand , the government may support rules that set high qualifications for certain jobs academic training , certificates or licenses , or experience . When these qualifications are made tougher , the number of qualified workers will decrease at any given wage . On the other hand , the government may also subsidize training or even reduce the required level Government of qualifications . For example , government might offer subsidies for nursing schools or nursing students . Policies Such provisions would shift the supply curve of nurses to the right . In addition , government policies that change the relative desirability of Working versus not working also affect the labor supply . These include unemployment benefits , maternity leave , child care benefits and Welfare policy . For example , child care benefits may increase the labor supply of working mothers . Long term unemployment benefits may discourage job searching for unemployed workers . All these policies must therefore be carefully designed to minimize any negative labor supply effects . Table . Factors that Can Shift Supply A change in salary will lead to a movement along labor demand or labor supply curves , but it will not shift those curves . However , other events like those outlined here will cause either the demand or the supply of labor to shift , and thus will move the labor market to a new equilibrium salary and quantity . TECHNOLOGY AND WAGE INEQUALITY THE PROCESS Economic events can change the equilibrium salary ( or wage ) and quantity of labor . Consider how the wave of new information technologies , like computer and telecommunications networks , has affected and workers in the economy . From the perspective of employers who demand labor , these new technologies are often a substitute for laborers like file clerks who used to keep file cabinets full of paper records of transactions . However , the same new technologies are a complement to workers like managers , who benefit from the technological advances by being able to monitor more information , communicate more easily , and juggle a wider array of responsibilities . So , how will the new technologies affect the wages of and ers ?

For this question , the process of analyzing how shifts in supply or demand affect ket ( introduced in Demand and Supply ) works in this way Step . What did the markets for labor and labor look like before the arrival of the new technologies ?

In Figure ( a ) and Figure ( is the original supply curve for labor and Do is the original demand curve for labor in each market . In each graph , the original point of equilibrium , occurs at the price and the quantity . Step . Does the new technology affect the supply of labor from households or the demand for labor

PRINCIPLES or ECONOMICS 135 SO SE . In . I I , I . DA , I ' I . Quantity of Labor Quantity of Labor ( a ) change and labor ) change and labor Figure . Technology and Wages Applying Demand and Supply ( a ) The demand for labor shifts to the left when technology can do the job previously done by these workers . New technologies can also increase the demand for labor in fields such as information technology and network administration . from firms ?

The technology change described here affects demand for labor by firms that hire ers . Step . Will the new technology increase or decrease demand ?

Based on the description earlier , as the substitute for labor becomes available , demand for labor will shift to the left , from Do to . As the technology complement for labor becomes cheaper , demand for labor will shift to the right , from Do to . Step . The new equilibrium for labor , shown as point with price and quantity , has a lower wage and quantity hired than the original equilibrium , The new equilibrium for labor , shown as point with price and quantity , has a higher wage and quantity hired than the original equilibrium ( So , the demand and supply model predicts that the new computer and communications technologies will raise the pay of workers but reduce the pay of workers . Indeed , from the 19703 to the , the wage gap widened between and labor . According to the National Center for Education Statistics , in 1980 , for example , a college graduate earned about 30 more than a high school graduate with comparable job experience , but by 2012 , a college earned about 60 more than an otherwise comparable high school graduate . Many economists believe that the trend toward greater wage inequality across the economy was primarily caused by the new technologies . Visit this Website to read about ten tech skills that have lost relevance in today Workforce .

136 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER i El PRICE FLOORS IN THE LABOR MARKET LIVING WAGES AND MINIMUM WAGES In contrast to goods and services markets , price ceilings are rare in labor markets , because rules that prevent people from earning income are not politically popular . There is one exception sometimes limits are proposed on the high incomes of top business executives . The labor market , however , presents some prominent examples of price floors , which are often used as an attempt to increase the wages of workers . The government sets a minimum wage , a price floor that makes it illegal for an employer to pay employees less than a certain hourly rate . In , the minimum wage was raised to per hour . Local political movements in a ber of cities have pushed for a higher minimum wage , which they call a living wage . Promoters of living wage laws maintain that the minimum wage is too low to ensure a reasonable standard of living . They base this conclusion on the calculation that , if you work 40 hours a week at a minimum wage of per hour for 50 weeks a year , your annual income is , which is less than the official government definition of what it means for a family to be in poverty . A family with two adults earning minimum wage and two young children will find it more cost efficient for one parent to provide childcare while the other works for income . So the family income would be , which is significantly lower than the federal poverty line for a family of four , which was in 2014 . Supporters of the living wage argue that workers should be assured a high enough wage so that they can afford the essentials of life food , clothing , shelter , and healthcare . Since Baltimore passed the first living wage law in 1994 , several dozen cities enacted similar laws in the late and the . The living wage ordinances do not apply to all employers , but they have specified that all employees of the city or employees of firms that are hired by the city be paid at least a certain wage that is usually a few dollars per hour above the minimum wage . Figure illustrates the situation of a city considering a living wage law . For simplicity , we assume that there is no federal minimum wage . The wage appears on the vertical axis , because the wage is the price in the labor market . Before the passage of the living wage law , the equilibrium wage is 10 per hour and the city hires workers at this wage . However , a group of concerned citizens persuades the city council to enact a living wage law requiring employers to pay no less than 12 per hour . In response to the higher wage , workers look for jobs with the city . At this higher wage , the city , as an employer , is willing to hire only 700 workers . At the price floor , the quantity supplied exceeds the quantity demanded , and a surplus of labor exists in this market . For workers who continue to have a job at a higher salary , life has improved . For those who were willing to work at the old wage rate but lost their jobs with the wage increase , life has not improved . Table shows the differences in supply and demand at different wages .

14 13 Wage ( Figure . A Living Wage Example of a Price Floor The original equilibrium in this labor market is a wage of hour and a quantity of workers , shown at point Imposing a wage at leads to an excess supply of labor . At that wage , the quantity of labor supplied is and the quantity of labor PRINCIPLES OF ECONOMICS supply or surplus , I . IVE ( 10 ) Quantity of Labor ( of workers ) 700 600 demanded is only 700 . Wage Table . Living Wage Example of a Price Floor Quantity Labor Demanded Quantity Labor Supplied 900 700 500 400 500 900 THE MINIMUM WAGE AS AN EXAMPLE OF A PRICE FLOOR 137 The minimum wage is a price that is set either very close to the equilibrium wage or even slightly below it . About of American workers are actually paid the minimum wage . In other words , the vast majority of the labor force has its wages determined in the labor market , not as a result of the government price . But for workers with low skills and little experience , like those without a high school diploma or teenagers , the minimum wage is quite important . In many cities , the eral minimum wage is apparently below the market price for unskilled labor , because employers offer more than the minimum wage to checkout clerks and other workers without any ment prodding . Economists have attempted to estimate how much the minimum wage reduces the quantity

133 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER demanded of labor . A typical result of such studies is that a 10 increase in the minimum wage would decrease the hiring of unskilled workers by to , which seems a relatively small tion . In fact , some studies have even found no effect of a higher minimum wage on employment at certain times and these studies are controversial . Let suppose that the minimum wage lies just slightly below the equilibrium wage level . Wages could fluctuate according to market forces above this price , but they would not be allowed to move beneath the floor . In this situation , the price floor minimum wage is said to be is , the price is not determining the market outcome . Even if the minimum wage moves just a tle higher , it will still have no effect on the quantity of employment in the economy , as long as it remains below the equilibrium wage . Even if the minimum wage is increased by enough so that it rises slightly above the equilibrium wage and becomes binding , there will be only a small excess supply gap between the quantity demanded and quantity supplied . These insights help to explain why minimum wage laws have historically had only a small impact on employment . Since the minimum wage has typically been set close to the equilibrium wage for labor and sometimes even below it , it has not had a large effect in creating an excess ply of labor . However , if the minimum wage were increased , if it were doubled to match the living wages that some cities have its impact on reducing the demanded of employment would be far greater . The following Clear It Up feature describes in greater detail some of the arguments for and against changes to minimum wage . WHAT THE HARM IN RAISING THE MINIMUM WAGE ?

Because of the law of demand , a higher required Wage will reduce the amount of employment either in terms of employees or in terms of work hours . Although there is controversy over the numbers , let say for the sake of the argument that a 10 rise in the minimum wage will reduce the employment of workers by . Does this outcome mean that raising the minimum Wage by 10 is bad public policy ?

Not necessarily . If 98 of those receiving the minimum wage have a pay increase of 10 , but of those receiving the minimum wage lose their jobs , are the gains for society as a whole greater than the losses ?

The answer is not clear , because job losses , even for a small group , may cause more pain than modest income gains for others . For one thing , we need to consider which mum wage workers are losing their jobs . If the of minimum wage workers who lose their jobs are struggling to support families , that is one thing . If those who lose their job are high school students picking up spending money over summer vacation , that is something else . Another complexity is that many minimum Wage workers do not work for an entire year . Imagine a minimum wage Worker who holds different jobs for a few months at a time , with bouts of unemployment in between . The worker in this situation receives the 10 raise in the minimum wage when working , but also ends up working fewer hours during the year because the higher minimum Wage reduces how much employers want people to work . Overall , this worker income would rise because the 10 pay raise would more than offset the fewer hours worked . Of course , these arguments do not prove that raising the minimum wage is necessarily a good idea either . There may well be other , better public policy options for helping workers . The Poverty and Economic Inequality chapter some possibilities . The lesson from this maze of minimum wage arguments is that complex social problems rarely have simple answers . Even those who agree on how a proposed economic policy affects quantity demanded and quantity supplied may still disagree on whether the policy is a good idea .

PRINCIPLES OF ECONOMICS 139 KEY CONCEPTS AND SUMMARY In the labor market , households are on the supply side of the market and firms are on the demand side . In the market for financial capital , households and firms can be on either side of the market they are suppliers of financial capital when they save or make financial investments , and of capital when they borrow or receive financial investments . In the demand and supply analysis of labor markets , the price can be measured by the annual salary or hourly wage received . The quantity of labor can be measured in various Ways , like number of Workers or the number of hours worked . Factors that can shift the demand curve for labor include a change in the quantity demanded of the product that the labor produces a change in the production process that uses more or less labor and a change in government policy that affects the quantity of labor that firms wish to hire at a given Wage . Demand can also increase or decrease ( shift ) in response to Workers level of education and training , technology , the number of companies , and availability and price of other inputs . The main factors that can shift the supply curve for labor are how desirable a job appears to Workers relative to the alternatives , government policy that either restricts or encourages the quantity of workers trained for the job , the number of workers in the economy , and required education . SELF CHECK QUESTIONS . In the labor market , what causes a movement along the demand curve ?

What causes a shift in the demand curve ?

In the labor market , what causes a movement along the supply curve ?

What causes a shift in the supply curve ?

Why is a living Wage considered a price ?

Does imposing a living Wage have the same outcome as a minimum wage ?

REVIEW QUESTIONS . What is the price commonly called in the labor market ?

Are households or suppliers in the goods market ?

Are firms or suppliers in the goods market ?

What about the labor market and the financial market ?

Name some factors that can cause a shift in the demand curve in labor markets . Name some factors that can cause a shift in the supply curve in labor markets . CRITICAL THINKING QUESTIONS Other than the demand for labor , What would be another example of a derived demand ?

140 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Suppose that a increase in the minimum wage causes a reduction in employment . How would this affect employers and how would it affect workers ?

In your opinion , would this be a good policy ?

What assumption is made for a minimum wage to be a price ?

What assumption is made for a living wage price to be binding ?

PROBLEMS . Identify each of the following as involving either demand or supply . Draw a circular diagram and label the A through ( Some choices can be on both sides of the goods market . Households in the labor market Firms in the goods market Firms in the financial market Households in the goods market Firms in the labor market Households in the financial market . Predict how each of the following events will raise or lower the equilibrium wage and quantity of coal miners in West Virginia . In each case , sketch a demand and supply diagram to illustrate your answer . The price of oil rises . New equipment is invented that is cheap and requires few workers to run . Several major companies that do not mine coal open factories in West Virginia , offering a lot of jobs . Government imposes costly new regulations to make a safer job . REFERENCES American Community Survey . 2012 . School Enrollment and Work Status 201 Accessed April 13 , National Center for Educational Statistics . Digest of Education ( 2008 and 2010 ) Accessed December 11 , minimum wage a price that makes it illegal for an employer to pay employees less than a certain hourly rate SOLUTIONS Answers to Questions

. 141 PRINCIPLES OF ECONOMICS Changes in the wage rate ( the price of labor ) cause a movement along the demand curve . A change in anything else that affects demand for labor ( changes in output , changes in the production process that use more or less labor , government regulation ) causes a shift in the demand curve . Changes in the wage rate ( the price of labor ) cause a movement along the supply curve . A change in anything else that affects supply of labor ( changes in how desirable the job is perceived to be , government policy to promote training in the field ) causes a shift in the supply curve . Since a living Wage is a suggested minimum Wage , it acts like a price floor ( assuming , of course , that it is followed ) If the living Wage is binding , it will cause an excess supply of labor at that Wage rate .

DEMAND AND SUPPLY IN FINANCIAL MARKETS LEARNING OBJECTIVES By the end of this section , you will be able to Identify the and suppliers in a financial market . Explain how interest rates can affect supply and demand Analyze the economic effects of US . debt in terms of domestic financial markets Explain the role of price ceilings and usury laws in the US . nited States households , institutions , and domestic businesses saved almost trillion in 2013 . Where did that savings go and What was it used for ?

Some of the savings ended up in banks , which in turn loaned the money to individuals or businesses that wanted to borrow money . Some was invested in private companies or loaned to government agencies that wanted to borrow money to raise funds for purposes like building roads or mass transit . Some firms reinvested their savings in their own businesses . In this section , we will determine how the demand and supply model links those who wish to supply financial capital ( savings ) with those who demand financial capital ( borrowing ) Those who save money ( or make financial investments , which is the same thing ) Whether individuals or , are on the supply side of the financial market . Those who borrow money are on the demand side of the financial market . For a more detailed treatment of the different kinds of financial like bank accounts , stocks and bonds , see the Financial Markets chapter . WHO DEMANDS AND WHO SUPPLIES IN FINANCIAL MARKETS ?

In any market , the price is what suppliers receive and What pay . In financial markets , those who supply financial capital through saving expect to receive a rate of return , while those who demand financial capital by receiving funds expect to pay a rate of return . This rate of return can come in a variety of forms , depending on the type of investment . The simplest example of a rate of return is the interest rate . For example , when you supply money into a savings account at a bank , you receive interest on your deposit . The interest paid to you as a percent of your deposits is the interest rate . Similarly , if you demand a loan to buy a car or a computer , you will need to pay interest on the money you borrow . Let consider the market for borrowing money with credit cards . In 2014 , almost 200 million

PRINCIPLES OF ECONOMICS 143 were . Credit cards allow you to borrow money from the card issuer , and pay back the borrowed amount plus interest , though most allow you a period of time in which you can repay the loan without paying interest . A typical credit card interest rate ranges from 12 to 18 per year . In 2014 , Americans had about 793 billion outstanding in credit card debts . About half of lies with credit cards report that they almost always pay the full balance on time , but of families with credit cards say that they hardly ever pay off the card in full . In fact , in 2014 , 56 of consumers carried an unpaid balance in the last 12 months . Lets say that , on average , the annual interest rate for credit card borrowing is 15 per year . So , Americans pay tens of billions of dollars every year in interest on their credit basic fees for the credit card or fees for late payments . Figure illustrates demand and supply in the financial market for credit cards . The horizontal axis of the financial market shows the quantity of money that is loaned or borrowed in this market . The vertical or price axis shows the rate of return , which in the case of credit card borrowing can be with an interest rate . Table shows the quantity of financial capital that consumers demand at various interest rates and the quantity that credit card firms ( often banks ) are willing to supply . 25 Excess supply or ' An Interest rate ' 93 Interest rate it A below ' Interest rate , demand or shortage ' I , 5200 400 800 Quantity ( billions of dollars ) Figure . Demand and Supply for Borrowing Money with Credit Cards . In this market for credit card borrowing , the demand curve ( for borrowing financial capital intersects the supply curve ( for lending financial capital at equilibrium . At the equilibrium , the interest rate ( the price in this market ) is 15 and the quantity of financial capital being loaned and borrowed is 600 billion . The equilibrium price is where the quantity demanded and the quantity supplied are equal . At an interest rate like 21 , the quantity of financial capital supplied would increase to 750 billion , but the quantity demanded would decrease to 480 billion . At a interest rate like 13 , the quantity of financial capital demanded would increase to 700 billion , but the quantity of financial capital supplied would decrease to 510 billion .

144 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER ( Borrowing ) billions ) billions ) 11 800 420 13 700 510 15 600 600 17 550 660 19 500 720 21 480 750 Table . Demand and Supply for Borrowing Money with Credit Cards The laws of demand and supply continue to apply in the financial markets . According to the law of demand , a higher rate of return ( that is , a higher price ) will decrease the quantity demanded . As the interest rate rises , consumers will reduce the quantity that they borrow . According to the law of ply , a higher price increases the quantity supplied . Consequently , as the interest rate paid on credit card borrowing rises , more firms will be eager to issue credit cards and to encourage customers to use them . Conversely , if the interest rate on credit cards falls , the quantity of financial capital supplied in the credit card market will decrease and the quantity demanded will fall . EQUILIBRIUM IN FINANCIAL MARKETS In the financial market for credit cards shown in Figure , the supply curve ( and the demand curve ( cross at the equilibrium point ( The equilibrium occurs at an interest rate of 15 , where the quantity of funds demanded and the quantity supplied are equal at an equilibrium quantity of 600 billion . If the interest rate ( remember , this measures the price in the financial market ) is above the level , then an excess supply , or a surplus , of financial capital will arise in this market . For example , at an interest rate of 21 , the quantity of funds supplied increases to 750 billion , while the quantity demanded decreases to 480 billion . At this interest rate , firms are eager to supply loans to credit card borrowers , but relatively few people or businesses wish to borrow . As a result , some credit card firms will lower the interest rates ( or other fees ) they charge to attract more business . This strategy will push the interest rate down toward the equilibrium level . If the interest rate is below the equilibrium , then excess demand or a shortage of funds occurs in this market . At an interest rate of 13 , the quantity of funds credit card borrowers demand increases to 700 billion but the quantity credit card firms are willing to supply is only 510 billion . In this tion , credit card firms will perceive that they are overloaded with eager borrowers and conclude that they have an opportunity to raise interest rates or fees . The interest rate will face economic pressures to creep up toward the equilibrium level . SHIFTS IN DEMAND AND SUPPLY IN FINANCIAL MARKETS Those who supply financial capital face two broad decisions how much to save , and how to divide up their savings among different forms of financial investments . We will discuss each of these in turn . Participants in financial markets must decide when they prefer to consume goods now or in the future . Economists call this decision making because it involves decisions across

PRINCIPLES or ECONOMICS 145 time . Unlike a decision about what to buy from the grocery store , decisions about investment or ing are made across a period of time , sometimes a long period . Most workers save for retirement because their income in the present is greater than their needs , while the opposite will be true once they retire . So they save today and supply financial markets . If their income increases , they save more . If their perceived situation in the future changes , they change the amount of their saving . For example , there is some evidence that Social Security , the program that workers pay into in order to qualify for government checks after retirement , has tended to reduce the quantity of financial capital that workers save . If this is true , Social Security has shifted the supply of financial capital at any interest rate to the left . By contrast , many college students need money today when their income is low ( or nonexistent ) to pay their college expenses . As a result , they borrow today and demand from financial markets . Once they graduate and become employed , they will pay back the loans . Individuals borrow money to chase homes or cars . A business seeks financial investment so that it has the funds to build a factory or invest in a research and development project that will not pay off for five years , ten years , or even more . So when consumers and businesses have greater confidence that they will be able to repay in the future , the quantity demanded of financial capital at any given interest rate will shift to the right . For example , in the technology boom of the late , many businesses became extremely confident that investments in new technology would have a high rate of return , and their demand for financial capital shifted to the right . Conversely , during the Great Recession of 2008 and 2009 , their demand for financial capital at any given interest rate shifted to the left . To this point , we have been looking at saving in total . Now let us consider what affects saving in types of financial investments . In deciding between different forms of financial investments , suppliers of financial capital will have to consider the rates of return and the risks involved . Rate of return is a positive attribute of investments , but risk is a negative . If Investment A becomes more risky , or the return diminishes , then savers will shift their funds to Investment the supply curve of financial capital for Investment A will shift back to the left while the supply curve of capital for Investment shifts to the right . THE UNITED STATES AS A GLOBAL BORROWER In the global economy , trillions of dollars of financial investment cross national borders every year . In the early , financial investors from foreign countries were investing several hundred billion dollars per year more in the economy than financial investors were investing abroad . The following Work It Out deals with one of the concerns for the economy in recent years . THE EFFECT OF GROWING DEBT Imagine that the economy became viewed as a less desirable place for foreign investors to put their money because of fears about the growth of the US . public debt . Using the process for analyzing how changes in supply and demand affect equilibrium outcomes , how would increased US . public debt affect the equilibrium price and quantity for capital in US financial markets ?

Step . Draw a diagram showing demand and supply for financial capital that represents the original scenario in which 146 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER investors are pouring money into the economy . Figure shows a demand curve , and a supply curve , Where the supply of capital includes the funds arriving from foreign investors . The original equilibrium Eo occurs at interest rate and quantity of financial investment . 89 ) Quantity of Financial Capital Figure . The United States as a Global Borrower Before Debt Uncertainty . The graph shows the demand for financial capital from and supply of financial capital into the financial markets by the foreign sector before the increase in uncertainty regarding public debt . The original equilibrium ( occurs at an equilibrium rate of return ( and the equilibrium quantity is at . Step . Will the diminished confidence in the economy as a place to invest affect demand or supply of financial capital ?

Yes , it will affect supply . Many foreign investors look to the US . financial markets to store their money in safe financial vehicles with low risk and stable returns . As the debt increases , debt servicing will is , more current income will be used to pay the interest rate on past debt . Increasing debt also means that businesses may have to pay higher interest rates to borrow money , because business is now competing with the government for financial resources . Step . Will supply increase or decrease ?

When the enthusiasm of foreign investors for investing their money in the US . economy diminishes , the supply of financial capital shifts to the left . Figure shows the supply curve shift from So to . Step . Thus , foreign investors diminished enthusiasm leads to a new equilibrium , which occurs at the higher interest rate , and the lower quantity of financial investment , The economy has experienced an enormous of foreign capital . According to the Bureau of Economic Analysis , by the third quarter of 2014 , investors had accumulated trillion of foreign assets , but foreign investors owned a total of trillion of assets . If foreign investors were to pull their money out of the economy and invest elsewhere in the world , the result could be a significantly lower quantity of financial investment in the United States , available only at a higher interest rate . This reduced of foreign financial investment could impose hardship on and firms interested in borrowing . In a modern , developed economy , financial capital often moves invisibly through electronic transfers

PRINCIPLES or ECONOMICS 147 SE . a I , I , Quantity of Financial Capital Figure . The United States as a Global Borrower Before and After Debt Uncertainty . The graph shows the demand for financial capital and supply of financial capital into the financial markets by the foreign sector before and after the increase in uncertainty regarding public debt . The original equilibrium ( occurs at an equilibrium rate of return ( and the equilibrium quantity is at . between one bank account and another . Yet these flows of funds can be analyzed with the same tools of demand and supply as markets for goods or labor . PRICE CEILINGS IN FINANCIAL MARKETS USURY LAWS As we noted earlier , about 200 million Americans own credit cards , and their interest payments and fees total tens of billions of dollars each year . It is little wonder that political pressures sometimes arise for setting limits on the interest rates or fees that credit card companies charge . The firms that issue credit cards , including banks , oil companies , phone companies , and retail stores , respond that the higher interest rates are necessary to cover the losses created by those who borrow on their credit cards and who do not repay on time or at all . These companies also point out that can avoid paying interest if they pay their bills on time . Consider the credit card market as illustrated in Figure . In this financial market , the vertical axis shows the interest rate ( which is the price in the financial market ) in the credit card ket are households and businesses suppliers are the companies that issue credit cards . This figure does not use specific numbers , which would be hypothetical in any case , but instead focuses on the underlying economic relationships . Imagine a law imposes a price ceiling that holds the interest rate charged on credit cards at the rate , which lies below the interest rate that would otherwise have prevailed in the market . The price ceiling is shown by the horizontal dashed line in Figure . The demand and supply model predicts that at the lower price ceiling interest rate , the quantity demanded of credit card debt will increase from its original level of to however , the quantity supplied of credit card debt will decrease from the original to . At the price ceiling ( quantity demanded

143 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER will exceed quantity supplied . Consequently , a number of people who want to have credit cards and are willing to pay the prevailing interest rate will find that companies are unwilling to issue cards to them . The result will be a credit shortage . Interest Rate 050 a Price ceiling set here , Excess demand or shortage I Quantity ( credit card lending and borrowing ) Figure Credit Card Interest Rates Another Price Ceiling Example . The original intersection of demand and supply occurs at equilibrium . However , a price ceiling is set at the interest rate , below the equilibrium interest rate , and so the interest rate can not adjust upward to the equilibrium . At the price ceiling , the quantity demanded , exceeds the quantity supplied , There is excess demand , also called a shortage . Many states do have usury laws , which impose an upper limit on the interest rate that lenders can charge . However , in many cases these upper limits are well above the market interest rate . For ple , if the interest rate is not allowed to rise above 30 per year , it can still fluctuate below that level according to market forces . A price ceiling that is set at a relatively high level is , and it will have no practical effect unless the equilibrium price soars high enough to exceed the price ceiling . KEY CONCEPTS AND SUMMARY In the demand and supply analysis of financial markets , the price is the rate of return or the interest rate received . The quantity is measured by the money that from those who supply financial to those who demand it . Two factors can shift the supply of financial capital to a certain investment if people want to alter their existing levels of consumption , and if the riskiness or return on one investment changes tive to other investments . Factors that can shift demand for capital include business confidence and consumer confidence in the financial investments received in the present are typically repaid in the future .

149 PRINCIPLES OF ECONOMICS SELF ' QUESTIONS In the financial market , what causes a movement along the demand curve ?

What causes a shift in the demand curve ?

In the financial market , what causes a movement along the supply curve ?

What causes a shift in the supply curve ?

If a usury law limits interest rates to no more than 35 , what would the likely impact be on the amount of loans made and interest rates paid ?

Which of the following changes in the financial market will lead to a decline in interest rates a a rise in demand a fall in demand CA a rise in supply . a fall in supply Which of the following changes in the financial market will lead to an increase in the quantity of loans made and received a a rise in demand a fall in demand CA a rise in supply . a fall in supply REVIEW QUESTIONS How is equilibrium defined in financial markets ?

What would be a sign of a shortage in financial markets ?

Would usury laws help or hinder resolution of a shortage in financial markets ?

CRITICAL THINKING QUESTIONS Suppose the economy began to grow more rapidly than other countries in the world . What would be the likely impact on financial markets as part of the global economy ?

If the government imposed a federal interest rate ceiling of 20 on all loans , who would gain and who would lose ?

150 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER PROBLEMS . Predict how each of the following economic changes will affect the equilibrium price and quantity in the financial market for home loans . Sketch a demand and supply diagram to support your answers . The number of people at the most common ages for increases . People gain confidence that the economy is growing and that their jobs are secure . Banks that have made home loans find that a larger number of people than they expected are not repaying those loans . Because of a threat of a war , people become uncertain about their economic future . The overall level of saving in the economy diminishes . The federal government changes its bank regulations in a way that makes it cheaper and easier for banks to make home loans . Table shows the amount of savings and borrowing in a market for loans to purchase homes , measured in millions of dollars , at various interest rates . What is the equilibrium interest rate and quantity in the capital financial market ?

How can you tell ?

Now , imagine that because of a shift in the perceptions of foreign investors , the supply curve shifts so that there will be 10 million less supplied at every interest rate . Calculate the new equilibrium interest rate and quantity , and explain why the direction of the interest rate shift makes intuitive sense . Interest Rate 130 170 135 150 140 140 145 135 150 125 10 155 10 Table . Loans to Purchase Homes at Various Rates REFERENCES . GLOSSARY interest rate the price of borrowing in the financial market a rate of return on an investment usury laws laws that impose an upper limit on the interest rate that lenders can charge SOLUTIONS Answers to Questions

PRINCIPLES OF ECONOMICS 151 Changes in the interest rate ( the price of financial capital ) cause a movement along the demand curve . A change in anything else ( variable ) that affects demand for financial capital ( changes in confidence about the future , changes in needs for borrowing ) would shift the demand curve . Changes in the interest rate ( the price of financial capital ) cause a movement along the supply curve . A change in anything else that affects the supply of financial capital ( a variable ) such as income or future needs would shift the supply curve . If market interest rates stay in their normal range , an interest rate limit of 35 would not be binding . If the equilibrium interest rate rose above 35 , the interest rate would be capped at that rate , and the quantity of loans would be lower than the equilibrium quantity , causing a shortage of loans . and will lead to a fall in interest rates . At a lower demand , lenders will not be able to charge as much , and with more available lenders , competition for borrowers will drive rates down . a and will increase the quantity of loans . More people who want to borrow will result in more loans being given , as will more people who want to lend .

THE MARKET SYSTEM AS AN EFFICIENT MECHANISM FOR INFORMATION LEARNING OBJECT By the end of this section , you will be able to Apply demand and supply models to analyze prices and quantities Explain the effects of price controls on the equilibrium of prices and quantities exist in markets for goods and services , for labor , and for financial capital . In all of these markets , prices serve as a remarkable social mechanism for collecting , combining , and information that is relevant to the , the relationship between demand and then serving as messengers to convey that information to buyers and sellers . In a economy , no government agency or guiding intelligence oversees the set of responses and that result from a change in price . Instead , each consumer reacts according to that persons preferences and budget set , and each producer reacts to the impact on its expected profits . The following Clear It Up feature examines the demand and supply models . WHY ARE DEMAND AND SUPPLY CURVES IMPORTANT ?

The demand and supply model is the second fundamental diagram for this course . The opportunity set model introduced in the Choice in a World of Scarcity chapter was the first . ust as it would be foolish to try to learn the arithmetic of long division by memorizing every possible combination of numbers that can be divided by each other , it would be foolish to try to memorize every specific example of demand and supply in this chapter , this textbook , or this course . Demand and supply is not primarily a list of examples it is a model to analyze prices and quantities . Even though demand and supply diagrams have many labels , they are fundamentally the same in their logic . Your goal should be to understand the ing model so you can use it to analyze any market . Figure displays a generic demand and supply curve . The horizontal axis shows the different measures of quantity a of a good or service , or a quantity of labor for a given job , or a quantity of financial capital . The vertical axis shows a measure of price the price of a good or service , the wage in the labor market , or the rate of return ( like the interest rate ) in the financial market . The demand and supply model can explain the existing levels of prices , wages , and rates of return . To carry out such an analysis , think about the quantity that will be demanded at each price and the quantity that will be supplied at each is , think about the shape of the demand and supply how these forces will combine to produce equilibrium .

PRINCIPLES or ECONOMICS 153 Demand and supply can also be used to explain how economic events will cause changes in prices , wages , and rates of return . There are only four possibilities the change in any single event may cause the demand curve to shift right or to shift left or it may cause the supply curve to shift right or to shift left . The key to analyzing the effect of an economic event on equilibrium prices and quantities is to determine which of these four possibilities occurred . The way to do this correctly is to think back to the list of factors that shift the demand and supply curves . Note that if more than one variable is changing at the same time , the overall impact will depend on the degree of the shifts when there are multiple variables , economists isolate each change and analyze it independently . Price Wage Rate of Return Quantity of Goods and Services Quantity of Labor Quantity of Financial Capital Figure . Demand and Supply Curves . The figure displays a generic demand and supply curve . The horizontal axis shows the different measures of quantity a quantity of a good or service , a quantity of labor for a given job , or a quantity of financial capital . The vertical axis shows a measure of price the price of a good or service , the wage in the labor market , or the rate of return ( like the interest rate ) in the financial market . The demand and supply curves can be used to explain how economic events will cause changes in prices , wages , and rates of return . An increase in the price of some product signals consumers that there is a shortage and the product should perhaps be on . For example , if you are thinking about taking a plane trip to Hawaii , but the ticket turns out to be expensive during the week you intend to go , you might consider other weeks when the ticket might be cheaper . The price could be high because you were planning to travel during a holiday when demand for traveling is high . Or , maybe the cost of an input like jet fuel increased or the airline has raised the price temporarily to see how many people are willing to pay it . Perhaps all of these factors are present at the same time . You do not need to analyze the market and break down the price change into its underlying factors . You just have to look at the price of a ticket and decide whether and when to . In the same way , price changes provide useful information to producers . Imagine the situation of a farmer who grows oats and learns that the price of oats has risen . The higher price could be due to an

154 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER increase in demand caused by a new scientific study proclaiming that eating oats is especially ful . Or perhaps the price of a substitute grain , like corn , has risen , and people have responded by ing more oats . But the oat farmer does not need to know the details . The farmer only needs to know that the price of oats has risen and that it will be profitable to expand production as a result . The actions of individual consumers and producers as they react to prices overlap and interlock in markets for goods , labor , and financial capital . A change in any single market is transmitted through these multiple to other markets . The vision of the role of prices helping to reach equilibrium and linking different markets together helps to explain why price controls can be so counterproductive . Price controls are government laws that serve to regulate prices rather than allow the various markets to determine prices . There is an old proverb Don kill the In ancient times , messengers carried information between distant cities and kingdoms . When they brought bad news , there was an emotional impulse to kill the messenger . But killing the ger did not kill the bad news . Moreover , killing the messenger had an undesirable side effect Other messengers would refuse to bring news to that city or kingdom , depriving its citizens of vital . Those who seek price controls are trying to kill the at least to an unwelcome message that prices are bringing about the equilibrium level of price and quantity . But price controls do nothing to affect the underlying forces of demand and supply , and this can have serious . During China Great Leap Forward in the late , food prices were kept artificially low , with the result that 30 to 40 million people died of starvation because the low prices depressed farm production . Changes in demand and supply will continue to reveal themselves through and producers behavior . the price messenger through price controls will deprive everyone in the economy of critical information . Without this information , it becomes cult for and sellers react in a and appropriate manner as changes occur throughout the economy . BABY BOOMERS COME OF AGE The theory of supply and demand can explain what happens in the labor markets and suggests that the demand for nurses will increase as healthcare needs of baby boomers increase , as Figure shows . The impact of that increase will result in an average salary higher than the earned in 2012 referenced in the first part of this case . The new equilibrium ( will be at the new equilibrium price ( quantity will also increase from to . Suppose that as the demand for nurses increases , the supply shrinks due to an increasing number of nurses entering ment and increases in the tuition of nursing degrees . The impact of a decreasing supply of nurses is captured by the ward shift of the supply curve in Figure The shifts in the two curves result in higher salaries for nurses , but the overall impact in the quantity of nurses is uncertain , as it depends on the relative shifts of supply and demand . While we do not know if the number of nurses will increase or decrease relative to their initial employment , we know they will have higher salaries . The situation of the labor market for nurses described in the beginning of the chapter is different from this example , because instead of a shrinking supply , we had the supply growing at a lower rate than the growth in demand . Since both curves were shifting to the right , we would have an unequivocal increase in the quantity of nurses . And because the shift in the demand curve was larger than the one in the supply , we would expect higher wages as a result . KEY CONCEPTS AND SUMMARY The market price system provides a highly efficient mechanism for disseminating information about

PRINCIPLES OF ECONOMICS 155 , Pe I ' I I Quantity of Nurses Figure . Impact of Increasing Demand for Nurses . In 2012 , the median salary for nurses was . As demand for services increases , the demand curve shifts to the right ( from Do to ) and the equilibrium quantity of nurses increases from to . The equilibrium salary increases from to . relative of goods , services , labor , and financial capital . Market participants do not need to know why prices have changed , only that the changes require them to revisit previous decisions they made about supply and demand . Price controls hide information about the true scarcity of products and thereby cause of resources . SELF CHECK QUESTIONS . Identify the most accurate statement . A price will have the largest effect if it is set a substantially above the equilibrium price slightly above the equilibrium price slightly below the equilibrium price . substantially below the equilibrium price Sketch all four of these possibilities on a demand and supply diagram to illustrate your answer . A price ceiling will have the largest effect a substantially below the equilibrium price slightly below the equilibrium price substantially above the equilibrium price . slightly above the equilibrium price Sketch all four of these possibilities on a demand and supply diagram to illustrate your answer .

156 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER ! i , I ( We I , Fe ' I Oe Qe Oe . Quantity of Nurses Figure . Impact of Decreasing Supply of Nurses between 2012 and 2022 . Initially , salaries increase as demand for nursing increases to . When demand increases , so too does the equilibrium quantity , from to . The decrease in the supply of nurses due to nurses retiring from the workforce and fewer nursing graduates ( causes a leftward shift of the supply curve resulting in even higher salaries for nurses , at Peg , but an uncertain outcome for the equilibrium quantity of nurses , which in this representation is less than , but more than the initial . Select the correct answer . A price will usually shift demand supply both neither Illustrate your answer with a diagram . Select the correct answer . A price ceiling will usually shift demand supply both neither

PRINCIPLES OF ECONOMICS 157 REVIEW QUESTIONS Whether the product market or the labor market , what happens to the equilibrium price and quantity for each of the four possibilities increase in demand , decrease in demand , increase in supply , and decrease in supply . CRITICAL THINKING QUESTIONS . Why are the factors that shift the demand for a product different from the factors that shift the demand for labor ?

Why are the factors that shift the supply of a product different from those that shift the supply of labor ?

During a discussion several years ago on building a pipeline to Alaska to carry natural gas , the US . Senate passed a bill stipulating that there should be a guaranteed minimum price for the natural gas that would be carried through the pipeline . The thinking behind the bill was that if private firms had a guaranteed price for their natural gas , they would be more willing to drill for gas and to pay to build the pipeline . a . Using the demand and supply framework , predict the effects of this price on the price , quantity demanded , and quantity supplied . With the enactment of this price for natural gas , what are some of the likely unintended consequences in the market ?

Suggest some policies other than the price that the government can pursue if it wishes to encourage drilling for natural gas and for a new pipeline in Alaska . PROBLEMS . Imagine that to preserve the traditional way of life in small fishing Villages , a government decides to impose a price that will guarantee all fishermen a certain price for their catch . Using the demand and supply framework , predict the effects on the price , quantity demanded , and quantity supplied . With the enactment of this price for fish , what are some of the likely unintended consequences in the market ?

Suggest some policies other than the price to make it possible for small fishing villages to continue . What happens to the price and the quantity bought and sold in the cocoa market if countries producing cocoa experience a drought and a new study is released demonstrating the health benefits of cocoa ?

Illustrate your answer with a demand and supply graph . SOLUTIONS Answers to Questions 153 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER . A price prevents a price from falling below a certain level , but has no effect on prices above that level . It will have its biggest effect in creating excess supply ( as measured by the entire area inside the dotted lines on the graph , from to ) if it is substantially above the equilibrium price . This is illustrated in the following figure . Quantity Figure . It will have a lesser effect if it is slightly above the equilibrium price . This is illustrated in the next figure . Excess I supply I . Quantity Figure .

PRINCIPLES OF ECONOMICS 159 It will have no effect if it is set either slightly or substantially below the equilibrium price , since an price above a price will not be affected by that price . The following figure illustrates these situations . Quantity Quantity ( a ) Price slightly below equilibrium price ( Price floor substantially below equilibrium price Figure . A price ceiling prevents a price from rising above a certain level , but has no effect on prices below that level . It will have its biggest effect in creating excess demand if it is substantially below the equilibrium price . The following figure illustrates these situations . Price ceiling Price ceiling Excess demand Excess demand Quantity Quantity ( a ) Price ceiling substantially below equilibrium price ( Price ceiling slightly below equilibrium price Figure . When the price ceiling is set substantially or slightly above the equilibrium price , it will have no effect on creating excess demand . The following figure illustrates these situations . Neither . A shift in demand or supply means that at every price , either a greater or a lower quantity is demanded or supplied . A price does not shift a demand curve or a supply curve . However , if the price

160 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Price ' Quantity Quantity ( a ) above ( slightly above Figure is set above the equilibrium , it will cause the quantity supplied on the supply curve to be greater than the quantity demanded on the demand curve , leading to excess supply . Neither . A shift in demand or supply means that at every price , either a greater or a lower quantity is demanded or supplied . A price ceiling does not shift a demand curve or a supply curve . However , if the price ceiling is set below the equilibrium , it will cause the quantity demanded an the demand curve to be greater than the quantity supplied on the supply curve , leading to excess demand .