Section 2 Review

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What is the definition of COMPETITIVE MARKET?

a market with many buyers and sellers of the same product

What does the SUPPLY AND DEMAND MODEL show?

illustrates how a competitive market works

What does the DEMAND SCHEDULE show?

shows the quantity demanded at each price and is represented graphically by a demand curve

What is the LAW OF DEMAND?

says that demand curves slope downward, meaning that as price decreases, the quantity demanded increases

When is there a MOVEMENT ALONG THE DEMAND CURVE?

occurs when the price changes and causes a change in the quantity demanded

What do economists mean when the talk about CHANGES IN DEMAND?

shifts of the demand curve

What are the 5 main factors that shift the demand curve?

- A change in the prices of related goods, such as SUBSTITUTES or COMPLEMENTS
- A change in income: when income rises, the demand for NORMAL GOODS increases and the demand for INFERIOR GOODS decreases
- A change in tastes
- A change in expectations
- A change in the number of consumers

What does the supply schedule show?

The QUANTITY SUPPLIED at each price and is represented graphically by a SUPPLY CURVE

When does a MOVEMENT ALONG THE SUPPLY CURVE occur?

It occurs when the price changes and causes a change in the quantity supplied

What is the definition of CHANGES IN SUPPLY?

shifts of the supply curve-a change in the quantity supplied at any given price

What are the five main factors that shift the supply curve?

- A change in INPUT prices
- A change in the prices of related goods and services
- A change in technology
- A change in expectations
- A change in the number of producers

What is the definition of EQUILIBRIUM PRICE or MARKET-CLEARING PRICE?

the price at which the quantity demanded is equal to the quantity supplied

What happens when there is an increase in demand?

There is then an increase in both the equilibrium price and the equilibrium quantity.

What happens when there is a decrease in demand?

There is then a decrease in both the equilibrium price and the equilibrium quantity.

True or False, Shifts of the demand curve and the supply curve can happen simultaneously

True

What can interventions take the form of?

PRICE CONTROLS or QUANTITY CONTROLS

What is a PRICE CEILING?

A maximum market price about the equilibrium price, benefits successful sellers but creates a persistent surplus

What is a PRICE FLOOR?

A minimum market price above the equilibrium price, befits successful sellers but creates a persistent surplus

What is the most known form of price floor?

MINIMUM WAGE

What is the definition of QUOTAS?

It limits the quantity of a good that can be bought or sold.

What is the definition of QUOTA RENT?

Earnings that accrue from ownership of the right to sell the good.

What is the definition of DEMAND PRICE?

It is what consumers are willing to pay for that amount.

What is the definition of SUPPLY PRICE?

What suppliers are willing to accept for that amount.

What does a quota drive a WEDGE between?

The demand price and the supply price.

What do quantity controls lead to?

DEADWEIGHT LOSS.

Problems

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1. A survey indicated that chocolate ice cream is America's favorite ice-cream flavor. For each of the following, indicate the possible effects on the demand and/or supply, equilibrium price, and equilibrium quantity of chocolate ice cream.

a. A severe drought in the Midwest causes dairy farmers to reduce the number of milk-producing cows in their herds by a third. These dairy farmers suppl cream that is used to manufacture chocolate ice cream.
b. A new report by the American Medical Association reveals that chocolate does, in fact, have significant health benefits.
c. The discovery of cheaper synthetic vanilla flavoring lowers the price of vanilla ice cream.
d. New technology for mixing and freezing ice cream lowers manufacturers' cost of producing chocolate ice cream.

2. In a supply and demand diagram, draw the change in demand for hamburgers in your hometown due to the following events. In each case show the effect on equilibrium price and quantity.

a. The price of tacos increases.
b. All hamburger sellers raise the price of their french fries.
c. Income falls in town. Assume that hamburgers are a normal good for most people.
d. Income falls in town. Assume that hamburgers are an inferior good for most people.
e. Hot dog stands cut the price of hot dogs.

3. The market for many goods changes in predictable ways according to the time of year, in response to events such as holidays, vacation times, seasonal changes in production, and so on. Using supply and demand, explain the change in price in each of the following cases. Note that supply and demand may shift simultaneously.

a. Lobster prices usually fall during the summer peak harvest season, despite the fact that people like to eat lobster during the summer months more than during any other time of year.
b. The price of a Christmas tree is lower after Christmas than before and fewer trees are sold.
c. The price of a round-trip ticket to Paris on Air France falls by more than $200 after the end of school vacation in September. This happens despite the fact that generally worsening weather increases the cost of operating flights to Paris, and Air France therefore reduces the number of flights to Paris at any given price.

4. Show in a diagram the effect on the demand curve, the supply curve, the equilibrium price, and the equilibrium quantity of each of the following events on the designated market.

a. the market for newspapers in your town
Case 1: The salaries of journalists go up.
Case 2: There is a big news event in your town, which is reported in the newspapers, and residents want to learn more about it.
b. the market for St. Louis Rams cotton T-shirts
Case 1: The rams win the national championship.
Case 2: The price of cotton increases.
c. the market for bagels
Case 1: People realize how fattening bagels are.
Case 2: People have less time to make themselves a cooked breakfast

5. Find the flaws in reasoning in the following statements, paying particular attention to the distinction between changes in and movements along the supply and demand curves. Draw a diagram to illustrate what actually happens in each situation.

a. "A technological innovation that lowers the cost of producing a good might seem at first to result in a reduction in the price of the good to consumers. But a fall in price will increase demand for the good, and higher demand will send the price up again. It is not certain, therefore, that an innovation will really reduce price in the end."

b. "A study shows that eating a clove of garlic a day can help prevent heart disease, causing many consumers to demand more garlic. This increase in demand results in a rise in the price of garlic. Consumers, seeing that price of garlic has gone up, reduce their demand for garlic. This causes the demand for garlic to decrease and the price of garlic to fall. Therefore, the ultimate effect of the study on the price of garlic is uncertain."

6. In Rolling Stone magazine, several fans and rock stars, including Pearl Jam, were bemoaning the high price of concert tickets. One superstar argued, "It just isn't worth $75 to see my play. No one should have to pay that much to go to a concert." Assume this star sold out arenas around the country at an average ticket price of $75.

a. How would you evaluate the arguments that ticket prices are too high?
b. Suppose that due to his star's protests, ticket prices were lowered to $50. In what sense is this price too low? Draw a diagram using supply and demand curves to support your argument.
c. Suppose Pearl Jam really wanted to bring down ticket prices. SInce the band controls the supply of its services, what do you recommend they do? Explain using a supply and demand diagram.
d. Suppose the band's next CD was a totoal dud. Do you think they would still have to worry about ticket prices being too high? Why or why not? Draw a supply and demand diagram to support your argument.
e. Suppose the group announced their next tour was going to be their last. What effect would this likely have on the demand for and price of tickets? Illustrate with a supply and demand diagram.

7. After several years of decline, the market for a handmade acoustic guitars is making a comeback. These guitars are usually made in small workshops employing relatively few usually made in small workshops employing relatively few highly skilled luthiers. Assess the impact on the equilibrium price and quantity of handmade acoustic guitars as a result of each of the following events. In your answers, indicate which curve(s) shift(s) and in which direction.

a. Environmentalists succeed in having the use of Brazilian rosewood banned in the United States, forcing luthiers to seek out alternative, more costly woods.
b. A foreign producer engineers the guitar-making process and floods the market with identical guitars.
c. Music featuring handmade acoustic guitars makes a comeback as audiences tire of heavy metal and grunge music.
d. The country goes into a deep recession and the income of the average American falls sharply.

8. Will Shakespeare is a struggling playwright in sixteenth-century London. As the price he receives for writing a play increases, he is willing to write more plays. For the following situations, use a diagram to illustrate how each event affects the equilibrium price and quantity in the market for Shakespeare's plays.

a. The playwright Christopher Marlowe, Shakespeare's chief rival, is killed in a bar brawl.
b. The bubonic plague, a deadly infectious disease, breaks out in London.
c. To celebrate the defeat of the Spanish Armada, Queen Elizabeth declares several weeks of festivities, which involves commissioning new plays.

9. The small town of Middling experiences a sudden doubling of the birth rate. After three years, the birth rate returns to normal. Use a diagram to illustrate the effect of these events on the following:

a. the market for an hour of babysitting services in Middling today
b. the market for an hour of babysitting services 14 years into the future, after the birth rate has returned to normal, by which time children born today are old enough to work as babysitters
c. the market for an our of babysitting services 30 years into the future, when children born today are likely to be having children of their own

10. Use a diagram to illustrate how each of the following events affects the equilibrium price and quantity of pizza.

a. The price of mozzarella cheese rises.
b. The health hazards of hamburgers are widely publicized.
c. The price of tomato sauce falls.
d. The incomes of consumers rise and pizza in an inferior good.
e. Consumers expect the price of pizza to fall next week.

11. Although he was a prolific artist, Pablo Picasso painted only 1,000 canvases during his "Blue Period." Picaso is now dead, and all of his Blue Period works are currently on display in museums and private galleries throughout Europe and the United States.

a. Draw a supply curve for Picasso Blue Period works. why is this supply curve different from ones you have seen?
b. Given the supply curve from part a, the price of a Picasso Blue Period work will entirely dependent on what factor(s)? Draw a diagram showing how the equilibrium price of such a work is determined.
c. Suppose that rich art collectors decide that it is essential to acquire Picasso Blue Period art for their collections. Show the impact of this on the market for these paintings.

12. Draw the appropriate curve in each of the following cases. Is it like or unlike the curves you have seen so far? Explain.

a. the demand for cardiac bypass surgery, given that the government pays the full cost for any patient
b. the demand for elective cosmetic plastic surgery, given that the patient pays the full cost
c. the supply of Rembrandt paintings
d. the supply of reproductions of Rembrandt paintings

13. Suppose it is decided that rent control in New York City will be abolished and that market rents will now prevail. Assume that all rental units are identical and are therefore offered at the same rent. To address the plight of residents who may be unable to pay the market rent, an income supplement will be paid to all low-income households equal to the difference between the old controlled rent and the new market rent.

a. Use a diagram to show the effect on the rental market of the elimination of rent control. What will happen to the quality and quantity of rental housing supplied?
b. Now use a second diagram to show the additional effect of the income-supplement policy on the market. What effect does it have on the market rent and quantity of rental housing supplied in comparison to your answer to part a?
c. Are tenants better or worse off as a result of these policies? Are landlords better off or worse?
d. From a political standpoint, why do you think cities have been more likely to resort to rent control rather than a policy of income supplements to help low-income people pay for housing?

14. In the late eighteenth century, the price of bread in New York City was controlled, set at a predetermined price above the market price.

a. Draw a diagram showing the effect of the policy. Did the policy act as a price ceiling or a price floor?
b. What kinds of inefficiencies were likely to have arisen when the controlled price of bread was above the market price? Explain in detail.
One year during this period, a poor wheat harvest caused a leftward shift in the supply of break and therefore and increase in its market price. New York bakers found that the controlled price of bread in New York was below the market price.
c. Draw a diagram showing the effect of the price control on the market for bread during this one-year period. Did the policy act as a price ceiling or a price floor?
d. What kinds of inefficiencies do you think occurred during this period? Explain in detail.

15. Suppose the U.S. government decides that the incomes of dairy farmers should be maintained at a level that allows the traditional family family dairy farm to survive. It therefore implements a price floor of $1 per pint by buying surplus milk until the market price is $1 per pint. Use the accompanying diagram to answer the following questions.

a. How much surplus milk will be produced as a result of this policy?
b. What will be the cost to the government of this policy?
c. Since milk is an important source of protein and calcium, the government decides to provide the surplus milk it purchases to elementary schools at a price of only $0.60 per pint. Assume that schools will buy any amount of milk available at this low price. But parents now reduce their purchases of milk at any price by 50 million pints per year because they know their children are getting milk at school. How much will the dairy program now cost the government?
d. Give two examples of inefficiencies arising from wasted resources that are likely to result from this policy. What is the missed opportunity in each case?

16. As noted in the text, European governments tend to make greater use of price controls than does the U.S. government. For example, the French government sets minimum starting yearly wages for new hires who have completed le bac, certification roughly equivalent to a high school diploma. The demand schedule for new hires with le bac and the supply schedule for similarly credentialed new job seekers are given in the accompanying table. The price here-given in euros, the currency used in France-is the same as the yearly wage.

a. In the absence of government interference, what is the equilibrium wage and number of graduates hired per year? Illustrate with a diagram. Will there be anyone seeking a job at the equilibrium wage who is unable to find one-that is, will there be anyone who is involuntarily unemployed?
b. Suppose the French government sets a minimum yearly wage of 35,000 euros. Is there any involuntary unemployment at this wage? If so, how much? Illustrate with a diagram. What if the minimum wage is set at 40,000 euros? Also illustrate with a diagram.
c. Given your answer to part b and the information in the table, what do you think is the relationship between the level of involuntary unemployment and the level of the minimum wage? Who benefits from such a policy? Who loses? What is the missed opportunity here?

17. Until recently, the standard number of hours worked per week for a full-time job in France was 39 hours, similar to in the United States. But in response to social unrest over high levels of involuntary unemployment, the French government instituted a 35-hour workweek-a worker could not work more that 35 hours per week even if both the worker and employer wanted it. The motivation behind this policy was that if current employees worked fewer hours, employers would be forced to hire more new workers. Assume that it is costly for employers to train new workers. French employers were greatly opposed to this policy and threatened to move their operations to neighboring countries that did not have such employment restrictions. Can you explain their attitude? Give and example of both an inefficiency and an illegal activity that are likely to arise from this policy.

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18. For the last 70 years, the U.S. government has used price supports to provide income assistance to U.S. farmers. At times the government has used price floors, which it maintains by buying up the surplus farm products. At other times, it has used target prices, giving the farmer an amount equal to the difference between the market price and the target price for each unit sold. Use the accompanying diagram to answer the following questions.

a. If the government sets a price floor of $5 per bushel, how many bushels of corn are produced? How many are purchased by consumers? by the government? How much does the program cost the government? How much revenue do corn farmers receive?
b. Suppose the government sets a target price of $5 per bushel for any quantity supplied up to 1,000 bushels. How many bushels of corn are purchased by consumers and at what price? by the government? How much does the program cost the government? How much revenue do corn farmers receive?
c. Which of these programs (in parts a and b) costs corn consumers more? Which program costs the government more? Explain.
d. What are the inefficiencies that arise in each of these cases (parts a and b)?

19. The waters off the north Atlantic coast were once teeming with fish. Now, due to overfishing by the commercial fishing industry, the stocks of fish are seriously depleted. In 1991, the National Marine Fishery Service of the U.S. government implemented a quota to allow fish stocks to recover. The quota limited the amount of swordfish caught per year by all U.S.-licensed fishing boats to 7 million pounds. As soon as the U.S. fishing fleet had met the quota, the swordfish catch was closed down for the rest of the year. The accompanying table gives the hypothetical demand and supply schedules for swordfish caught in the United States per year.

a. Use a diagram to show the effect of the quota on the market for swordfish in 1991.
b. How do you think fishermen will change how they fish in response to this policy?

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