Summary
Demand
- 1. The supply and demand model illustrates how a competitive market, one with many buyers and sellers of the same product, works.
- 2. The demand schedule shows the quantity demanded at each price and is represented graphically by a demand curve. The law of demand says that demand curves slope downward, meaning that as price decreases, the quantity demanded increases.
- 3. A movement along the demand curve occurs when the price changes and causes a change in the quantity demanded. When economists talk of changes in demand, they mean shifts of the demand curve—a change in the quantity demanded at any given price. An increase in demand causes a rightward shift of the demand curve. A decrease in demand causes a leftward shift.
- 4. There are five 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
Supply and Equilibrium
- 5. The supply schedule shows the quantity supplied at each price and is represented graphically by a supply curve. Supply curves usually slope upward.
- 6. A movement along the supply curve occurs when the price changes and causes a change in the quantity supplied. When economists talk of changes in supply, they mean shifts of the supply curve—a change in the quantity supplied at any given price. An increase in supply causes a rightward shift of the supply curve. A decrease in supply causes a leftward shift.
- 7. There are 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
- 8. The supply and demand model is based on the principle that the price in a market moves to its equilibrium price, or market-clearing price, the price at which the quantity demanded is equal to the quantity supplied. This quantity is the equilibrium quantity. When the price is above its market-clearing level, there is a surplus that pushes the price down. When the price is below its market-clearing level, there is a shortage that pushes the price up.
Changes in Equilibrium
- 9. An increase in demand increases both the equilibrium price and the equilibrium quantity; a decrease in demand has the opposite effect. An increase in supply reduces the equilibrium price and increases the equilibrium quantity; a decrease in supply has the opposite effect.
- 10. Shifts of the demand curve and the supply curve can happen simultaneously. When they shift in opposite directions, the change in price is predictable but the change in quantity is not. When they shift in the same direction, the change in quantity is predictable but the change in price is not. In general, the curve that shifts the greater distance has a greater effect on the changes in price and quantity.
Price Controls and Quantity Controls
- 11. Even when a market is effi cient, governments often intervene to pursue greater fairness or to please a powerful interest group. Interventions can take the form of price controls or quantity controls, both of which generate predictable and undesirable side effects, consisting of various forms of inefficiency and illegal activity.
- 12. A price ceiling, a maximum market price below the equilibrium price, benefi ts successful buyers but creates persistent shortages. Because the price is maintained below the equilibrium price, the quantity demanded is increased and the quantity supplied is decreased compared to the equilibrium quantity. This leads to predictable problems including inefficient allocation to consumers, wasted resources, and inefficiently low quality. It also encourages illegal activity as people turn to black markets to get the good. Because of these problems, price ceilings have generally lost favor as an economic policy tool. But some governments continue to impose them either because they don’t understand the effects or because the price ceilings benefi t some infl uential group.
- 13. A price floor, a minimum market price above the equilibrium price, benefits successful sellers but creates a persistent surplus: because the price is maintained above the equilibrium price, the quantity demanded is decreased and the quantity supplied is increased compared to the equilibrium quantity. This leads to predictable problems: inefficiencies in the form of inefficient allocation of sales among sellers, wasted resources, and inefficiently high quality. It also encourages illegal activity and black markets. The most well known kind of price floor is the minimum wage, but price floors are also commonly applied to agricultural products.
- 14. Quantity controls, or quotas, limit the quantity of a good that can be bought or sold. The government issues licenses to individuals, the right to sell a given quantity of the good. The owner of a license earns a quota rent, earnings that accrue from ownership of the right to sell the good. It is equal to the difference between the demand price at the quota amount, what consumers are willing to pay for that amount, and the supply price at the quota amount, what suppliers are willing to accept for that amount. Economists say that a quota drives a wedge between the demand price and the supply price; this wedge is equal to the quota rent. By limiting mutually beneficial transactions, quantity controls generate inefficiency. Like price controls, quantity controls lead to deadweight loss and encourage illegal activity.
International Trade
- 15. International trade is of growing importance to the United States and of even greater importance to most other countries. International trade, like trade among individuals, arises from comparative advantage: the opportunity cost of producing an additional unit of a good is lower in some countries than in others. Goods and services purchased abroad are imports; those sold abroad are exports. Foreign trade, like other economic linkages between countries, has been growing rapidly, a phenomenon called globalization.
- 16. Autarky refers to a situation in which a country does not trade with other countries. The domestic demand curve and the domestic supply curve determine the price of a good in autarky. When international trade occurs, the domestic price is driven to equality with the world price, the price at which the good is bought and sold abroad.
- 17. If the world price is below the autarky price, a good is imported. This leads to an increase in domestic consumption and a decrease in domestic production. If the world price is above the autarky price, a good is exported. This leads to an increase in domestic production and a decrease in domestic consumption.
- 18. International trade leads to expansion in exporting industries and contraction in import-competing industries. This raises the domestic demand for factors of production used in the exporting industries and reduces the demand for factors of production used in the import-competing industries.
- 19. Most economists advocate free trade, but in practice many governments engage in trade protection. The two most common forms of protection are tariffs and quotas. On rare occasions, export industries are subsidized.
- 20. A tariff is a tax levied on imports. It raises the domestic price above the world price, hurting consumers, benefi ting domestic producers, and generating government revenue. An import quota is a legal limit on the quantity of a good that can be imported. It has the same effects as a tariff, except that the revenue goes not to the government but to those who receive import licenses.
- 21. In the past few years, many concerns have been raised about the effects of globalization. One issue is the increase in income inequality due to the surge in imports from relatively poor countries over the past 20 years. Another is the increase in offshore outsourcing, as many jobs once considered safe from foreign competition have been moved abroad.