4.5 End-of-Chapter Material
The supply-and-demand framework is almost certainly the most powerful model in the economist’s toolkit. Armed with an understanding of this framework, you can make sense of much economic news, and you can make intelligent predictions about future changes in prices.
A true understanding of this framework is more than just an ability to shift curves around, however. It is an understanding of how markets and prices are one of the main ways in which the world is interlinked. Markets are, quite simply, at the heart of economic life. Markets are the means by which suppliers and demanders of goods and services can meet and exchange their wares. Since exchange creates value—because it makes both buyers and sellers better off—markets are the means by which our economy can prosper. Markets are the means by which economic activity is coordinated in our economy, allowing us to specialize in what we do best and to buy other goods and services.
Economists regularly point to these features of markets, but this should not blind us to the fact that markets can go wrong. There are many ways in which market outcomes may not be the most desirable or efficient, as the global financial crisis revealed. In the remainder of this book, we look in considerable detail at all the ways that markets can fail us as well as help us.
- International Monetary Fund (IMF): www.imf.org/external/pubs/ft/weo/2008/01/pdf/c3.pdf
- IMF video on its response to the crisis: http://www.youtube.com/watch?v=f0z6nWQfvuA&feature=channel_page
- Federal Reserve Bank of San Francisco: http://www.frbsf.org/publications/economics/letter/2008/el2008-21.html
- New York University Stern blog on the financial crisis: http://sternfinance.blogspot.com/search/label/overview/
- What would the impact be on the market demand curve for new homes if there were an increase in the price of old homes?
- Name two factors that cause market demand curves to shift outward.
Fill in the blanks in the following table. What can you say about the missing price in the table?
Table 4.2 Individual and Market Demand
Price of Chocolate Bar Household 1’s Demand Household 2’s Demand Market Demand 1 7 22 2 11 16 10 .5 3 3.5 .75 4 4.75
- If the income levels of all households increase, what happens to the individual demand curves? What happens to market demand?
- Suppose the price of coffee increases. Household 1 always eats a chocolate bar while drinking coffee. What will happen to Household 1’s demand for chocolate bars when the price of coffee increases? Household 2 has either coffee or a chocolate bar for dessert. What happens to Household 2’s demand for chocolate bars when the price of coffee increases? What happens to the market demand for chocolate bars when the price of coffee increases?
- (Advanced) In Figure 4.3 "The Market Supply of Houses" we showed the market supply curve for new houses. Suppose that a change in government regulations makes it easier for people to become qualified electricians. What will happen to the supply curve for houses?
- We said that the equilibrium price and quantity in a market is always positive. More precisely, this is true as long as the vertical intercept of the demand curve is bigger than the vertical intercept of the supply curve. If this is not the case, then the most that any buyer is willing to pay is less than the least any seller is willing to accept. Draw a version of Figure 4.5 "Market Equilibrium" to illustrate this possibility. How much trade do you expect in this market?
- Suppose that households become worried about losing their jobs and decide to save more. What happens in the credit market? Do you expect interest rates to increase or decrease?
- When interest rates decrease, firms find it cheaper to borrow. What do you think happens to the demand for labor? What happens to the real wage?
What happens to the value of the US dollar if
- foreign investors decide they want to buy more US assets.
- there is a recession in other countries that buy goods produced in the United States.
- What do you think will be the effect on the markets for used homes and apartments if there is a reduction in expected capital gains from owning a new home? The shift in the supply curve came from an increase in the cost of credit. Where might the increase in the cost of credit come from?
- Think about your hometown as an economy. What does it import (i.e., what goods and services does it purchase from outside the town)? What does it export (i.e., what goods and services are produced in the town and sold outside it)? What about the street you live on—what are its imports and exports?
- Using supply and demand, explain how an increase in Chinese demand for Australian butter might be one of the factors causing the Australian dollar to appreciate. How might this affect the labor markets in Australia?
- If oil prices increase, what will this do to the demand for apartments and houses in warm climates? What will happen to housing prices in cold climates? Use supply and demand to illustrate.
- Find three news articles that discuss the financial crisis. Which markets are discussed in these articles? Can you use a supply-and-demand picture to help you make sense of anything that is discussed in the articles you find?
- Find one example of another country where there was a major decrease in housing prices, as in the United States and England. Find another country where housing prices did not seem to be affected.
Using a spreadsheet, construct a version of Table 4.1 "Market Equilibrium: An Example" assuming thatmarket demand = 50 − 0.005 × price.
Fill in all the prices (in thousands) from 1,000 to 100,000. What is the equilibrium price and quantity in the market? How would you explain the difference between this equilibrium and the one displayed in Table 4.1 "Market Equilibrium: An Example"?