In the late 1990s, the prices of company shares on stock markets rase to levels which, for ‘many firms, were much higher than warranted by the values of their assets and their profits How can demand and supply analysis explain why this “bubble” in stock market prices was caused by expectations that share prices would continue to rise? Exercises | 1, Market Equilibrium Using Demand and Supply Schedules The demand and supply schedules for athletic shoes sold at Trendy Shoes Inc. a the local mall are hypothesized to be as follows (in pairs of shoes per week): @ @ a Quantity Excess Demand (+) Price Demande ipplied _Excess Supply ( | D | $120 40 130 | 110 50 110 100 60 90 | 90 70 —_ 70 80 80 — 50 | 70 90 - 30 60 100 10 @ provided in Figure 3-1, plot the demand and supply curves. Indicate m levels of price and quantity. Figure 3-1 120 100 80 60 Price 40 20 0 2 «4 «660 O10 12040. Quantity of Shoes (pairs per week) CHAPTERS: DEMAND, SUPPLY, ANDPRICE 49(b) Fill in column 4 in the table on the previous page for values of excess demand and. excess supply. What is the value of excess demand (supply) at equilibrium? (©) Suppose there is a change in teenage fashion such that a substitute shoe, Block Mardens, becomes trendy. As a result, the quantity demanded of athletic shoes at ‘Trendy Shoes Inc, decreases by 30 units per week at each and every price. Put the new quantities demanded in column (2) on the previous page, and draw the new , demand curve D' on the grid. (@ _Atthe inital equilibrium price you reported in answer (b), what market pressure on | price is created by this change in tastes? How does price respond to this pressure? How do quantities demanded and supplied react? \ (© After price has adjusted to the new equilibrium, what is the equilibrium price and the equilibrium quantity? “Fair Pricing” and Black Markets ‘The Executive of the Students’ Association at the University of Equality has recently | announced that “in the interests of faimess” all seats for on-campus concerts will se at the same price regardless ofthe popularity of the performer. The campus concert hall has @ seating capacity of 5000, Suppose the demand schedule for tickets for a (ypical concert or performer is as follows: Price Quantity Demanded $6 8000 8 5000 10 2500 2 1500 4 1000 (a) If the Executive sets a price of $10 per seat, is there an excess demand or supply of tickets for a typical concert? (&) What price would fil the concert hall without creating a shortage of seats at a typical concert? (©) Suppose the quantity of tickets demanded at each price doubles when a particularly popular performer is booked. What would be the equilibrium ticket price for a popular performer? 50 PART2;ANINTRODUCTIONTO DEMAND AND SUPPLY(@) Ifthe Executive set the price for ll concerts at the equilibrium price for a typical concert, how will ticket scalping (a type of “black market” where some people buy tickets at the box-office price and resell them at higher prices) affect the achievement of the “faimess” objective? 3. Practising with Demand and Supply Read the description of events (2nd column of the table below) in each market (Ist column), Predict the impact on each market of these events by drawing the appropriate shifts of curves in the accompanying diagram. Use + and to indicate whether there will be | an increase or a decrease in demand (D), supply (S) equilibrium price (P), and equilibrium quantity (Q) If there is no change, use 0. Ifthe change can’t be predicted, use U for uncertain. [Wore: See “Hints and Tips” for finding the answer when two events occur simultaneously.] Figure 3-2 Market Event (@) Canadian Early frost destroys a wine large percentage of the rape crop in British x Columbia - (b) Wood- The price ofheatingoil =| = burning and natural gas triples) stoves L (© Cell___Technological advances plones reduce thecostsof | >< producing cellphones @ Gold Large gold deposits are | discovered in northern Ontario 5 (© Fastfoods The public show greater concer over high sodium aed cholesterol in fast foods; als, there is an increase in the OX minimum wage (® Bicycles There is increasing concem by consumers about physical fitness; also, the price of gasoline falls CHAPTERS: DEMAND, SUPPLY,ANDPRICE $1Market Event @ Beer The population of drinking age increases; also, brewery unions negotiate @ big increase in wages (h) Housing House prices are expected to rise significantly inthe near? future 4, Movements along Curves versus Shifts of Curves For each of the following, determine if the sentence is referring to a change in demand, a change in quantity demanded, a change in supply, or a change in quantity supplied. If applicable, indicate the resulting change in equilibrium price and quantity. (a) In August 2005, Hurricane Katrina caused an increase in the world price of oil. (b) Prices of personal computers fall despite a substantial increase in the number sold. (©) Apartment rental prices rise as student enrollment swells @ Lower airfares reduce the number of empty seats on regularly scheduled flights, [Hint: There is a fixed supply of seats on regularly scheduled flights.) (©) Increases in the price of Christmas trees cause trees to be planted on land previously used by dairy farmers. [Nove: Answer for both the market for Christmas trees and the market for milk] (An increase in the price of Pacific salmon is linked to a reduction in fishing for Atlantic cod. [Note: Answer for both the market for Atlantic cod and the market for Pacific salmon.] [Hfint: The two types of fish are substitutes in consumption. (g) The 1998 ice storm in Quebec affected the market for portable gas-powered. generators not only in Quebec but also in other regions of Canada. 52 PART2;ANINTRODUCTIONTO DEMAND AND SUPPLY5. Changes in Exogenous Variables ‘This question demonstrates how changes in exogenous variables impact market equilibrium, It takes you through the process of making a scale diagram from simple functional relationships for demand and supply, and then finding equilibrium on the diagram, [Note: A similar question is given in Extension Exercise E2, using algebra instead ofa scale diagram to find equilibrium.} ‘The quantity demanded of gadgets (Q”) depends on the price of gadgets (P) and the price of a substitute good (Py) according to the following relationship, P= 10-1P+05Py ‘The quantity of gadgets supplied (Q') is positively related to the price of gadgets and negatively related tothe price of some input (Pn) according to Q°=30+1P-0.1Pn (a) Assume initially that Py = $40 and Pn = $200. Substitute these values into the equations to obtain the equations for the demand and supply curves. (b) Using the equations you obtained in (a), find Q” and Q* when P =$0, and locate these quantities on the grid in Figure 3-3. Using the demand curve equation in (a), | find the P at which Q° = 0, and locate this price on the grid, (© Forevery $5 increase in the price of gadgets, what is the change in Q and Q*? What are the slopes of the demand and supply curves? Draw the demand and supply curves on the grid in Figure 3-3, and label them D, and S;, respectively. [Hint: The demand and supply curves are straight lines.] What is the equilibrium price and quantity? | Figure 3-3, 30 25 16 Price 10 5 10 15 20 25 30 Quantity CHAPTER3: DEMAND, SUPPLY, ANDPRICE $3 rrr(@ Now Py falls from $40 to $20, and Pr rises from $200 to $300. What are the new ‘equations for the demand and supply curves? Draw these new curves in Figure 3-3, and label them Dz and 5, respectively. (©) By how much have equilibrium price and quantity changed as a result ofthe simultaneous shifts in the demand and supply curves? What do you see when you compare the change in equilibrium quantity with the horizontal shifts in the demand and supply curves? Why? (What would happen to equilibrium price and quantity if Py fell by more than $20? Why? What if Py fell by less than $202Solutions Chapter Review 14a) 24e) 34a) 4.(b) 56) 6() 7.(6) 8c) 944) 10.(e) 116) 12.(6) 13,c) 14.(€) 15.4) 16.6) 17.42) 18.8) 194) Short-Answer Questions 1. Bquilibrium isa condition of stability, with no existing pressures for change. New pressures arise from changes in the exogenous variables that shift the demand and supply curves. Such shifts create excess demand or excess supply atthe old equilibrium price, which are market forces that put pressure on price and quantity until anew position of stability (Le, equilibrium) is reached, Because of the “other things constant” (ie, ceteris paribus) condition, prices of other goods are constant all along a demand curve. Consequently, as the dolar price (Le. the absolute price) ofa good falls, its price relative to the price of other goods is also falling. The fallin relative price isa fal in the ‘2004's opportunity cost, to which demanders react by inereasing quantity demanded (i, a movement along the demand curve). 62 PART2;ANINTRODUCTION TO DEMAND AND SUPPLY