04 Mill Micro1ce PPT ch04-2

ECONOMICS TODAY
A Canadian Perspective Microeconomics, First Edition
Chapter 4
Extensions of Demand and
Supply Analysis
Copyright © 2023 Pearson Canada Inc. 4-1

INTRODUCTION
• The Canadian government regulates the price

pharmaceutical companies can charge on
prescription medicines.
• Drug spending has increased significantly. Health
Canada has proposed a number of regulatory
changes. These changes will significantly lower
the prices for these medications.
• So, while consumers may pay a lower price for
their prescribed medications, they may end up
paying higher costs in other, less transparent
ways. In this chapter, you will learn why this
occurs.

4.1 Discuss the essential features of the price
system
4.2 Evaluate the effects of changes in demand and

supply on the market price and equilibrium quantity
LEARNING
OBJECTIVE 4.3 Understand the rationing function of prices
S
4.4 Explain the effects of price ceilings
4.5 Explain the effects of price floors and

government-imposed quantity restrictions

CHAPTER OUTLINE
4.3 The
4.1 The Price 4.2 Changes in
Rationing
System and Demand and
Function of
Markets Supply
Prices
4.5 Price Floors

4.4 Price
and Quantity
Ceilings
Restrictions

DID YOU KNOW THAT ...
• In Canada’s largest cities, construction of new rental
housing has failed to keep up with demand, creating
significant shortages.
• In cities that have experienced these shortages, rental
rates have risen considerably. As a consequence, these
cities have seen significant increases in apartment and
condo construction. and shortages are forecasted to ease.
• In some areas, however, legally binding price ceilings
prevent rental rates from increasing in response to an
excess of quantity demanded over quantity supplied. The
consequence has been that substantial shortages of
middle-priced apartments have persisted.

• Price system, or market system
• An economic system in which relative
prices are constantly changing to reflect
changes in supply and demand:
4.1 PRICE • The prices are signals as to what is
SYSTEM & relatively scarce and relatively
abundant.
MARKETS
• Prices provide information to
individuals and businesses.
• Voluntary exchange
• An act of trading, done on a mutually
agreed upon basis between individuals in
the price system
• Makes both parties to the trade subjectively
better off
• Transaction costs
• All the costs associated with the exchange, including:

• The informational costs of finding out the price
and quality, service record, and durability of a
product
• The cost of contracting and enforcing that
contract
4.1 PRICE • The role of middlemen
SYSTEM & • Middlemen (intermediaries) or brokers reduce

transaction costs by providing information to buyers
MARKETS and sellers.
• Platform firms
• Companies whose services link people to other

individuals who share their interests or who seek to buy
firms’ products, often via networks that the companies
operate.

AI—DECISION MAKING THROUGH
DATA: TRANSACTION COSTS AND
“PRICE STICKINESS”
• Alberto Cavallo of the Massachusetts

Institute of Technology has utilized data
analytics to examine more than 60 million
different prices.
• He concluded that transaction costs induced
firms to make few price changes over given
intervals of time—about every 9 months in
the U.S.
• He interpreted this as a considerable degree
of transaction-cost-generated “price
stickiness.”

4.2 CHANGES IN DEMAND & SUPPLY
FIGURE 4-1 SHIFTS IN DEMAND AND IN
SUPPLY: DETERMINATE RESULTS, PANEL (A)
• Changes in supply and

demand create a
disequilibrium.
• The market price and
quantity adjust to a new
equilibrium.
• In panel (a), supply is
unchanged at S.
• The demand curve shifts
rightward from D1 to D2.
• The equilibrium price and
quantity rise from P1, Q1 to
P2, Q2, respectively.

FIGURE 4-1 SHIFTS IN DEMAND AND IN SUPPLY:
DETERMINATE RESULTS, PANEL (B)
• In panel (b), the supply

curve is unchanged at S.
• The demand curve shifts

leftward from D1 to D3.
• Both equilibrium price

and equilibrium quantity
fall.
Copyright © 2023 Pearson Canada Inc. 4 - 10

DETERMINATE RESULTS, PANEL (C)
• In panel (c), demand

now remains unchanged
at D.
• The supply curve shifts

from S1 to S2. The
equilibrium price falls
from P1 to P2.
• The equilibrium quantity

increases, however,
from Q1 to Q2.

DETERMINATE RESULTS, PANEL (D)
• In panel (d), demand is

unchanged at D.
• The supply curve shifts

leftward from S1 to S3.
• The market clearing price

increases from P1 to P3.
The equilibrium quantity
falls from Q1 to Q3.

4.2 CHANGES IN DEMAND &
SUPPLY
• Summary:
• Increases in demand increase equilibrium price and quantity.
• Decreases in demand decrease equilibrium price and quantity.
• Increases in supply decrease equilibrium price and increase

equilibrium quantity.
• Decreases in supply increase equilibrium price and decrease
equilibrium quantity.

When both demand and supply change:
• If both the supply and demand curves shift simultaneously, the outcome is
indeterminate for either equilibrium price or equilibrium quantity.
• The resulting effect depends upon how much each curve shifts.
When both demand and supply increase:
• The change in equilibrium price is indeterminate.

• The equilibrium quantity increases unambiguously.
When both demand and supply decrease:
• The change in equilibrium price is indeterminate.

• The equilibrium quantity decreases unambiguously

4.2 CHANGES IN DEMAND AND SUPPLY
When supply decreases and demand

increases:
• The equilibrium price increases.
• The change in the equilibrium quantity is
uncertain without more information.
When supply increases and demand

decreases:
• The equilibrium price decreases.
• The change in the equilibrium quantity is
uncertain without more information.

4.2 CHANGES IN DEMAND AND SUPPLY
Price flexibility: Adjustment speed:

• Prices that are quite flexible • Market characteristics
in some markets can be less influence adjustment speed.
flexible in other market • Markets may overshoot in
scenarios: the adjustment process.
• May take the form of • Markets are subject to
subtle adjustments such energy shocks, labour
as hidden payments and strikes, and severe weather.
quality changes
• May not reach
equilibrium right away

EXAMPLE: THE EFFECTS OF A SIMULTANEOUS
DECREASE IN THE SUPPLY OF AND AN INCREASE IN
THE DEMAND FOR VINYL RECORDS
• A substantial increase in the price of machines

used to press vinyl records has resulted in an
increase in the cost of producing vinyl records,
shifting the supply curve to the left.
• Meanwhile, consumers have developed a
renewed taste for “vinyl,” substantially raising
the demand for vinyl records.
• As a consequence, the market clearing price of a
vinyl record has unambiguously increased and
on net, the equilibrium quantity has also
increased.

FIGURE 4-2 THE EFFECTS OF A SIMULTANEOUS DECREASE IN THE
SUPPLY OF & INCREASE IN THE DEMAND FOR VINYL RECORDS
• A renewed taste for phonograph-generated

sounds has resulted in an increase in the
demand for vinyl phonograph records, as
shown by the shift in the demand curve from
D1 to D2.
• At the same time, the higher cost of machines

used to press vinyl records has generated
decreases in the supply of vinyl records,
depicted by the leftward shift in the supply
curve from S1 to S2.
• On net, the equilibrium quantity of records

has increased, from 11 million to about 25
million.
• The price of a vinyl record has increased from

$30 to about $40.

4.3 THE RATIONING FUNCTION OF PRICES
Synchronization of decisions of buyers and

sellers that leads to equilibrium is called the
rationing function of prices.
Methods of nonprice rationing:

Rationing by
Rationing by queues Rationing by
random assignment Rationing by power
(waiting in line) physical force
or coupons

INTERNATIONAL EXAMPLE: CUSTOMERS OF
EWATER PREFER PRICE RATIONING OVER
FIRST COME, FIRST SERVED AT A ZERO PRICE
• In villages of the African nations of Gambia

and Tanzania, almost one of three water
pumps placed by governments and charitable
organizations was inoperable due to overuse
or misuse.
• A British company called eWater introduced
dispensers that charge people a fee to
purchase water.
• The operations have expanded rapidly as
people do not have to wait long to access the
water and they seek to avoid spilling.

• The essential role of rationing:
4.3 THE • Necessary due to scarcity
• Price versus nonprice rationing mechanism:

RATIONING • Price rationing leads to the most
FUNCTION efficient use of available resources.
OF PRICES • All gains from mutually beneficial

trade are captured in a freely rationing
price system.

4.4 PRICE CEILINGS
Price controls
• Government-mandated minimum or maximum prices that may be charged for goods and services
Price ceiling
• A legal maximum price that may be charged for a particular good or service
Price floor
• A legal minimum price below which a good or service may not be sold
Price ceiling and black markets:
• A price ceiling will take effect if it is below the equilibrium price.

• A price ceiling that is set below the market clearing price creates a shortage.
Nonprice rationing devices
• All methods used to ration scarce goods that are price-controlled
Black market
• A market in which price-controlled

Copyrightgoods
© are sold Pearson
2023 at an illegally high price
Canada Inc. 4 - 22
FIGURE 4-3 BLACK MARKETS FOR
PORTABLE ELECTRIC GENERATORS
• The demand curve is D. The supply
curve is S. The equilibrium price is
$1,000.
• The government, however, steps in and

imposes a maximum price of $600.
• At that lower price, the quantity

demanded will be 15,000, but the
quantity supplied will be only 5,000.
• There is a “shortage.”
• If the price ceiling is fully enforced,
the implicit supply curve becomes
the vertical line Sʹ
• The effective price (including time
costs) tends to increase to
$1,400.
• If black markets arise, as they

generally will, the equilibrium black
market price will end up somewhere
between $600 and $1,400.

4.4 PRICE CEILINGS
• Promote the efficient maintenance and construction

Functions of of housing
• Allocate existing housing
rental prices: • Ration the use of housing
• Controls discourage construction:

Rent controls • A 2019 study reduced the supply of available
& rental housing by 15% in San Francisco.
• A 2020 study conducted by KPMG confirmed
construction rent control leads to a decrease in rental study.

4.4 PRICE CEILINGS
Effects on the existing supply

Attempts to evade rent Who wins and who loses
of housing and current use of
controls: from rent controls?
housing:
Property owners cannot recover Forcing tenants to leave Losers:

costs: Tenants subletting apartments • Property owners
• Maintenance, repairs, capital Housing courts • Low-income individuals
improvements Winners:
Rations the current use of • Upper-income professionals
housing:
• Reduces tenant mobility
leading to “housing gridlock”

WHAT HAPPENS WHEN ... THE PRICE OF A GRAM OF
CANNABIS PURCHASED FROM A GOVERNMENT-
APPROVED RETAILER COSTS ALMOST TWICE AS
MUCH AS THAT FROM AN ILLEGAL SOURCE?
• On October 17, 2018, recreational cannabis use

became legal in Canada. A goal of legalization
was to take a significant part of the market share
away from organized crime.
• Since legalization, a gram of cannabis purchased
from government-approved retailers cost $10.30
in the fourth quarter of 2019 while the same
product from an illegal source cost only $5.73.
• A consequence of this large price difference is
that 4 in 10 Canadians continue to buy at least
some of their cannabis from illegal sources.

4.5 PRICE • Support price
FLOORS & • The government chooses a price floor for a
QUANTITY product and then acts to ensure that the price
RESTRICTIONS of the product never falls below the support
level:
• Price floors are associated with many
agricultural products.
• A price floor that is set above the
market clearing price results in a
surplus.

FIGURE 4-4 AGRICULTURAL PRICE SUPPORTS
• Free market equilibrium occurs
at E
• Equilibrium price of $1.00
per litre
• Equilibrium quantity of 31.5
million hectolitres.
• Government sets a support

price at $1.50 per litre,
• Quantity demanded is 27.3
million hectolitres
• Quantity supplied is 49.8
million hectolitres.
• The difference is the surplus,

which the government buys.

• Questions:
• How could the government keep the price from
4.5 PRICE falling?
FLOORS AND • Who benefits from agricultural price supports?
QUANTITY • Minimum wage
RESTRICTIONS • A wage floor, legislated by government, that sets

the lowest hourly wage rate that firms may legally
pay their workers
• Governments can impose quantity restrictions.
• The most obvious restriction is an outright ban on the

ownership or trading of a good.
• Examples are banning ownership or trading of goods:
• Psychoactive drugs such as cocaine, heroin

FIGURE 4-7 THE EFFECT OF MINIMUM WAGES
• The market clearing wage rate is We.
• The market clearing quantity of

employment is Qe, determined by the
intersection of supply and demand at
point E.
• A minimum wage equal to Wm is

established.
• The quantity of labour demanded is
reduced to Qd.
• The reduction in employment from
Qe to Qd is equal to the distance
between B and A.
• That distance is smaller than the excess

quantity of labour supplied at wage rate
Wm.
• The distance between B and C is the

increase in the quantity of labour
supplied, to Qs, that results from the
higher minimum wage rate.
EXAMPLE: “99-SEAT THEATRES” IN
LOS ANGELES ADAPT TO A MINIMUM
WAGE REQUIREMENT
• In Los Angeles, many struggling actors perform at low
wages in so-called 99-seat theatres—stages hosting
productions of plays funded by ticket receipts of small
crowds of patrons.
• In response to a minimum wage of $15 per hour, a
union—Actor’s Equity Association—ruled that actors
at 99-seat theatres had to earn an hourly wage of at
least $15.
• As a result, some theatres use actors as unpaid
volunteers, others only hire non-union actors, some
have stopped producing high-cast plays, and others
have closed their doors.

4.5 PRICE FLOORS & QUANTITY RESTRICTIONS
Government
prohibitions and
Import quota
licensing
requirements
• Some commodities • Supply restriction
cannot be purchased that prohibits the
at all legally; others importation of more
require a licence. than a specified
quantity of a
particular good

BEHAVIOURAL EXAMPLE: EXPERIMENTAL EVIDENCE
VERIFIES PREDICTIONS ABOUT THE EFFECTS OF IMPOSING A
PRICE FLOOR IN A LABOUR MARKET
• A recent experimental study

imposed minimum hourly
wages on firms that posted
job openings in an online
labour market.
• As predicted by the theory of
price floors
• Firms subject to the
minimum wage
requirement
responded by cutting
back on hiring and by
reducing the number
of work hours for
hired workers.

ECONOMIC IN • During her campaign for the mayor of
YOUR LIFE: A
MAYOR the city of Baltimore, Catherine Pugh
FAVOURS THE supported a plan of gradually increasing
MINIMUM WAGE
UNTIL the citywide minimum hourly wage rate
CONFRONTING from $9.25 to $15 by 2022.
ITS
CONSEQUENCES • However, after major employers in the
city told her that they would respond by
reducing their hiring of new workers,
she eventually vetoed the city council’s
action to approve the new minimum
wage plan.

ISSUES & APPLICATIONS: WHY SHORTAGES
OF SOME PHARMACEUTICALS GENERATE
HIGHER PRICES FOR OTHER DRUGS
• Shortages exist in Canadian markets for prescription

drugs as governmental price controls hold down drug
prices.
• Drug manufacturers typically respond to a price
ceiling by cutting back or even halting production,
resulting in a shortage of drugs.
• When faced with drug shortages, physicians and
pharmacists look to alternative medications to
substitute (i.e., Medication B) that perform similar
functions to Medication A.
• The demand curve for Medication B shifts rightward,
resulting in an increase in its market clearing price.

FIGURE 4-8
HOW A SHORTAGE OF MED A CAN PUSH UP THE PRICE OF A SUBSTITUTE
MED B
• Many patients’
physicians respond to the
resulting 10,000-unit
shortage of Medication A
by providing
prescriptions for a
substitute, Medication B.
In panel (a), the market clearing price of • As a result, as shown in panel (b), the demand for
Medication A is $50 per unit. Medication B increases, from D1 to D2.
• The legal ceiling price, however, is $40 per unit. • The resulting upward movement along the supply curve
• At this ceiling price, the quantity of generates
Medication A demanded by patients is • An increase in the equilibrium quantity of
25,000 units, Medication B, from 15,000 units to 18,000 units
• but the quantity supplied by manufacturers • And a rise in market clearing price of Medication
is only 15,000 units. B, from $35 per unit to $45 per unit.

SUMMARY DISCUSSION OF
LEARNING OBJECTIVES
4.1 Discuss the essential features of the price system
• A price system (market system) allows prices to respond to changes in
supply and demand for different commodities.
• Intermediaries reduce transaction costs by bringing buyers and sellers
together.
4.2 Evaluate the effects of changes in demand and supply on the

market price and equilibrium quantity
• Increases in demand increase equilibrium price and quantity; decreases in
demand decrease equilibrium price and quantity.
• Increases in supply decrease market price and increase equilibrium quantity;
decreases in supply increase market price and decrease equilibrium quantity.

LEARNING OBJECTIVES
4.2 Evaluate the effects of changes in demand and supply on
the market price and equilibrium quantity
• When both demand and supply shift at the same time, the outcome
is indeterminate for either equilibrium price or equilibrium
quantity.
4.3 Understand the rationing function of prices

• In a market system, prices ration scarce goods and services.
• Other ways of rationing include first come, first served; political
power; physical force; random assignment; and coupons.

LEARNING OBJECTIVES
4.4 Explain the effects of price ceilings
• A price ceiling set below the market clearing price results in a shortage:
• The resulting shortage can lead to nonprice rationing devices and black markets.
4.5 Explain the effects of price floors and government-imposed quantity

restrictions
• If the price floor is set above the market clearing price, a surplus results:
• A price floor can take the form of a government-imposed price support or
minimum wage.
• Bans on sale or ownership
• Licensing restrictions
• Import quotas

APPENDIX C: CONSUMER SURPLUS AND
PRODUCER SURPLUS WITHIN A PRICE
SYSTEM (1 OF 4)
• Consumer surplus
• The difference between the total amount that consumers would have
been willing to pay for an item and the total amount that they actually
pay

FIGURE C-1 CONSUMER SURPLUS

SYSTEM (2 OF 4)
• Producer surplus
• The difference between the total amount that producers actually
receive for an item and the total amount that they would have been
willing to accept for supplying that item

FIGURE C-2 PRODUCER SURPLUS

SYSTEM (3 OF 4)
• Gains realized by consumers and producers from engaging

in voluntary trade
• The sum of consumer surplus and producer surplus is the total value
generated by the mutually beneficial voluntary exchange

APPENDIX C: CONSUMER SURPLUS AND PRODUCER
SURPLUS WITHIN A PRICE SYSTEM

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ECONOMICS TODAY

A Canadian Perspective Microeconomics, First Edition

Copyright © 2023 Pearson Canada Inc. 4-1

• The Canadian government regulates the price

Copyright © 2023 Pearson Canada Inc. 4-2

4.2 Evaluate the effects of changes in demand and

4.5 Explain the effects of price floors and

Copyright © 2023 Pearson Canada Inc. 4-3

4.5 Price Floors

Copyright © 2023 Pearson Canada Inc. 4-4

Copyright © 2023 Pearson Canada Inc. 4-5

• All the costs associated with the exchange, including:

SYSTEM & • Middlemen (intermediaries) or brokers reduce

• Companies whose services link people to other

Copyright © 2023 Pearson Canada Inc. 4-7

• Alberto Cavallo of the Massachusetts

Copyright © 2023 Pearson Canada Inc. 4-8

• Changes in supply and

Copyright © 2023 Pearson Canada Inc. 4-9

• In panel (b), the supply

• The demand curve shifts

• Both equilibrium price

Copyright © 2023 Pearson Canada Inc. 4 - 10

• In panel (c), demand

• The supply curve shifts

• The equilibrium quantity

Copyright © 2023 Pearson Canada Inc. 4 - 11

• In panel (d), demand is

• The supply curve shifts

• The market clearing price

Copyright © 2023 Pearson Canada Inc. 4 - 12

• Increases in supply decrease equilibrium price and increase

Copyright © 2023 Pearson Canada Inc. 4 - 13

When both demand and supply change:

When both demand and supply increase:

• The change in equilibrium price is indeterminate.

When both demand and supply decrease:

• The change in equilibrium price is indeterminate.

Copyright © 2023 Pearson Canada Inc. 4 - 14

When supply decreases and demand

When supply increases and demand

Copyright © 2023 Pearson Canada Inc. 4 - 15

Price flexibility: Adjustment speed:

Copyright © 2023 Pearson Canada Inc. 4 - 16

• A substantial increase in the price of machines

Copyright © 2023 Pearson Canada Inc. 4 - 17

• A renewed taste for phonograph-generated

• At the same time, the higher cost of machines

• On net, the equilibrium quantity of records

• The price of a vinyl record has increased from

Copyright © 2023 Pearson Canada Inc. 4 - 18

Synchronization of decisions of buyers and

Methods of nonprice rationing:

Copyright © 2023 Pearson Canada Inc. 4 - 19

• In villages of the African nations of Gambia

Copyright © 2023 Pearson Canada Inc. 4 - 20

4.3 THE • Necessary due to scarcity

• Price versus nonprice rationing mechanism:

OF PRICES • All gains from mutually beneficial

Copyright © 2023 Pearson Canada Inc. 4 - 21

Price ceiling and black markets:

• A price ceiling will take effect if it is below the equilibrium price.