All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

Questions of the Day
Supply & Demand

1. The following information was gathered from a survey of the Pizza buying habits of University students. They were asked how many pizzas they would buy at different prices.

1. Please convert this information into a graph.
2. How many pizzas do they want to buy at a price of 8?
3. What would happen to the curve if demand increased by 5?

2. A recent article in The Wall Street Journal discussed the trend in home sales. Last year there were record sales of 5.1 million new and used houses despite the fact that there was a 10 percent rise in the median price of new homes. At the time, the median price of homes was $53,500. Given your knowledge of the market system, can you explain this puzzling result - a positive relationship between the change in price and the quantity demanded? (Ignore inflation.)

3. You are to find a headline in a newspaper or magazine that is related to price changes and convert the words in the article to a supply-demand graph.  You may use a hard copy source, or you may decide to try an on-line article from the Market Information on the Data Sources page.  

4. Develop a S&D diagram to describe the impact on the:

1. price of oil of the decision to allow IRAQ to begin selling oil in the world market
2. market for iMac portable computers of a favorable review in the Wall Street Journal
3. market for middle management of downsizing in American companies
4. market for Nebraska homes of a very strong Nebraska economy
5. market for nursing homes of the aging of the baby boomers
6. market for home computers of technological advances that produce substantial decreases in the cost of computing power

5. Use a supply-demand diagram to demonstrate the following situations:

1. recession's impact on the market for domestic automobiles
2. impact of drought on the cereal market
3. impact of mechanization in agriculture on the market for grains
4. impact on the market for oil of OPEC's decision to restrict oil output
5. impact on the market for oil of a worldwide recession
6. impact on the market for U.S. grain of the slowdown in the Asian economies during the crises of 1997-98
7. impact of rising enrollments at University on rents in the local area
8. impact on future housing prices of the aging of the baby boom

6.  Demonstrate with a S-D diagram:

1. market where supply is perfectly elastic
2. the existence of scalpers at the World Series games
3. empty seats at a recent Broadway play
4. impact of rent control on market for apartments in NYC

7. In 1996, after a very heated debate, we raised the minimum wage in the US. Some argued that the increase would seriously reduce employment, while others argued that there would be little reduction in employment. Please develop a diagram in which you show how these differences can be shown as differences in the supply and/or demand curves.

More Questions and some answers

2. The following information was gathered from a survey of the Pizza buying habits of University students. They were asked how many pizzas they would buy at different prices.

• Please convert this information into a graph.

The blue line is the demand curve.

• How many pizzas do they want to buy at a price of 8?

All youneed to dois draw the line at a height of 8 and moveto the right until you run into the demand curve.  If you drop the line down you will find that quantity demanded is 30.

• What would happen to the curve if demand increased by 5?

An increase in demand by 5 means that at every price the demand will be five more than it was in the original situation. We can show this with the red demand curve. At the price of $8, we now have demand of 35.

3. A recent article in The Wall Street Journal discussed the trend in home sales. Last year there were record sales of 5.1 million new and used houses despite the fact that there was a 10 percent rise in the median price of new homes. At the time, the median price of homes was $53,500. Given your knowledge of the market system, can you explain this puzzling result - a positive relationship between the change in price and the quantity demanded? (Ignore inflation.)

What are the facts? We have seen both quantity (home sales) and price (median price of homes) rise. As you can see from the diagrams, this could be explained by an increase in demand for homes. This rightward shift in the demand curve produces the desired results.

4. It is time to do a little forecasting, something you will find yourself doing often in life. More specifically, I am interested in your forecasts of some price that will have a significant bearing on the future financial structure of the University.

• What will happen to the earnings of college graduates, what one might call the price of college grads, in the next five years?
• What will happen in the market for university faculty? More specifically, what will happen to the earning (price) of faculty?
• What will happen to the future cost of energy to heat the University's buildings?
• What will happen to the future price of computers which the University will be purchasing for its faculty, staff, and students?

In each of these the answer depends upon what you think will happen over that period of time. As a guide to the answers, I would suggest the cookbook approach where we attempt to identify the market participants, the shocks to the market, and the participants who will be most directly affected by the shock. For example, if we were interested in the earnings of college grads, we would want to know about possible 'shocks; to both the supply and demand curves in the market for college grads. If you assume that the number of college graduates will be increasing, then, all other things equal, this would tend to increase the supply of graduates which would tend to lower their earnings.

You would now follow the same logic on each of the other forecasts.  For example, what about the future cost of computing technology?  If you assume that the patterns of significant annual increases in productivity continue, then you should see the supply curve shift outward and this will tend to put downward pressure on future prices.  You are on your own to look at the other forecasts.

5. Develop a S&D diagram to describe the impact on:

• the price of oil of the decision to allow IRAQ to sell oil
• the wages of middle management of the downsizing of American companies
• wages of auto workers of increased imports of automobiles
• the price of Apple computers of the recent headlines concerning fears that Apple is a 'doomed' company
• the market for home computers of the substantial decreases in the cost of computing power

In answering this question, it is best to return to the generic supply-demand diagram below and work to 'customize' it to the particular problem.

To customize the graph for the first question, the graph depicts the world market for oil. The decision to let Iraq sell oil can be seen here as an outward shift in the supply curve (Iraq is a seller of oil) which will tend to drive down the world price of oil.

For the second question, the graph would be depicting the market for managers. The downsizing of American companies (buyers in the labor market) has resulted in decreased demand for managers. This should result in fewer managers being hired and lower wages.

In the market for autoworkers, meanwhile, the rise in the number of imports could mean that there will be a decrease in demand for US produced autos which will result in lower demand for US auto workers.

The headlines about Apple may make some potential buyers of Apple computers reconsider their decision and this would decrease demand-an inward shift in the curve.

Finally, what happens to the computer market if we have dramatic improvements in productivity? This will directly affect the suppliers and we would expect that this would result in an outward shift in the supply which would produce a lower price.

6. Use a supply-demand diagram to demonstrate the following situations.

To answer many of the additional questions you should use the graphs below. These represent the four possibilities if we have a shift in one of the curves.

a. recession's impact on the market for domestic automobiles

The recession will lower household income which will reduce households' demand for automobiles. The demand curve shifts in.

b. reduction (elimination) of import quota on Japanese cars on the market for domestic cars in the U.S.

The elimination of the quota on Japanese cars will likely increase the supply of Japanese cars supplied to the US which will reduce their price. Because Japanese and American cars are substitutes, we should expect that a decrease in the price of Japanese cars to decrease demand for American cars.

c. impact of drought on the cereal market

The drought will raise the cost of production or lower the yield (productivity) on the farms. Both hurt the seller and the supply curve shifts in.

d. impact of mechanization in agriculture on the market for grains

Mechanization will increase the yield (productivity) on the farms which we can demonstrate by an outward shift in the supply curve.

e. impact on price of gold associated with the recent downward revisions in expected inflation

A little bit tougher. Gold is an asset which protects investors from inflation (at least they think so).  If inflation decreases, investors (demanders) will want to hold less gold (less financial wealth) and this willdecrease the demand for gold which will lead to lower prices of gold.

f. impact on the price of U.S. grain of a rebound in Russian grain production

Russia imports grain from the US and a rebound in output of grain in Russia will result in a decrease in demand for US grain. The result would be an inward shift in demand.

g. impact on future housing prices of the aging of the baby boom

As the baby boomers moved into the home buying age bracket they pushed up demand for homes in the 1970s and 1980s. Now as they move through middle age and they are followed by the much smaller baby bust generation, some forecasters are projecting demand for homes to decline.

h. impact on the market for oil of OPEC's decision to restrict output

In 1973 OPEC shocked the world by restricting the supply of oil. The result was a dramatic increase in the price of oil which triggered a decade of stagflation (high unemployment and inflation). Because OPEC controls supply, we would show this with an inward shift in the supply curve.

i. market where supply is perfectly elastic

The supply curve would be horizontal - we would see suppliers willing to supply any amount at the 'going' price.

j. impact of declining enrollments at University on rents in the local area

If enrollments declined then we should expect to see fewer students 'demanding' rental properties. We would show this with an inward shift in the demand curve.

k. impact of IBM compatibility feature of new Apple computers on the market for Apple computers

This was done by Apple to reduce the cost to users of incompatibilities between their Macs and the PC which dominate the market. Apple expected that this would increase demand for their machines - an outward shift in the demand curve.

l. the existence of scalpers at the World Series games

Scalpers would be an example of what we could expect to see when there is a shortage. The problem here is that the price is too low-below the equilibrium.

m. empty seats at a recent Broadway play

Empty seats would be an example of a surplus. The problem here is that the price is too high-above the equilibrium.

7. Why do phone companies offer off-peak prices? Please demonstrate with the aid of a S&D diagram.

We can begin by assuming that we have a fixed capacity (the vertical supply curve). We also know that in the peak demand periods demand is higher than in the off-peak periods. We see this in the graph with the peak period demand curve being further to the right. To equate supply and demand in the two periods, we will need to set a price of Pp in the peak period and Po in the off-peak period.

8. Find a headline in a newspaper or magazine that is related to price changes and convert the words in the article to a supply-demand graph.

9. In 1996, after a very heated debate, we raised the minimum wage in the US. Some argued that the increase would seriously reduce employment, while others argued that there would be little reduction in employment. Please develop a diagram in which you show how these differences can be shown as differences in the supply and/or demand curves.

In the diagram above we have two graphs that differ only in the demand curve. In the left-side graph we have a steep demand (price inelastic) and in the right-side graph we have a flat slope (price elastic). before there was any minimum wage, we had an equilibrium wage of W* and employment of L*. Once the government set a minimum wage (the red line), then we had a disequilibrium in the labor market. In each case the supply of labor at the new higher wage (Ls) was more than the demand (Ld). The result was that we had unemployment (Ls-Ld). In the right-side diagram, however, we find that the decline in Ld was larger given the greater responsiveness of demand. We can conclude that the magnitude of the decline in employment (and magnitude of increase in unemployment) will depend upon the responsiveness of demand-as demand becomes more responsive, the employment effect becomes larger. You should try to follow this model and compare the situations when we have one demand curve and two supply curves - one where supply is flat (responsive) and one where supply is steep (unresponsive).

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