Module-9. The invisible hand

Transcription

1 Module-9 Mar k e t equilibrium:

2 TEACHER S GUIDE P. 265 Defined P. 271 Content standards P. 271 Materials P. 272 Procedure P. 276 Closure P. 277 Assessment P. 287 Overheads P Answer key Visuals N Visuals for overhead projector. Copy to transparent paper for overhead. P. 282 NVisual-1:Supply P. 283 NVisual-2:Demand P. 284 NVisual-3:Equilibrium defined P. 285 NVisual-4:Shortage P. 286 NVisual-5:Surplus Lessons 2 Copy and handout to students. P Lesson-I: Equilibrium P Lesson-II: CD equations P Lesson-III: CD schedule

3 Teacher DEFINED Babysitting is often a source of income for many teenagers. What influences a teenager s decision to babysit? How does a parent choose whether to hire a babysitter? In a community, how much babysitting occurs? In a market oriented economy, the interaction between supply and demand, producer and consumer, determines quantity and price. Supply The supply curve relates the price and quantity of a good produced. In the case of babysitting, the supply curve relates the hours of babysitting community teenagers will provide at various hourly wages or prices. Recall that supply curves are almost always upward sloping. De m a n d The quantity of a commodity purchased is based largely on price, income, and the price of related goods. The demand curve relates how many hours of babysitting will be purchased by neighboring parents at each hourly wage. Recall that the law of demand requires that demand curves are downward sloping. Equilibrium What determines how much of a commodity will be consumed and provided at any point in time? We have seen on the supply and demand graphs with price per unit on the y-axis and quantity or number of units on the x-axis that the supply curve is upward sloping (a positive relationship) and the demand curve is downward sloping (a negative relationship). Where the supply and demand curves intersect is the equilibrium point. At this point, quantity demanded is exactly equal to quantity supplied. The following example provides the mathematical background for the supply and demand curves and derives the equilibrium price and quantity. You may wish to teach using the mathematical calculations or you can teach a more abstract equilibrium using the supply and demand from previous modules without the mathematical derivations. The schedule below shows that the quantity supplied and the Copyright 2008 by MCEE ( Economics: The Study of Choices 265

4 Teacher quantity demanded are equal at $4 per hour. This is the intersection of supply and demand in the graph. At $4 per hour babysitters are willing to provide 80 hours of babysitting per week and parents are willing to purchase 80 hours of babysitting per week. Mathematical derivations Weekly Supply and Demand for Babysitting Quantity Supplied Price per Hour Quantity Demanded Copyright 2008 by MCEE ( Economics: The Study of Choices

5 Teacher Mathematically this can be shown with the supply curve that is the function: Q S = 20P where, Q S is the quantity supplied at each price, P The demand curve is the function: Q D = P Q D is the quantity demanded at each price, P. Notice: The functions for the supply and demand curves have the quantity on the left side of the equation rather than price, as inferred by the graph. Conventionally, demand and supply curves are graphed with price on the vertical axis and quantity on the horizontal axis, even though mathematically the quantity is on the left side and price is in the right side. Furthermore, notice the supply curve has a positive slope because of the positive coefficient on price. The demand curve is negatively sloped because of the negative coefficient on price. Mathematically the equilibrium can then be calculated by setting the equation for quantity supplied equal to the equation for quantity demanded: Q S = Q D 20P = P Solve for P to find the equilibrium price. 50P = 200 P = 4 The equilibrium quantity can then be calculated by substituting the equilibrium price of $4 for P in the equations and solving for quantity supplied, Q S, or quantity demanded Q D. Q S = 20(4) = 80 Q D = (4) = 80 But how do babysitters know they should charge $4 per hour? And how do parents know they should pay $4 per hour? A shortage puts upward pressure on price. Imagine if the wage for babysitting was only $2 per hour. Would you babysit for $2 per hour? The table and graph below show that teenagers will provide only about 40 hours of babysitting for a wage of $2 per hour. This is the point where the price of $2 per hour intersects the supply curve. At this low Copyright 2008 by MCEE ( Economics: The Study of Choices 267

6 Teacher wage, however, parents would like to hire many hours of babysitting. This is shown where the $2 hourly wage intersects the demand curve at 140 hours. The result is a shortage of 100 hours. The shortage is the difference between the quantity demanded of 140 hours and the quantity supplied of only 40 hours. Mathematically: Q S = 20P, so at a price of $2 Q S = 40 hours. Q D = P, then at a price of $2 Q D = 140 hours Q D > Q S The shortage will encourage parents to offer a higher price to find a babysitter. The higher price will encourage teenagers to babysit more. The higher price will result in northeasterly movement along the supply curve and more quantity supplied. The higher price will also result in an northwesterly movement along the demand curve so the quantity demanded declines. Because the higher price increases the quantity supplied and reduces the quantity demanded, the shortage will diminish. The price increase will continue until the shortage is eliminated and quantity supplied equals quantity demanded. This is where the market is in equilibrium, at a price of $4 per hour and quantity of 80 hours. 268 Copyright 2008 by MCEE ( Economics: The Study of Choices

7 Teacher A surplus puts downward pressure on price Imagine the wage for babysitting was $6 per hour. We can see from the table and graph below that more hours of babysitting will now be provided (120 hours, where the new $6 hourly wage intersects the supply curve). At this wage, parents are not willing to hire as many hours of babysitting (only 20 hours, where the $6 wage intersects the demand curve). The result is a surplus of 100 hours (120 quantity supplied less the 20 quantity demanded). Weekly Supply and Demand for Babysitting Quantity Supplied Price per Hour Quantity Demanded Surplus: Weekly Supply and Demand for Babysitting Copyright 2008 by MCEE ( Economics: The Study of Choices 269

8 Teacher Mathematically: Q S = 20P, so at $6 per hour Q S = 120 hours Q D = P, then at $6 per hour Q D = 20 hours Q D < Q S Babysitters begin to realize that to find employment they may need to lower their wages. Parents realize they can reduce the wage paid and still obtain the babysitting services. As the price of babysitting is reduced, the quantity supplied declines and the quantity demanded increases. Eventually, the market moves into an equilibrium position where quantity supplied equals quantity demanded. When there is a surplus there will be downward pressure on price. A firm s profit maximizing behavior is manifested in the supply curve. Consumer desires are manifested in the demand curve. The determination of price and quantity of the commodity is determined by the market through the interaction of supply and demand. Therefore, the market transmits information between producers and consumers, such that the quantity consumed is equal to the quantity produced. The Invisible Hand Through this mechanism, firms satisfy consumers. By meeting producer goals, producers benefit society: They do well by doing good. The eighteenth century economist and moral philosopher, Adam Smith, labeled this market mechanism the invisible hand. No central planning is necessary to coordinate buyers and sellers. Prices, the cost of production, and consumer willingness to pay are all signals to firms. Firms respond by producing those goods and services where there is a potential profit because of consumers willingness to purchase. CONCEPTS 1. Equilibrium 2. Surplus (excess supply) 3. Shortage (excess demand) Copyright 2008 by MCEE ( Economics: The Study of Choices

9 Teacher OBJECTIVES 1. Understand the economic meaning of equilibrium. 2. Realize that price signals producers and consumers. 3. Know the difference between a shortage and a surplus in the market. 4. Understand the naturally occurring corrective mechanisms in markets; the invisible hand. CONTENT STANDARDS National Content Standards in Economics 1. (Standard 2) Effective decision making requires comparing the additional costs of alternatives with the additional benefits. 2. (Standard 3) Different methods can be used to allocate goods and services. 3. (Standard 5) Voluntary exchange occurs only when all participating parties expect to gain. 4. (Standard 7) Markets exist when buyers and sellers interact. 5. (Standard 8) Prices send signals and provide incentives to buyers and sellers. Montana Social Studies Content (Standard 5) 1. (Benchmark 1) Identify and explain basic economic concepts. 2. (Benchmark 3) Understand the social costs and benefits to society of allocating goods and services through private and public sectors. 3. (Benchmark 4) Understand how different values and beliefs influence economic decisions in different economic systems. TIME REQUIRED 1-2 class periods MATERIALS Overhead projector Transparency pen Copyright 2008 by MCEE ( Economics: The Study of Choices 271

10 Teacher Visuals for overhead projector: Copy to transparency. NVisual-1: Supply NVisual-2: Demand NVisual-3: Equilibrium defined NVisual-4: Shortage NVisual-5: Surplus Lesson worksheets: Copy for each student: 2Lesson-I: Equilibrium 2Lesson-II: CD equations 2Lesson-III: CD schedule PROCEDURE 1. Review the concept, supply. Display NVisual-1: Supply. a. LQuestion: Why is the supply curve typically upward sloping? Answer: When the prospects for profits in an industry increase, firms are likely to increase output. The supply curve shows the relationship between price and quantity, holding all other factors constant. When price changes, potential profits also change (Profit = Total Revenue-Total Cost, Total Revenue = Price x Quantity). The positive relationship between price and quantity supplied is reflected in the upward sloping supply curve. b. LQuestion: How does a change in price influence the supply curve and the amount of the commodity produced? Answer: A change in price can be shown as a movement along the supply curve which will change the quantity supplied. A movement from point E to point F on NVisual-1: Supply shows a change in quantity demanded resulting from a change in price. c. LQuestion: How will a change in the price of an input affect the supply curve of a commodity? Answer: A change in the price of an input will shift the supply curve. An increase in the price of an input will decrease supply; a shift to the left. A decrease in the price of an input will increase supply; a shift to the right. d. Draw a new supply curve on NVisual-1: Supply to demonstrate an increase or a decrease in supply on the visual. LQuestion: What other factors will shift the supply curve? Answer: A change in technology will increase supply (shift 272 Copyright 2008 by MCEE ( Economics: The Study of Choices

11 Teacher right), an increase in taxes or regulations will decrease supply (left shift), an increase in the number of producers will increase supply (right shift). Natural and political disruptions can also shift the supply curve. Hurricane Katrina, for example, destroyed a number of oil refineries, decreasing the supply of oil and shifting the curve to the left. Demonstrate these shifts on NVisual-1: Supply. 2. Review the concept, demand. Display NVisual-2: Demand. a. LQuestion: Why is the demand curve downward sloping? Answer: As the price of a commodity rises, less will be consumed. This is the result of scarcity. Income is limited and substitutes exist. There is an inverse, or negative, relationship between the price and quantity demanded. b. LQuestion: How does a change in price affect the demand curve and the quantity demanded? Answer: A change in price can be shown as a movement along the demand curve changing the quantity demanded. This is shown on NVisual 2: Demand, as a movement from point E to point G. c. LQuestion: How will a change in the price of a related good affect the demand curve? Answer: Generally, a change in the price of a complement will shift the demand curve of the original commodity in the opposite direction as the price change. If peanut butter and jelly are complements and the price of jelly rises, the demand for peanut butter will decrease and shift to the left. A change in the price of a substitute will shift the demand curve of the original commodity in the same direction as the price change. If Coke and Pepsi are substitutes and the price of Coke increases, the demand for Pepsi will also increase and shift to the right. Demonstrate a change in demand by drawing a new demand curve on the visual. A shift to the right shows an increase in demand, a shift left shows a decrease in demand. d. LQuestion: What other factors will shift the demand curve? Answer: A change in the number of consumers, a change in tastes and preferences, and a change in expectations can all cause a shift in the demand curve. Demonstrate these on NVisual-2: Demand. Copyright 2008 by MCEE ( Economics: The Study of Choices 273

12 Teacher 3. Display NVisual-3: Equilibrium defined. The intersection of supply and demand, at point E, is the equilibrium. This could also be shown by overlaying visuals 1 and 2. At the equilibrium price, P E, the quantity demanded is equal to the quantity supplied at Q E. Typically, unfettered markets will bring us to the intersection of supply and demand, the equilibrium. In equilibrium, the quantity that consumers are willing to consume is exactly equal to what firms are willing to produce at a given price. 4. Handout 2 Lesson-I: Equilibrium. Give students time to read through section I of the lesson. The lesson displays the supply and demand schedules for babysitting and graphs the two curves. It also provides the mathematical calculation for each curve using linear equations. Each equation is set such that y = f(x); (y is a function of x). The x, on the horizontal axis, is known as the independent variable, and y, the dependent variable, is placed on the vertical axis. The slope of the line, m, measures the change in y divided by the change in x. The y-intercept, b, is the point where the line intersects the y, or the vertical, axis (where x = 0). y = mx + b The dependent variable (y) is isolated on the left and the independent variable (x) is on the right. In economics, the dependent variable on the horizontal axis is quantity, Q, and the independent variable on the vertical axis, is price, P. Note that the coefficient for the slope of the supply curve, Q S, is positive, reflecting the positive relationship between price and quantity. The result is an upward sloping supply curve. The coefficient on the slope of the demand curve, Q D, is negative, indicative of the inverse relationship between price and quantity and the downward sloping demand curve. Given a set of linear equations for supply and demand, you can calculate the equilibrium level of price and quantity. Setting Q S and Q D equal and solving for price will determine the equilibrium price. Plug the equilibrium price back into either equation and solve for Q to calculate the equilibrium quantity. Using the equilibrium price and solving for Q in both equations is a good check for accuracy. To be in equilibrium Q D = Q S. 5. LQuestion: What happens when quantity demanded, Q D, is not equal to quantity supplied, Q S? 274 Copyright 2008 by MCEE ( Economics: The Study of Choices

13 Teacher This is shown in Section 2 of the handout. Work through section II of the handout with students. First discuss what happens when the price is too low and a shortage occurs. This is shown in NVisual-4: Shortage. a. If the price per unit charged is less than the equilibrium price, consumers will desire to purchase a greater quantity than the equilibrium quantity. Using NVisual-4: Shortage show students that the quantity demanded can be determined by finding the point where a horizontal line from the $2 per hour price intersects the demand curve; 140 hours in this example. Producers won t be willing to provide as much as the equilibrium quantity. Babysitters will only work to the point where the $2 per hour wage intersects the supply curve; 40 hours in this example. The result is a shortage, quantity demanded is greater than quantity supplied (Q D > Q S ). The shortage is the difference between the quantity demanded (140 hours) and the quantity supplied (40 hours). The shortage in this example is 100 hours of babysitting. Parents would like to hire babysitters for 100 more hours than the babysitters are willing to provide. b. When there is a shortage, producers, babysitters in this example, begin to realize that they can charge a higher price, and consumers, parents, are willing to pay a higher price to find a babysitter. This puts upward pressure on price bringing it back to the equilibrium level of $4 per hour. c. Another method to determine the shortage quantity, the number of units desired but not provided in the market, is by using the supply and demand schedule. Take the difference between the quantity demanded and the quantity supplied at the price being charged ( = 100). d. Finally, the shortage can be determined by using the linear equations. Plug the price of $2 into each equation and solve for quantity supplied (Q S ) and quantity demanded (Q D ). The difference between them is the shortage. Q S = 20P Q D = P Q S = 20(2) Q D = (2) Q S = 40 Q D = 140 Q D -Q S = 100 Copyright 2008 by MCEE ( Economics: The Study of Choices 275

14 Teacher 6. Now discuss what happens when price is above the equilibrium price level. This is shown in NVisual-5: Surplus. If price per unit is greater than the equilibrium price, consumers won t want to purchase as much of the commodity as the equilibrium level. At the same time, however, producers would like to provide more than the equilibrium quantity. Again, drawing a horizontal line from the now $6 price the quantity supplied and quantity demanded can be determined by its intersection with the respective curves. At $6 per hour the quantity babysitters would like to supply is 120 hours. Parents are only interested in buying 20 hours of babysitting at the $6 wage rate. The result is a surplus, quantity supplied is greater than quantity demanded (Q S > Q D ). The surplus is the difference between quantity supplied (120 hours) and quantity demanded (20 hours) or 100 hours. Consumers, parents in this example, are not willing to hire as many hours of babysitting at the higher price. Teenagers that earn money by babysitting realize that if they want more hours of work they must lower their wage. This puts downward pressure on price bringing it back to the equilibrium level of $4 per hour. Again, the surplus can be determined by using the supply and demand schedules, examining the graph, or through mathematical calculation using the linear equations. 7. Handout 2Lesson-II: CD Equations. Working alone or in pairs, have the students work through the lesson. 8. Handout 2Lesson-III: CD Schedule for students to complete at home. Note that both lessons use the same equations. Students can check their work from 2Lesson-II: CD Equations, with their answers to 2Lesson-III: CD Schedule. CLOSURE Lesson review 1. LQuestion: Why is the supply curve upward sloping? Answer: The supply curve is generally upward sloping because, everything else held constant, an increase in price will increase profit. 276 Copyright 2008 by MCEE ( Economics: The Study of Choices

15 Teacher Most firms behave to maximize profits. 2. LQuestion: Why is the demand curve downward sloping? Answer: The Law of demand states that when the price of a commodity rises, and nothing else changes, the quantity consumed declines, hence a downward sloping demand curve. This is true for a number of reasons. First, income is limited. Given income is fixed, when the price of one commodity rises, not enough money is available to maintain consumption of the same basket of goods. Also, substitutes are available. When the price of one item rises, it becomes relatively more expensive than other goods. 3. LQuestion: What is equilibrium? Answer: The point markets generally reach such that quantity demanded equals quantity supplied at the market price. 4. Question: What happens when markets are out of equilibrium? Answer: Left alone, markets will usually come back to equilibrium automatically. If price is above the equilibrium price, producers will provide more than consumers are willing to buy creating a surplus. To remove the surplus, producers will lower price. As price declines, consumers will increase quantity demanded. Price will eventually return to its equilibrium level where quantity demanded equals quantity supplied. If price is below the equilibrium level, then producers will not be willing to provide as much as consumers would like to buy. This shortage will disappear as consumers bid up the price and producers increase the quantity supplied at higher prices. This automatic movement toward equilibrium is referred to as the invisible hand. ASSESSMENT Multiple-choice questions 1. LQuestion: Which of the following demonstrates a market equilibrium? a. Quantity supplied equals quantity demanded. b. Quantity supplied is greater than quantity demanded. Copyright 2008 by MCEE ( Economics: The Study of Choices 277

16 Teacher c. Quantity supplied is less than quantity demanded. d. The shortage is greater than the surplus. 2. LQuestion: is a mechanism that? a. Ensures government intervention will assist markets to reach equilibrium. b. Shifts the supply curve when consumers desires are too great. c. Prevents commercialization of commodities. d. Automatically works to bring markets into equilibrium. 3. LQuestion: If markets are allowed to function, what happens when price is higher than the equilibrium price? a. There will be surplus putting downward pressure on price. b. There will be a shortage putting downward pressure on price. c. There will be a surplus putting upward pressure on price. d. There will be a shortage putting upward pressure on price. 4. LQuestion: If markets are allowed to function, what happens when price is lower than the equilibrium? a. There will be surplus putting downward pressure on price. b. There will be a shortage putting downward pressure on price. c. There will be a surplus putting upward pressure on price. d. There will be a shortage putting upward pressure on price. 5. LQuestion: What moves markets toward equilibrium price and quantity? a. Government sets price where supply is equal to demand. b. Nothing. Most markets are not even close to equilibrium. c. Price signals to producers and consumers help eliminate any surplus or shortage. d. Government purchase of market surplus. Answers: 1. a 2. d 3. a 4. d 5. c 278 Copyright 2008 by MCEE ( Economics: The Study of Choices

17 Teacher Discussion/Essay Questions 1. LQuestion: What is equilibrium? Answer: Equilibrium is the point markets generally reach such that quantity demanded equals quantity supplied at the market price. 2. LQuestion: The new hit band, Blueberry Beasties, put out a CD just in time for Christmas. All available CDs rolled off music store shelves within hours of its release. There was a shortage of Blueberry Beasties CDs in music stores. Explain how mechanisms in the market will resolve the situation over time (assuming consumer demand for the CD does not shift). Answer: At the given price in music stores the quantity demanded was greater than the quantity supplied. Over time producers will realize the greater demand and be willing to provide more CDs at a higher price, moving up along the supply curve. As price rises there will be upward movement along the demand curve reducing the quantity demanded. Eventually the market will come back into equilibrium where quantity demanded equals quantity supplied. Alternatively, if no more CDs were produced we could see the price changes in other markets such as on e-bay. 3. LQuestion: Sammy s Sports Shack bought 500 pairs of top of the line skis this fall only to learn that people wanted snowboards, not skis. By January they had sold only 100 pairs of skis. What is Sammy s likely to do that will help increase ski sales so that they have enough space for their spring and summer sports gear that will be coming into the shop soon? Answer: Sammy s price was above the equilibrium price. We know this because the quantity demanded was less than the quantity supplied and a surplus resulted. Sammy s will probably lower price to move the skis out the door and make more room for the incoming merchandise. Copyright 2008 by MCEE ( Economics: The Study of Choices 279

18 Teacher NOTES 280 Copyright 2008 by MCEE ( Economics: The Study of Choices

19 Module-9 O v e r h e a d v i s u a l s

20 Vi s u a l Visual-1: SUPPLY N282 relates the price and quantity of a good produced. In the case of babysitting, the supply curve relates the hours of babysitting community teenagers will provide at various hourly wages or prices. Recall that supply curves are almost always upward sloping.

21 Vi s u a l Visual-2: demand relates how many hours of babysitting will be purchased by neighboring parents at each hourly wage. Recall that the law of demand requires that demand curves are downward sloping. N283

22 Vi s u a l Visual-3: Equilibrium Defined the demand curve is downward sloping (a negative relationship). Where the supply and demand curves intersect is the equilibrium point. At this point, quantity demanded is exactly equal to quantity supplied. N284

23 Vi s u a l Visual-4: Shortage At this low wage parents would like to hire many hours of babysitting. less than Shortage: WHEN QUANTITY SUPPLIED IS LESS THAN QUANTITY DEMANDED. N285

24 Vi s u a l Visual-5: Surplus surplus: WHEN QUANTITY SUPPLIED IS greater THAN QUANTITY DEMANDED. At this high wage everyone wants to babysit. But Parents are not willing to hire as many hours of babysitting. SURPLUS: WEEKLY SUPPLY and DEMAND FOR BABYSITTING greater than N286

25 Module-9 L e s s o n w o r k s h e e t s

26 Lesson Lesson I: Equilibrium : Supply. Section-I Do you babysit? Why? Or why not? Earlier class discussion developed some of the reasons why some people babysit and others do not. The supply curve shows the quantity of a good produced at each price. In this case, the supply curve for babysitting shows the amount of babysitting teenagers will provide at each hourly wage. Remember supply curves are almost always upward sloping. Demand. How does a parent decide whether or not to hire a babysitter? Similar to your decision to purchase donuts, a parent decides whether or not to hire a babysitter based on price, preferences, income, and the price of related goods. The demand curve shows how many hours of babysitting will be purchased by parents at each hourly wage. Remember the Law of demand states that demand curves are downward sloping. Equilibrium. How are quantity supplied and quantity demanded determined at any point in time? We have seen on the supply and demand graphs with price per unit on the y-axis and quantity on the x-axis that the supply curve is upward sloping (a positive relationship) and the demand curve is downward sloping (a negative relationship). Where the supply and demand curves intersect is the equilibrium. At the equilibrium price, the quantity demanded is exactly equal to the quantity supplied. The supply and demand curves from the schedule below are traced in the graph. The supply curve is the function: Q S = 20P, where Q S is the quantity supplied at each price, P. The demand curve is the function: Q D = P, where Q D is the quantity demanded at each price, P. Notice: The functions for the supply and demand curves have the quantity on the left side of the equation rather than price, as inferred by the graph. Conventionally, demand and supply curves are graphed with price on the vertical axis and quantity on the horizontal axis, even though mathematically the quantity is on the left side and price is in the right side. The schedule shows that the quantity supplied and the quantity demanded are equal at $ Copyright 2008 by MCEE ( Economics: The Study of Choices

27 Lesson Lesson I: Equilibrium Weekly Supply and Demand for Babysitting Quantity Supplied Price per Hour Quantity Demanded per hour. This is the intersection of supply and demand in the graph. At $4 per hour babysitters are willing to provide 80 hours of babysitting per week and parents are willing to purchase 80 hours of babysitting per week. Mathematically this is calculated by setting the quantity supplied equal to the quantity demanded: Q S = Q D 20P = P Solve for P to find the equilibrium price. 50P = 200 P = 4 The equilibrium quantity can then be calculated by substituting the equilibrium price of $4 for P in the equations and solving for quantity supplied, Q S, or quantity demanded, Q D. Q S = 20(4) = 80 Q D = (4) = 80 Co p y r i g h t 2008 b y MCEE (w w w.e c o n e d m o n ta n a.o r g) Ec o n o m i c s: Th e St u d y o f Ch o i c e s 2289

28 Lesson Lesson I: Equilibrium Section-II How do babysitters know they should charge $4 per hour? How do parents know they should pay $4 per hour? A shortage puts upward pressure on price. Imagine the wage for babysitting is only $2 per hour. We can see from the table and graph above that fewer hours of babysitting will be supplied. Would you babysit for $2 per hour? At this low wage, however, parents would like to hire many hours of babysitting. Mathematically, Q S = 20P, so at a price of $2 Q S = 40 hours Q D = P, then at a price of $2 Q D = 140 hours Q D > Q S Copyright 2008 by MCEE ( Economics: The Study of Choices

29 Lesson Lesson I: Equilibrium Weekly Supply and Demand for Babysitting Quantity Supplied Price per Hour Quantity Demanded The result is a shortage of 100 hours (140 hours demanded less 40 hours supplied). The shortage will encourage parents to offer a higher price for babysitting. The higher price will encourage teenagers to babysit more. The higher price will result in upward movement along the supply curve and more quantity supplied. The higher price will also result in an upward movement along the demand curve so the quantity demanded declines. Because the higher price increases the quantity supplied and reduces the quantity demanded, the shortage decreases. The price increase will continue until the shortage is eliminated and quantity supplied equals quantity demanded. This is where the market is in equilibrium, at a price of $4 per hour and quantity of 80 hours. Co p y r i g h t 2008 b y MCEE (w w w.e c o n e d m o n ta n a.o r g) Ec o n o m i c s: Th e St u d y o f Ch o i c e s 2291

30 Lesson Lesson I: Equilibrium Weekly Supply and Demand for Babysitting Quantity Price per Hour Quantity Supplied 40 2 Demanded SURPLUS: WEEKLY SUPPLY and DEMAND FOR BABYSITTING A surplus puts downward pressure on price. Imagine the wage for babysitting is $6 per hour. We can see from the table and graph above that more hours of babysitting will now be produced. At this wage, parents are not willing to hire as many hours of babysitting. Mathematically, Q S = 20P, so at $6 per hour Q S = 120 hours Q D = P, then at $6 per hour Q D = 20 hours Q D < Q S Copyright 2008 by MCEE ( Economics: The Study of Choices

31 Lesson Lesson I: Equilibrium A firm s profit maximizing behavior is manifested in the supply curve. Consumer desires are manifested in the demand curve. The determination of price and quantity of the commodity is determined by the market through the interaction of supply and demand. Therefore, the market transmits information between producers and consumers such that the quantity consumed is equal to the quantity produced. Through this mechanism, firms satisfy consumers. By meeting producer goals, producers benefit society: They do well by doing good. The eighteenth century economist and moral philosopher, Adam Smith, labeled this market mechanism the invisible hand. No central planning is necessary to coordinate buyers and sellers. Prices, the cost of production, and consumer willingness to pay are all signals to firms. Firms respond by producing those goods and services where there is a potential profit because of consumers willingness to purchase. The result is a surplus of 100 hours (120 hours supplied less 20 hours demanded). Babysitters begin to realize that to get work they may need to lower their wages. Parents realize they can reduce the amount paid and still obtain the babysitting services. As the price of babysitting is reduced, the quantity supplied declines and the quantity demanded increases. Eventually, the market moves into an equilibrium position where quantity supplied equals quantity demanded. When there is a surplus there will be downward pressure on price. Co p y r i g h t 2008 b y MCEE (w w w.e c o n e d m o n ta n a.o r g) Ec o n o m i c s: Th e St u d y o f Ch o i c e s 2293

32 Lesson Lesson II: CD Equations CD Eq u at i o n s The following equations are for the supply and demand of CDs in the United States (in millions of CDs). Q D = -2P + 29 Q S =.5P-1 1. LQuestion: Calculate the equilibrium price of CDs. Set Q D = Q S and solve for P 2. LQuestion: Calculate the equilibrium quantity of CDs that will be produced and consumed. Solve for Q D and Q S, given P = 12 3a. LQuestion: If the price per CD is $14, will more or fewer CDs be produced? 3b. LQuestion: Will there be a shortage or surplus of CDs? 3c. LQuestion: Over time, what will happen to price (assuming markets are allowed to function without intervention)? 4a. LQuestion: If the price per CD is $8, will more or fewer CDs be produced? 4b. LQuestion: Will there be a shortage or surplus of CDs? 4c. LQuestion: Over time, what will happen to price (assuming markets are allowed to function without intervention)? Copyright 2008 by MCEE ( Economics: The Study of Choices

33 Lesson Lesson III: CD Schedule Supply and demand schedule for CDs The following equations are for the supply and demand of CDs in the United States. Q D = -2P + 29 Q S =.5P-1 Complete the supply and demand schedule by calculating the quantity supplied and the quantity demanded at the various prices. Supply and Demand Schedule for CDs Supply and Demand for CDs Quantity Demanded Price per CD $8 $10 $12 $14 Quantity Supplied Price per CD $20 $16 $12 $8 $4 Plot the supply and demand curves on the axes provided 1. LQuestion: What is the equilibrium price and quantity of CDs? $ Quantity of CDs (millions) 2a. LQuestion: How many CDs will be produced at $14 per CD? 2b. LQuestion: Will there be a shortage or surplus of CDs? LQuestion: How many units will the excess supply (surplus) or excess demand (shortage) be? 2c. LQuestion: What will happen to price (assuming markets are allowed to function without intervention)? 3a. LQuestion: How many CDs will be produced at $8 per CD? 3b. LQuestion: Will there be a shortage or surplus? How many units will the excess supply (surplus) or excess demand (shortage) be? 3c. LQuestion: What will happen to price (assuming markets are allowed to function without intervention)? Co p y r i g h t 2008 b y MCEE (w w w.e c o n e d m o n ta n a.o r g) Ec o n o m i c s: Th e St u d y o f Ch o i c e s 2295

34 Lesson Lesson Assessment Multiple-choice questions 1. LQuestion: Which of the following demonstrates a market equilibrium? a. Quantity supplied equals quantity demanded. b. Quantity supplied is greater than quantity demanded. c. Quantity supplied is less than quantity demanded. d. The shortage is greater than the surplus. 2. LQuestion: is a mechanism that? a. Ensures government intervention will assist markets to reach equilibrium. b. Shifts the supply curve when consumers desires are too great. c. Prevents commercialization of commodities. d. Automatically works to bring markets into equilibrium. 3. LQuestion: If markets are allowed to function, what happens when price is higher than the equilibrium price? a. There will be surplus putting downward pressure on price. b. There will be a shortage putting downward pressure on price. c. There will be a surplus putting upward pressure on price. d. There will be a shortage putting upward pressure on price. 4. LQuestion: If markets are allowed to function, what happens when price is lower than the equilibrium? a. There will be surplus putting downward pressure on price. b. There will be a shortage putting downward pressure on price. c. There will be a surplus putting upward pressure on price. d. There will be a shortage putting upward pressure on price. 5. LQuestion: What moves markets toward equilibrium price and quantity? a. Government sets price where supply is equal to demand. b. Nothing. Most markets are not even close to equilibrium. c. Price signals to producers and consumers help eliminate any surplus or shortage. d. Government purchase of market surplus Copyright 2008 by MCEE ( Economics: The Study of Choices

35 Lesson Lesson Assessment Discussion/essay questions 1. LQuestion: What is equilibrium? 2. LQuestion: The new hit band, Blueberry Beasties, put out a CD just in time for Christmas. All available CDs rolled off music store shelves within hours of its release. There was a shortage of Blueberry Beasties CDs in music stores. Explain how mechanisms in the market will resolve the situation over time (assuming consumer demand for the CD does not shift). 3. LQuestion: Sammy s Sports Shack bought 500 pairs of top of the line skis this fall only to learn that people wanted snowboards, not skis. By January they had sold only 100 pairs of skis. What is Sammy s likely to do that will help increase ski sales so that they have enough space for their spring and summer sports gear that will be coming into the shop soon? Co p y r i g h t 2008 b y MCEE (w w w.e c o n e d m o n ta n a.o r g) Ec o n o m i c s: Th e St u d y o f Ch o i c e s 2297

36 Mo d u l e Answer Lesson II: Answer Key CDs equations The following equations are for the supply and demand of CDs in the United States (in millions of CDs). Q D = -2P + 29 Q S =.5P-1 1. LQuestion: Calculate the equilibrium price of CDs. Set Q D = Q S and solve for P Answer: -2P + 29 =.5P =.5P + 2P 30 = 2.5P P = LQuestion: Calculate the equilibrium quantity of CDs that will be produced and consumed. Solve for Q D and Q S, given P = 12 Answer: Q D = -2(12) + 29 = 5 Q S =.5(12)-1 = 5 3a. LQuestion: If the price per CD is $14, will more or fewer CDs be produced? Answer: More CDs will be produced at a higher price. 3b. LQuestion: Will there be a shortage or surplus of CDs? Answer: There will be a surplus because more CDs are produced but fewer will be purchased by consumers Copyright 2008 by MCEE ( Economics: The Study of Choices

37 Mo d u l e Answer Lesson II: Answer Key 3c.LQuestion: Over time, what will happen to price (assuming markets are allowed to function without intervention)? Answer: There will be downward pressure on price bringing consumer desires back in line with the quantity firms are willing to produce. 4a. LQuestion: If the price per CD is $8, will more or fewer CDs be produced? Answer: Fewer CDs will be produced at a lower price. 4b. LQuestion: Will there be a shortage or surplus of CDs? Answer: There will be a shortage because consumers desire more CDs but producers are providing less of them. 4c. LQuestion: Over time, what will happen to price (assuming markets are allowed to function without intervention)? Answer: There will be upward pressure on price until the quantity demanded is equal to the quantity supplied. Co p y r i g h t 2008 b y MCEE (w w w.e c o n e d m o n ta n a.o r g) Ec o n o m i c s: Th e St u d y o f Ch o i c e s 2299

38 Mo d u l e Answer Lesson III: Answer Key Supply and demand schedule for CDs The following equations are for the supply and demand of CDs in the United States. Q D = -2P + 29 Q S =.5P-1 Complete the supply and demand schedule by calculating the quantity supplied and the quantity demanded at the various prices. Supply and Demand Schedule for CDs Supply and Demand for CDs Quantity Price per CD Quantity Demanded 13 $8 Supplied 3 9 $ $ $14 6 Price per CD $20 $16 $12 $8 $4 S D $ Quantity of CDs (millions) Plot the supply and demand curves on the axes provided Copyright 2008 by MCEE ( Economics: The Study of Choices

39 Mo d u l e Answer Lesson III: Answer Key 1. LQuestion: What is the equilibrium price and quantity of CDs? Answer: Equilibrium price = $12. Equilibrium quantity = 5 2a.LQuestion: How many CDs will be produced at $14 per CD? Answer: 6 (million) CDs will be produced at $14 2b. LQuestion: Will there be a shortage or surplus of CDs? How many units will the excess supply (surplus) or excess demand (shortage) be? Answer: There will be a surplus of 5 (million) CDs. Producers will provide 6 (million) but consumers will buy only 1 (million) at $14 per CD. 2c. LQuestion: What will happen to price (assuming markets are allowed to function without intervention)? Answer: There will be downward pressure on price. 3a. LQuestion: How many CDs will be produced at $8 per CD? Answer: 3 (million) CDs will be produced at $8. 3b. LQuestion: Will there be a shortage or surplus? How many units will the excess supply (surplus) or excess demand (shortage) be? Answer: There will be a shortage of 10 ( million) CDs. Only 3 (million) will be produced but consumers would like to buy 13 (million) at a price of $8. 3c. LQuestion: What will happen to price (assuming markets are allowed to function without intervention)? Answer: There will be upward pressure on price until the quantity demanded equals the quantity supplied at $12. Co p y r i g h t 2008 b y MCEE (w w w.e c o n e d m o n ta n a.o r g) Ec o n o m i c s: Th e St u d y o f Ch o i c e s 2301

40 Teacher NOTES 302 Copyright 2008 by MCEE ( Economics: The Study of Choices