中国经济管理大学
MBA课堂
《宏观经济学原理》

Chapter 4: Demand, Supply, and the Price System

Outline of Text Material

I. Introduction
This chapter continues studying supply, demand, and the price system.
??? TEACHING TIP: The chapter begins with a discussion of the role of prices in allocating resources. This helps to set the stage for the material on government intervention. However you don’t necessarily need to discuss this issue in detail at this point. If you’re teaching microeconomics you’ll have a chance again later on when students will have better tools. But if you’re teaching macroeconomics this is your only chance to present this material. Depending on how important you believe this is, you may want to spend as much as an hour on it.
 Students may not see the role of prices as a source of information for firms; remind students that firms see their competitors’ advertising (just as consumers do), and that every consumer who does not buy from a firm leads its management to wonder why not. The more consumers “shop around” the more information firms gain about their rivals (are there stores in your area that advertise that they will meet or better their competition’s price?).
 Finally you may want to mention the information content of prices, especially the signals a market price conveys to buyers and sellers.?
II. The Price System: Rationing and Allocating Resources
A. The price system performs two important and closely related functions.
1. It allocates goods and services when there is a shortage (price rationing).
2. It determines the allocation of resources among producers and hence the final mix of outputs.
B. Price Rationing
1. Price rationing eliminates shortages and surpluses in free markets.
2. When there is a shortage or surplus the price will adjust in the direction of equilibrium.
C. Constraints on the Market and Alternative Rationing Mechanisms
1. Governments and private firms sometimes decide to ration a particular product using some non-price mechanism. The rationale given for this is usually “fairness,” which includes:
a. price-gouging is “bad;”
b. income is distributed “unfairly;” and
c. some items are “necessities” and everyone should be able to buy them at a “reasonable” price.
2. Oil, Gasoline and OPEC: The OPEC oil embargo of 1973-74 is often blamed for the queues at gasoline stations during this period. In fact the queues were caused by government price controls.
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87 \f "Wingdings 2" TEACHING TIP: The notion of “fairness” is often the justification given for government intervention in the market. There are other motivations for government involvement that are worth students’ consideration, such as lobbying and political supporters.
 This is a good point to remind students of the “law of unintended consequences” first noted in the previous chapter. Even though price ceilings and price floors are supposed to help the poor, they often have the opposite effect. Rent control often means high-income people pay low rents. The minimum wage means some people will be unemployed who would otherwise have jobs.?
a.. A price ceiling is the maximum price that can be legally charged for a product. The “fairness” rationale is that this will keep the product from being so expensive that the poor can’t afford it.
b. This does not resolve the problem of excess demand, but rather means that other mechanisms will have to be used to ration. Examples are queuing (waiting in line), favored customers, or ration coupons.
c. When a price ceiling is imposed a black market usually develops with illegal trading taking place at market determined prices. Ironically the price in the black market is often above what the equilibrium price would have been without the price ceiling.
3. NCAA March Madness: College Basketball’s National Championship Consider how tickets to sporting events and concerts are sold and distributed. Ticket scalping is an example of how “willingness to pay” will find a way to assert itself.
  TOPIC FOR CLASS DISCUSSION: 
Ask students about a sporting event or concert they may have attended. How did they get the tickets? How was the amount they paid related to their willingness to pay? Ask whether anyone simply didn’t go because the “scalper’s” price was too high.?
D. Prices and the Allocation of Resources
1. The market determines more than just the distribution of final outputs. It also determines what gets produced and how resources are allocated among competing uses.
2. Shifts in demand cause higher prices, which raise profits, attract capital, and increase wages. Higher wages attract labor. Thus, markets determine the allocation of resources and the ultimate combinations of products produced.
E. A price floor is the minimum price that must be legally paid for a product.
1. The result will be excess supply (a surplus).
2. The text uses the standard economist’s example of a price floor: the minimum wage. Point out that the true minimum wage is zero. That’s the wage earned by people who are thrown into unemployment when the minimum wage is raised.
  TOPIC FOR CLASS DISCUSSION: 
Some well-known economists have come out in favor of raising the minimum wage. After telling this to the class, ask them if they can figure out why. Students should quickly note that this is normative economics. Steer the discussion in the direction of gains and losses. Those who still have minimum-wage jobs after the increase will gain. Those who become unemployed will lose. The economists are making a value judgment: The gains outweigh the losses in their opinion.?gdings 2"
??? TEACHING TIP: When discussing price ceilings and price floors, introduce students to the short-side rule: “When demand and supply differ, the short side of the market (whichever is less) determines the quantity that will actually be sold.” This follows from the voluntary nature of exchange in a free market. In the diagram below, there is an excess supply at price  , as supply at that price is larger than demand. Buyers are on the short side of this market, and they will determine the quantity actually bought. Why? Simply because in a free market, buyers cannot be forced to buy more than they want. At price  , however, there is excess demand, as demand at that price is larger than supply. Here, sellers are on the short side, so they will determine the quantity actually bought. In a free market, sellers cannot be forced to sell more than they want.
  ?
III. Supply and Demand Analysis: An Oil Import Fee
A. Should the U.S. impose a tariff on imported oil? By using the tools of supply and demand we can see the preliminary results.
B. Imposing this fee would increase domestic oil production and reduce domestic demand. U.S. oil imports would decrease.
C. This would have the benefits of reducing air pollution, U.S. dependency on foreign oil, and the trade deficit. (The issues of “dependency” and the “trade deficit” are normative economics.)
D. Will oil exporting countries retaliate with tariffs of their own?
??? TEACHING TIP: This chapter covers only the rather simple case of a tax on imports. You may be tempted to extend the discussion of taxes and subsidies. At this early stage, students are still unclear on basic supply and demand. While a graphical analysis of general taxes and subsidies is attractive to economists it will probably be more than your students can handle.You might simply mention that taxes and subsidies are yet another method of government intervention and discuss some examples of each (educational subsidies, “sin” taxes) without going into details.
 The chapter’s example of a tax on oil imports is a good one and quite easy for students to master. But be prepared for questions on two points: (1) why a tax on oil imports has no effect on the world price of oil, and (2) why—after the tax—imported oil and domestic oil must have the same price ($24 in the text example).
 The first point results from the text’s use of the “small country assumption.” Although not quite accurate for the United States, it is still true that the United States is just one of many oil importers. And the U.S. is a “small” country when measured in terms of the world oil market. Granted, the tax will reduce United States imports and probably cause the world price of oil to fall, but this effect is minor compared to the more profound impact analyzed here: the rise in the price of oil within the United States itself.
 You might try explaining the second point with the old “suppose not” approach: Suppose the price of domestic oil did not equal the price of imported oil. For example, suppose imported oil costs $24, whereas for some reason domestic oil costs less, say, $22. Then everyone in the United States would want to buy domestic oil, and the resulting excess demand would drive up its price. When would the price stop rising? When the price of domestic oil reached the price of imported oil—$24.?
IV. The Drug Wars: A Matter of Supply and Demand
A. The U.S. government’s “war on drugs” mainly focuses on restricting supply. This drives up prices and reduces quantity demanded.
B. However, demand for many drugs is price inelastic. That means quantity demanded does not drop as much as the price rises. The net effect is higher total revenue to drug producers.
C. Alternative policies might focus instead on reducing demand (education, rehabilitation) and legalization.
??? TEACHING TIP: The movie Traffic makes these points more powerfully than most of us can manage in class. Be cautious recommending it—the movie includes violence and profanity.?
V. Looking Ahead
 In the coming chapters the focus shifts from microeconomics to macroeconomics. Most economists believe that knowledge of microeconomics is essential to a clear understanding of macroeconomics.

 Extended Application
Application 1: Inflation Reforming Economies
Microeconomics can often help us understand macroeconomic events. For example, why has economic reform in former Communist bloc countries virtually always resulted in high rates of inflation? Certainly much of the explanation is macroeconomic (faster money supply growth, large and growing budget deficits, depreciating currencies), but microeconomics plays a major role as well.
Consider the market for a typical consumer good in a former Communist country. Under central planning, the quantity produced was fixed by the state, so we can draw the supply curve as the vertical line S1 in the diagram following. The demand curve, however, looked like demand curves everywhere: The higher the price, the less people would want to buy.

What about price? Under central planning, prices—like quantities—were simply set by the state. To keep things simple, let us assume that initially planners were wise enough to set the price at P1, where quantity supplied and quantity demanded were equal. (Central planners did indeed try to do this for many consumer goods.) At this price, everyone who wanted to buy the good at the going price could do so.
During the 1980s, for a variety of reasons, production of consumer goods decreased. (The reasons included increased defense production, deteriorating worker attitudes, depletion of natural resources, an aging capital stock, and a decrease in the ability to import goods from the West.) This decrease in production can be shown as a leftward shift of the supply curve from S1 to S2 (see the following diagram). To avoid excess demand and shortages, central planners would have had to raise the price to P2. But throughout the 1980s, Communist governments steadfastly refused to raise consumer prices. There were three reasons for this policy:
1. It had long been a source of great pride that “Communism had put an end to inflation.” Rising consumer prices would have been seen as an admission of failure.
2. Higher prices would have made consumer goods less affordable to those with lower incomes and little wealth, which was viewed as unfair by the government and intolerable by much of the public.
3. Prices were set by a slow-moving bureaucracy that—even if it wanted to—could not have kept up with changing conditions in any meaningful way.
The result of this failure to raise prices was predictable. Consumer goods markets in the 1980s were plagued by excess demand. But there was more. With long lines forming at stores, many consumers found the shelves empty when they got inside. Some could go to the black market to buy goods, but not everyone could do this, and not everyone who went there could find what they needed. Thus, many consumers who had the income to buy goods were unable to do so. In fact, the typical Eastern European family during the 1980s found itself in an ironic situation: It had more income than it could spend! Year after year, this unspendable income was saved—Western economists called it “forced saving”—resulting in a steadily increasing stock of cash and savings deposits—an increase in wealth.
Now, an increase in wealth causes a rightward shift in the demand curve for normal goods (shown as a move from D1 to D2).

Demand shifts like this—with fixed prices—served only to worsen the shortages, leading to more forced saving, further increases in wealth, further shifts of the demand curve, and still worse shortages.
By the time reform-minded leaders took power in these nations (1989 in Eastern Europe, 1991 and 1992 in the former Soviet republics), the shortages had grown intolerable. Something had to be done, and quickly. Because supplies of most goods would remain unchanged for some time (in the short run, production was constrained by the preexisting productive capacity of factories), the only option was to allow prices to rise closer to their equilibrium values. In many cases, this required price increases of hundreds or even thousands of percent.