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The sugar industry obviously benefits from the price-control program. But consumers
pay for it in the form of higher prices for sugar and sugar-filled products such as soft
drinks, candy bars, and cookies. Although estimates vary, the federal sugar price support
program appears to cost consumers approximately $1.5 billion per year.
If all of this sounds a bit abstract to you, take a look at the ingredients in a U.S.-made
soft drink. Instead of sugar, you will likely find “high-fructose corn syrup” listed as a
sweetener. Foreign producers generally use sugar, but sugar is simply too expensive to be
used for this purpose in the United States.


A Can of Worms
Our two case studies”rent controls and sugar price supports”illustrate some of the ma-
jor side effects of price floors and ceilings but barely hint at others. Difficulties arise that




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Chapter 4 75
Supply and Demand: An Initial Look



we have not even mentioned, for the market mechanism is a tough bird that imposes suit-
able retribution on those who seek to evade it by government decree. Here is a partial list
of other problems that may arise when prices are controlled.

Favoritism and Corruption When price ceilings or floors create shortages or sur-
pluses, someone must decide who gets to buy or sell the limited quantity that is available.
This decision-making process can lead to discrimination along racial or religious lines, po-
litical favoritism, or corruption in government. For example, many prices were held at ar-
tificially low levels in the former Soviet Union, making queuing for certain goods quite
common. Even so, Communist Party officials and other favored groups were somehow
able to purchase the scarce commodities that others could not get.

Unenforceability Attempts to limit prices are almost certain to fail in industries
with numerous suppliers, simply because the regulating agency must monitor the be-
havior of so many sellers. People will usually find ways to evade or violate the law,
and something like the free-market price will generally reappear. But there is an im-
portant difference: Because the evasion process, whatever its form, will have some op-
erating costs, those costs must be borne by someone. Normally, that someone is the
consumer, who must pay higher prices to the suppliers for taking the risk of breaking
the law.

Auxiliary Restrictions Fears that a system of price controls will break down invari-
ably lead to regulations designed to shore up the shaky edifice. Consumers may be told
when and from whom they are permitted to buy. The powers of the police and the courts
may be used to prevent the entry of new suppliers. Occasionally, an intricate system of
market subdivision is imposed, giving each class of firms a protected sphere in which oth-
ers are not permitted to operate. For example, in New York City, there are laws banning
conversion of rent-controlled apartments to condominiums.

Limitation of Volume of Transactions To the extent that controls succeed in affect-
ing prices, they can be expected to reduce the volume of transactions. Curiously, this is
true regardless of whether the regulated price is above or below the free-market equilib-
rium price. If it is set above the equilibrium price, the quantity demanded will be below
the equilibrium quantity. On the other hand, if the imposed price is set below the free-
market level, the quantity supplied will be reduced. Because sales volume cannot exceed
either the quantity supplied or the quantity demanded, a reduction in the volume of
transactions is the result.9

Misallocation of Resources Departures from free-market prices are likely to re-
sult in misuse of the economy™s resources because the connection between production
costs and prices is broken. For example, Russian farmers used to feed their farm ani-
mals bread instead of unprocessed grains because price ceilings kept the price of bread
ludicrously low. In addition, just as more complex locks lead to more sophisticated bur-
glary tools, more complex regulations lead to the use of yet more resources for their
avoidance.
Economists put it this way: Free markets are capable of dealing efficiently with the
three basic coordination tasks outlined in Chapter 3: deciding what to produce, how to
produce it, and to whom the goods should be distributed. Price controls throw a monkey
wrench into the market mechanism. Although the market is surely not flawless, and gov-
ernment interferences often have praiseworthy goals, good intentions are not enough.
Any government that sets out to repair what it sees as a defect in the market mechanism
runs the risk of causing even more serious damage elsewhere. As a prominent economist

See Discussion Question 4 at the end of this chapter.
9




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76 Getting Acquainted with Economics



once quipped, societies that are too willing to interfere with the operation of free markets
soon find that the invisible hand is nowhere to be seen.



A SIMPLE BUT POWERFUL LESSON
Astonishing as it may seem, many people in authority do not understand the law of
supply and demand, or they act as if it does not exist. For example, a few years ago the
New York Times carried a dramatic front-page picture of the president of Kenya setting
fire to a large pile of elephant tusks that had been confiscated from poachers. The ac-
companying story explained that the burning was intended as a symbolic act to per-
suade the world to halt the ivory trade.10 One may certainly doubt whether the burning
really touched the hearts of criminal poachers, but one economic effect was clear: By re-
ducing the supply of ivory on the world market, the burning of tusks forced up the price
of ivory, which raised the illicit rewards reaped by those who slaughter elephants. That
could only encourage more poaching”precisely the opposite of what the Kenyan gov-
ernment sought to accomplish.



| SUMMARY |
1. An attempt to use government regulations to force quantity demanded that is caused by a change in any
prices above or below their equilibrium levels is likely other determinant of quantity demanded is represented
to lead to shortages or surpluses, to black markets in by a shift of the demand curve.
which goods are sold at illegal prices, and to a variety of 8. This same distinction applies to the supply curve:
other problems. The market always strikes back at at- Changes in price lead to movements along a fixed sup-
tempts to repeal the law of supply and demand. ply curve; changes in other determinants of quantity
2. The quantity of a product that is demanded is not a supplied lead to shifts of the entire supply curve.
fixed number. Rather, quantity demanded depends on 9. A market is said to be in equilibrium when quantity
such influences as the price of the product, consumer in- supplied is equal to quantity demanded. The equilib-
comes, and the prices of other products. rium price and quantity are shown by the point on the
3. The relationship between quantity demanded and price, supply-demand graph where the supply and demand
holding all other things constant, can be displayed curves intersect. The law of supply and demand states
graphically on a demand curve. that price and quantity tend to gravitate to this point in
a free market.
4. For most products, the higher the price, the lower the
quantity demanded. As a result, the demand curve usu- 10. Changes in consumer incomes, tastes, technology, prices
ally has a negative slope. of competing products, and many other influences lead
to shifts in either the demand curve or the supply curve
5. The quantity of a product that is supplied depends on
and produce changes in price and quantity that can be
its price and many other influences. A supply curve is a
determined from supply-demand diagrams.
graphical representation of the relationship between
quantity supplied and price, holding all other influ- 11. A tax on a good generally leads to a rise in the price at
ences constant. which the taxed product is sold. The rise in price is gen-
erally less than the tax, so consumers usually pay less
6. For most products, supply curves have positive slopes,
than the entire tax.
meaning that higher prices lead to supply of greater
quantities. 12. Consumers generally pay only part of a tax because
7. A change in quantity demanded that is caused by a the resulting rise in price leads them to buy less and
change in the price of the good is represented by a the cut in the quantity they demand helps to force
movement along a fixed demand curve. A change in price down.




The New York Times, July 19, 1989.
10




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Licensed to:

Chapter 4 77
Supply and Demand: An Initial Look



| KEY TERMS |
Invisible hand 56 Quantity supplied 61 Surplus 65
Quantity demanded 57 Supply schedule 61 Equilibrium 65
Demand schedule 58 Supply curve 62 Law of supply and demand 66
Demand curve 58 Supply-demand diagram 64 Price ceiling 70
Shift in a demand curve 59 Shortage 65 Price floor 73




| TEST YOURSELF |
1. What shapes would you expect for demand curves for
Quantity Demanded Quantity Supplied
the following:
Price per Year (millions) per Year (millions)
a. A medicine that means life or death for a patient
$170 43 27
b. French fries in a food court with kiosks offering
210 39 31
many types of food
250 35 35
2. The following are the assumed supply and demand 300 31 39
schedules for hamburgers in Collegetown: 330 27 43
370 23 47

Demand Schedule Supply Schedule
b. Now suppose that it becomes unfashionable to ride a
Quantity Quantity
bicycle, so that the quantity demanded at each price
Demanded Supplied
falls by 9 million bikes per year. What is the new
per Year per Year
equilibrium price and quantity? Show this solution
Price (thousands) Price (thousands)
graphically. Explain why the quantity falls by less
$2.75 14 $2.75 32
than 9 million bikes per year.
2.50 18 2.50 30
c. Suppose instead that several major bicycle producers
2.25 22 2.25 28
go out of business, thereby reducing the quantity sup-
2.00 26 2.00 26
plied by 9 million bikes at every price. Find the new
1.75 30 1.75 24
equilibrium price and quantity, and show it graphically.
1.50 34 1.50 22
Explain again why quantity falls by less than 9 million.
d. What are the equilibrium price and quantity if the
shifts described in Test Yourself Questions 3(b) and
3(c) happen at the same time?
a. Plot the supply and demand curves and indicate the
4. The following table summarizes information about the
equilibrium price and quantity.
market for principles of economics textbooks:
b. What effect would a decrease in the price of beef (a
hamburger input) have on the equilibrium price and
quantity of hamburgers, assuming all other things re-
mained constant? Explain your answer with the help Quantity Demanded Quantity Supplied
of a diagram. Price per Year per Year
c. What effect would an increase in the price of pizza $45 4,300 300
(a substitute commodity) have on the equilibrium 55 2,300 700
price and quantity of hamburgers, assuming again 65 1,300 1,300
that all other things remain constant? Use a diagram 75 800 2,100
in your answer. 85 650 3,100
3. Suppose the supply and demand schedules for bicycles
are as they appear below.
a. Graph these curves and show the equilibrium price a. What is the market equilibrium price and quantity of
and quantity. textbooks?




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Licensed to:
Part 1
78 Getting Acquainted with Economics



b. To quell outrage over tuition increases, the college tax of 50 cents per pound on sales of beef. Follow these
places a $55 limit on the price of textbooks. How steps to analyze the effects of the tax:
many textbooks will be sold now? a. Construct the new supply schedule (to replace Table 2)
c. While the price limit is still in effect, automated pub- that relates quantity supplied to the price that con-
lishing increases the efficiency of textbook production. sumers pay.
Show graphically the likely effect of this innovation b. Graph the new supply curve constructed in Test
on the market price and quantity. Yourself Question 7(a) on the supply-demand dia-
5. How are the following demand curves likely to shift in gram depicted in Figure 7. What are the new equilib-
response to the indicated changes? rium price and quantity?
a. The effect of a drought on the demand curve for c. Does the tax succeed in its goal of reducing the con-
umbrellas sumption of beef?
b. The effect of higher popcorn prices on the demand d. How much does the equilibrium price increase? Is the
curve for movie tickets price rise greater than, equal to, or less than the
50 cent tax?
c. The effect on the demand curve for coffee of a decline
in the price of Coca-Cola e. Who actually pays the tax, consumers or producers?

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