Federal Reserve

(The reason for the big return was that interest rates dropped
sharply as the Federal Reserve cut the overnight lending rate between
banks—its target federal funds rate—to 1.75 percent from
6.5 percent. Those rate cuts brought down interest rates across
the board, raising bill, note, and bond prices, which move in the
opposite direction of bond yields. And those price increases gave
investors big capital gains, which when added to the interest
paid on the bills, notes, and bonds combined for the nice return.)

Analysis of market

This analysis of the market for farm products also helps to explain a seeming
paradox of public policy: Certain farm programs try to help farmers by inducing
them not to plant crops on all of their land. Why do these programs do this? Their
purpose is to reduce the supply of farm products and thereby raise prices. With inelastic
demand for their products, farmers as a group receive greater total revenue
if they supply a smaller crop to the market. No single farmer would choose to
leave his land fallow on his own because each takes the market price as given. But
if all farmers do so together, each of them can be better off.

Farm technology increased

Although this example may at first seem only hypothetical, in fact it helps to
explain a major change in the U.S. economy over the past century. Two hundred
years ago, most Americans lived on farms. Knowledge about farm methods was
sufficiently primitive that most of us had to be farmers to produce enough food.
Yet, over time, advances in farm technology increased the amount of food that
each farmer could produce. This increase in food supply, together with inelastic
food demand, caused farm revenues to fall, which in turn encouraged people to
leave farming.

new hybrid

If farmers are made worse off by the discovery of this new hybrid, why do
they adopt it? The answer to this question goes to the heart of how competitive
markets work. Because each farmer is a small part of the market for wheat, he or
she takes the price of wheat as given. For any given price of wheat, it is better to

Discovery make farmers better off?

But this discovery make farmers better off? As a first cut to answer this question of what happens to the entire revenue of the farmers. Farmers PQ's total sales, the price for the wheat times the amount sold. The discovery concerns the farmers in two contrasting ways. The hybrid allows farmers to More wheat (Q increases), but now every bushel of wheat sold less (P drops). Whether total revenue rises or falls depends on the elasticity of demand. In practice, the demand for basic foods such as wheat is generally inelastic, These products are relatively inexpensive and have some good alternates. If the demand is inelastic, as shown in Figure 5-8, a decrease in the price causes total revenue to fall. You can do this in the figure: The price of wheat drops significantly, The quantity of wheat sold rising only slightly. Total sales drops from $ 300 to $ 220 So, the discovery of new hybrid lowers the total turnover, farmers receive for the sale of their crops.

When the supply curve shifts

In this case, the discovery of the new hybrid affects the supply curve. Because
the hybrid increases the amount of wheat that can be produced on each acre of
land, farmers are now willing to supply more wheat at any given price. In other
words, the supply curve shifts to the right. The demand curve remains the same
because consumers’ desire to buy wheat products at any given price is not affected
by the introduction of a new hybrid. Figure 5-8 shows an example of such a
change. When the supply curve shifts from S1 to S2, the quantity of wheat sold increases
from 100 to 110, and the price of wheat falls from $3 to $2.
But does this discovery make farmers better off?

What happens

Let’s now return to the question posed at the beginning of this chapter: What happens
to wheat farmers and the market for wheat when university agronomists discover
a new wheat hybrid that is more productive than existing varieties? Recall
from Chapter 4 that we answer such questions in three steps. First, we examine
whether the supply curve or demand curve shifts. Second, we consider which direction
the curve shifts. Third, we use the supply-and-demand diagram to see how
the market equilibrium changes

Petroleum Exporting Countries

Can good news for farming be bad news for farmers? Why did the Organization of
Petroleum Exporting Countries (OPEC) fail to keep the price of oil high? Does
drug interdiction increase or decrease drug-related crime? At first, these questions
might seem to have little in common. Yet all three questions are about markets,
and all markets are subject to the forces of supply and demand. Here we apply the
versatile tools of supply, demand, and elasticity to answer these seemingly complex
questions.

Example of this phenomenon.

Figure presents a numerical example of this phenomenon. When the price
rises from $3 to $4 (a 29 percent increase, according to the midpoint method), the
quantity supplied rises from 100 to 200 (a 67 percent increase). Because quantity
supplied moves proportionately more than the price, the supply curve has elasticity
greater than 1. By contrast, when the price rises from $12 to $15 (a 22 percent increase),
the quantity supplied rises from 500 to 525 (a 5 percent increase). In this
case, quantity supplied moves proportionately less than the price, so the elasticity
is less than 1.

M O N O P O L I S T I C C O M P E T I T I O N

You walk into a bookstore to buy a book to read during your next vacation. On the
store’s shelves you find a John Grisham mystery, a Stephen King thriller, a Danielle
Steel romance, a Frank McCourt memoir, and many other choices. When you pick
out a book and buy it, what kind of market are you participating in?
On the one hand, the market for books seems competitive. As you look over
the shelves at your bookstore, you find many authors and many publishers vying
for your attention. A buyer in this market has thousands of competing products
from which to choose. And because anyone can enter the industry by writing and
publishing a book, the book business is not very profitable. For every highly paid
novelist, there are hundreds of struggling ones

How analyze proposals

To analyze these proposals, we need to address a simple but subtle question:
When the government levies a tax on a good, who bears the burden of the tax? The
people buying the good? The people selling the good? Or, if buyers and sellers
share the tax burden, what determines how the burden is divided? Can the government
simply legislate the division of the burden, as the mayor is suggesting, or
is the division determined by more fundamental forces in the economy? Economists
use the term tax incidence to refer to these questions about the distribution
of a tax burden. As we will see, we can learn some surprising lessons about tax incidence
just by applying the tools of supply and demand.

The American Association of Debt Managament

All governments—from the federal government in Washington, D.C., to the local
governments in small towns—use taxes to raise revenue for public projects, such
as roads, schools, and national defense. Because taxes are such an important policy
instrument, and because they affect our lives in many ways, the study of taxes
is a topic to which we return several times throughout this book. In this section we
begin our study of how taxes affect the economy.
To set the stage for our analysis, imagine that a local government decides to
hold an annual ice-cream celebration—with a parade, fireworks, and speeches by
town officials. To raise revenue to pay for the event, it decides to place a $0.50 tax
on the sale of ice-cream cones. When the plan is announced, our two lobbying
groups swing into action. The National Organization of Ice Cream Makers claims
that its members are struggling to survive in a competitive market, and it argues
that buyers of ice cream should have to pay the tax. The American Association of
Ice Cream Eaters claims that consumers of ice cream are having trouble making
ends meet, and it argues that sellers of ice cream should pay the tax. The town
mayor, hoping to reach a compromise, suggests that half the tax be paid by the
buyers and half be paid by the sellers.

THE MINIMUM WAGE

An important example of a price floor is the minimum wage. Minimum-wage
laws dictate the lowest price for labor that any employer may pay. The U.S.
Congress first instituted a minimum wage with the Fair Labor Standards Act of
1938 to ensure workers a minimally adequate standard of living. In 1999 the
minimum wage according to federal law was $5.15 per hour, and some state
laws imposed higher minimum wages.
To examine the effects of a minimum wage, we must consider the market
for labor. Panel (a) of Figure 6-5 shows the labor market which, like all
markets, is subject to the forces of supply and demand. Workers determine
the supply of labor, and firms determine the demand. If the government
doesn’t intervene, the wage normally adjusts to balance labor supply and
labor demand.
Panel (b) of Figure 6-5 shows the labor market with a minimum wage. If the
minimum wage is above the equilibrium level, as it is here, the quantity of labor
supplied exceeds the quantity demanded. The result is unemployment. Thus,
the minimum wage raises the incomes of those workers who have jobs, but it
lowers the incomes of those workers who cannot find jobs.
To fully understand the minimum wage, keep in mind that the economy
contains not a single labor market, but many labor markets for different types of
workers. The impact of the minimum wage depends on the skill and experience
of the worker. Workers with high skills and much experience are not affected,
because their equilibrium wages are well above the minimum. For these workers,
the minimum wage is not binding.

Mutual fund numbers

The household balance sheet of Americans as a group shows
that stocks as a percentage of financial assets went from 20.5 percent
in 1980 to the 1999 high of 50 percent, before the recent decline,
according to data from the Federal Reserve.
The mix of assets held in mutual funds shows a similar shift,
with stocks as a percentage of total mutual fund assets rising as
high as 57.9 percent in 2000, from 24.6 percent in 1992, when
AMG Data Services began collecting these mutual fund numbers.
As noted earlier, this share is now a little lower.

Americans TRADERS

In part because their risk tolerance had been so low, Americans
were taking on more risk all during the bull market for
stocks from 1982 to 2000. This shift occurred as a new generation
came of age and grew to trust stocks the way their parents,
children of the Depression, learned to distrust them.

Price floor on the ice-cream market

When the government imposes a price floor on the ice-cream market, two outcomes
are possible. If the government imposes a price floor of $2 per cone when
the equilibrium price is $3, we obtain the outcome in panel (a) of Figure 6-4. In this
case, because the equilibrium price is above the floor, the price floor is not binding.
Market forces naturally move the economy to the equilibrium, and the price floor
has no effect.
Panel (b) of Figure 6-4 shows what happens when the government imposes a
price floor of $4 per cone. In this case, because the equilibrium price of $3 is below
the floor, the price floor is a binding constraint on the market. The forces of supply
and demand tend to move the price toward the equilibrium price, but when the
market price hits the floor, it can fall no further. The market price equals the price
floor. At this floor, the quantity of ice cream supplied (120 cones) exceeds the quantity
demanded (80 cones). Some people who want to sell ice cream at the going
price are unable to. Thus, a binding price floor causes a surplus.
Just as price ceilings and shortages can lead to undesirable rationing mechanisms,
so can price floors and surpluses. In the case of a price floor, some sellers
are unable to sell all they want at the market price. The sellers who appeal to the
personal biases of the buyers, perhaps due to racial or familial ties, are better able
to sell their goods than those who do not. By contrast, in a free market, the price
serves as the rationing mechanism, and sellers can sell all they want at the equilibrium
price.