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Role of Prices
EconomicsKoehn/Molter
Review
• A demand schedule shows:– How much consumers are willing to buy a various
prices.• A supply schedule shows:– How much sellers are willing to sell at various
prices.• Comparing these schedules should allow us
to find common ground for the two sides of the market.
Market Equilibrium
The point at which quantity demanded and quantity supplied are equal is called EQUILIBRIUM.
This can only occur when
Quantity demand (QD) = Quantity supplied (QS)
Examples
• Quantity demanded = Quantity supplied occurs where the demand curve intersects the supply curve.
• This will determine the equilibrium price and quantity. Equilibrium price = $5.00 and 5,000 pounds of coffee are bought and sold at that price
Picture Form
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Supply and Demand Together
D S Equilibrium: P has reached the level where quantity supplied equals quantity demanded
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Equilibrium price:
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The price that equates quantity supplied with quantity demanded
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Equilibrium quantity:
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The quantity supplied and quantity demanded at the equilibrium price
Quantity demanded = Quantity supplied (occurs when the demand curve intersects
the supply curve)
This will determine the equilibrium price and quantity.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus:when quantity supplied is greater than quantity demanded
Surplus Example: If P = $5,
then QD = 9 lattes
and QS = 25 lattes
resulting in a surplus of 16 lattes
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus:when quantity supplied is greater than quantity demanded
Facing a surplus, sellers try to increase sales by cutting price.
This causes QD to rise
Surplus
…which reduces the surplus.
and QS to fall…
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus:when quantity supplied is greater than quantity demanded
Facing a surplus, sellers try to increase sales by cutting price.
This causes QD to rise and QS to fall.
Surplus
Prices continue to fall until market reaches equilibrium.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Shortage:when quantity demanded is greater than quantity supplied
Example: If P = $1,
then QD = 21 lattesand QS = 5 lattesresulting in a shortage of 16 lattes
Shortage
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Shortage:when quantity demanded is greater than quantity supplied
Facing a shortage, sellers raise the price,
causing QD to fall
…which reduces the shortage.
and QS to rise,
Shortage
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Shortage:when quantity demanded is greater than quantity supplied
Facing a shortage, sellers raise the price,
causing QD to falland QS to rise.
Shortage
Prices continue to rise until market reaches equilibrium.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Three Steps to Analyzing Changes in Eq’m
To determine the effects of any event,
1. Decide whether event shifts S curve, D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see how the shift changes eq’m P and Q.
To determine the effects of any event,
1. Decide whether event shifts S curve, D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see how the shift changes eq’m P and Q.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE: The Market for Hybrid Cars
P
QD1
S1
P1
Q1
price of hybrid cars
quantity of hybrid cars
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
STEP 1: D curve shifts because price of gas affects demand for hybrids. S curve does not shift, because price of gas does not affect cost of producing hybrids.
STEP 2:
D shifts rightbecause high gas price makes hybrids more attractive relative to other cars.
EXAMPLE 1: A Change in DemandEVENT TO BE ANALYZED: Increase in price of gas.
P
QD1
S1
P1
Q1
D2
P2
Q2
STEP 3:
The shift causes an increase in price and quantity of hybrid cars.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE 1: A Change in Demand
P
QD1
S1
P1
Q1
D2
P2
Q2
Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.
Always be careful to distinguish b/w a shift in a curve and a movement along the curve.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
STEP 1: S curve shifts because event affects cost of production. D curve does not shift, because production technology is not one of the factors that affect demand.
STEP 2:
S shifts rightbecause event reduces cost, makes production more profitable at any given price.
EXAMPLE 2: A Change in Supply
P
QD1
S1
P1
Q1
S2
P2
Q2
EVENT: New technology reduces cost of producing hybrid cars.
STEP 3:
The shift causes price to fall and quantity to rise.
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Government Policies That Alter the Private Market Outcome
• Price controls– Price ceiling: a legal maximum on the price
of a good or service. Example: rent control. – Price floor: a legal minimum on the price of
a good or service. Example: minimum wage.
• Taxes– The govt can make buyers or sellers pay a specific
amount on each unit bought/sold.
We will use the supply/demand model to see how each policy affects the market outcome
(the price buyers pay, the price sellers receive, and eq’m quantity).
We will use the supply/demand model to see how each policy affects the market outcome
(the price buyers pay, the price sellers receive, and eq’m quantity).
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
EXAMPLE 1: The Market for Apartments
Eq’m w/o price
controls
Eq’m w/o price
controls
P
QD
SRental price of
apts
$800
300Quantity of apartments
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Ceilings Affect Market Outcomes
A price ceiling above the eq’m price is not binding – has no effect on the market outcome.
P
QD
S
$800
300
Price ceiling$1000
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Ceilings Affect Market Outcomes
The eq’m price ($800) is above the ceiling and therefore illegal.The ceiling is a binding constraint on the price, causes a shortage.
P
QD
S
$800
Price ceiling$500
250 400
shortage
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Ceilings Affect Market Outcomes
In the long run, supply and demand are more price-elastic. So, the shortage is larger.
P
QD
S
$800
150
Price ceiling$500
450
shortage
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Shortages and Rationing• With a shortage, sellers must ration the goods among
buyers.
• Some rationing mechanisms: (1) long lines (2) discrimination according to sellers’ biases
• These mechanisms are often unfair, and inefficient: the goods do not necessarily go to the buyers who value them most highly.
• In contrast, when prices are not controlled, the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair).
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
EXAMPLE 2: The Market for Unskilled Labor
Eq’m w/o price
controls
Eq’m w/o price
controls
W
LD
SWage paid to
unskilled workers
$4
500
Quantity of unskilled workers
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Floors Affect Market Outcomes
W
LD
S
$4
500
Price floor$3
A price floor below the eq’m price is not binding – has no effect on the market outcome.
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Floors Affect Market Outcomes
W
LD
S
$4
Price floor$5
The eq’m wage ($4) is below the floor and therefore illegal.The floor is a binding constraint
on the wage, causes a surplus (i.e., unemployment).
400 550
labor surplus
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Min wage laws do not affect highly skilled workers.
They do affect teen workers.
Studies: A 10% increase in the min wage raises teen unemployment by 1-3%.
The Minimum Wage
W
LD
S
$4
Min. wage$5
400 550
unemp-loyment
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