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Chapter 6 – PriceChapter 6 – Price
Cutler – Economics
BELLRINGERBELLRINGER
• What would happen if the government decided gas prices should be lowered by $2.50 per gallon?
Section 1 – Section 1 – Combining Supply and Combining Supply and
Demand Demand • Balancing the
Market– Defining Equilibrium– Graphing Equilibrium
• Disequilibrium– Excess Demand– Excess Supply
• Government Intervention
• Price Ceilings– The Cost of Price
Ceilings– Ending Rent Control
• Price Floors– Minimum Wage – Price Supports in
Agriculture
Balancing the MarketBalancing the Market
• Market System– Consumers can buy productions they want– Sellers make enough profit to stay in
business– Sellers respond to changing needs of
consumers
• Turning competing interests into a positive outcome for both sides
Balancing the MarketBalancing the Market
• Buyers and sellers come together in the market– Combining Supply and Demand
• Review Demand Schedule– Price of goods compared to how much is
produced
• Review Supply Schedule– Price of goods compared to how much is
consumed
Demand and Supply Demand and Supply ScheduleSchedule
Price of a slice of pizza
Quantity demanded
Quantity supplied
Result
Combined Supply and Demand Schedule
$ .50 300 100
$2.00
$2.50
$3.00
150
100
50
250
300
350
$1.50 200 200
$1.00 250 150
Defining Equilibrium Defining Equilibrium
• Equilibrium: The point at which quantity demanded and quantity supplied are equal
• Balance between price and quantity– Market is then stable
• The amount produced will equal the amount consumed
Graphing Equilibrium Graphing Equilibrium P
ric
e p
er
sli
ce
Equilibrium Point
Finding Equilibrium
Price of a slice
of pizza
Quantity demanded
Quantity supplied
Result
Combined Supply and Demand Schedule
$ .50 300 100
$3.50
$3.00
$2.50
$2.00
$1.50
$1.00
$.50
Slices of pizza per day
050 100 150 200 250 300 350
Supply Demand$2.00
$2.50
$3.00
150
100
50
250
300
350
Surplus from excess supply
$1.50 200 200 Equilibrium
Equilibrium Price
a
Eq
uili
briu
m
Qu
an
tity
$1.00 250 150
Shortage from excess demand
Disequilibrium Disequilibrium
• Disequilibrium: a point when quantity supplied does not equal quantity demanded
• Creates excess demand or excess supply
Excess DemandExcess Demand
Price
Slices of Pizza
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
50 100 150 200 250 300 350
Excess DemandExcess Demand
• At $1.00 per slice – QD = 250 Slices– QS = 150 Slices
• Creates a Shortage
Excess Supply Excess Supply
Price
Slices of Pizza
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
50 100 150 200 250 300 350
Excess SupplyExcess Supply
• At $2.50 per slice – QD = 100 Slices– QS = 300 Slices
• Creates a Surplus
Analyze the Data Analyze the Data
Price of a slice of pizza
Quantity demanded
Quantity supplied
Result
Combined Supply and Demand Schedule
$ .50 300 100
$2.00
$2.50
$3.00
150
100
50
250
300
350
$1.50 200 200
$1.00 250 150
Shortage Occurs because QD > QS
Surplus Occurs because QD < QS
Equilibrium QD = QS
BELLRINGERBELLRINGER
• Can you think of any products you buy that have recently changed in price?
Government InterventionGovernment Intervention
• Markets tend to reach equilibrium
• Price Ceiling: a maximum price that can be legally charged for a good or service
• Price Floor: a minimum price for a good or service
Price CeilingsPrice Ceilings
• Rent Control – Housing is essential but wages might not
keep up with the supply and demand of houses
– Reduces the quantity and quality of housing
Cost of Price CeilingsCost of Price Ceilings
• When price cannot rise to equilibrium, market determines who receives good or service
• By setting price below equilibrium, profits are reduced– Cost cutting occurs – Poor quality homes/apartments
Ending Rent ControlEnding Rent Control
• Landlords gain an incentive to maintain buildings
• What affect does it have on the number of apartments?– Rent Graph
Price FloorsPrice Floors
• Minimum price set by the government to be paid for a good or service
• Minimum Wage– Base level pay for work
Price FloorsPrice Floors
• Minimum wage above equilibrium rate decreases employment
Price FloorPrice Floor
Price
Labor
$4.50
$5.15
2 4 6
Price Supports in Price Supports in AgricultureAgriculture
• Price floors are used for many farm products
• Government would buy excess crops when price fell below floor
Section 2 – Changes in Section 2 – Changes in Market Equilibrium Market Equilibrium
• Changes in Price– Understanding a Shift in Supply– Finding a New Equilibrium – Changing Equilibrium
• A Fall in Supply• Shifts in Demand
– Problem of Excess Demand– Return to Equilibrium – A Fall in Demand
Changes in PriceChanges in Price
• Excess supply will cause firms to cut prices
• Falling prices cause QD to rise• QS will fall until they meet again• These are changes ALONG the supply
or demand curve… not shifts
Changes in PriceChanges in Price
• What shifts the supply curve?– Technology Change– New taxes/Subsidies by GOVT– Input costs change
• Because they want to be at equilibrium, curve shifts will create a new equilibrium price and quantity
Understanding a Understanding a Shift in Supply Shift in Supply
• Falling prices affect on supply– CD players were expensive initially – Now less than $100 and compete with MP3
or digital music
• Fall in production costs shifts supply curve to the right
Shifts in SupplyShifts in Supply
$800
$600
$400
$200
0
Pri
ce
Output (in millions)
Graph A: A Change in Supply
1 2 3 4 5
Original supply
Demand
a
New supply
b
c
Shift in SupplyShift in Supply
• As we saw…• The shift in the supply curve created a
surplus.– The price level didn’t change so now
suppliers are offering more but demand hasn’t caught up!
Finding a New EquilibriumFinding a New Equilibrium
• Excess supply or a surplus will cause producers to lower prices to eliminate the surplus
• Did the price drop change the demand curve?
New Equilibrium
$800
$600
$400
$200
0
Pri
ce
Output (in millions)
Graph A: A Change in Supply
1 2 3 4 5
Original supply
Demand
a
New supply
b
c
Change in Equilibrium
• Curve will keep shifting while new technology is introduced to lower production costs
• Equilibrium changes constantly– Changes in the market– Consumer wants and needs– Production costs
Fall in Supply
• Supply curve can shift to the left with a drop in supply
• A strike that results in higher wages• A tax by the government
Shifts in Demand
• New fads for Christmas • New version of a product
– iPhone 5
Shifts in DemandShifts in Demand
Graph B shows how the market finds a new equilibrium when there is an increase in demand.
Graph B: A Change in Demand
Output (in thousands)
$60
$50
$40
$30
$20
$10
0
900800700600500400300200100
Pri
ce
Supply
Original demand
a
New demand
c
b
Problem of Excess Demand
• Shifting the demand curve to the right creates shortages
Shifts in DemandShifts in Demand
Graph B: A Change in Demand
Output (in thousands)
$60
$50
$40
$30
$20
$10
0
900800700600500400300200100
Pri
ce
Supply
Original demand
a
New demand
c
b
Return to Equilibrium Return to Equilibrium
• Prices will rise by produces as a result of this change in demand
• Fall in demand has the opposite effect
BELLRINGERBELLRINGER
• What is the “Black Market?”
Section 3 – The Role of Prices
• Prices in the Free Market
• The Advantages of Prices– Price as an Incentive– Price as Signals– Flexibility– Price System is “Free”
• A Wide Choices of Goods– Rationing Shortages– The Black Market
• Efficient Resource Allocation
• Prices and the Profit Incentive– The Wealth of Nations– Market Problems
Prices in Free Market
• Prices serve a major role in the free market economy– Helps move the FOP
Advantages of Price
• Very Universal– Act as a standard measure of value– Barter system as alternative
• Price acts as an incentive– Think of the Law of Demand and Law of
Supply
Advantages of Prices
• Prices as Signals – Producers – Higher prices signal to producers to make
more– Also signals new suppliers to enter market– Lower prices signal too much is produced– Signals suppliers to leave the market
Advantages of Prices
• Prices as Signals – Consumers– Low prices signal to buy more– Low prices = low opportunity cost– High price to stop and think about a
purchase
Advantages of Prices
• Flexibility – Prices can easily be increased to solve
shortages (excess demand)– Prices can easily be decreased to solve
surpluses (excess supply)
Advantages of Prices
• Supply Shock: a sudden shortage of a good– Creates excess demand– Gasoline for example
• Rationing – Allocating scare goods and services using
criteria other than price– How easy is it to increase supply?
Supply Shock and Rationing
Price
Gallons
$2.50
$5.15
2 4 6
Price Shock and Rationing
• Raising prices quickest way to solve shortage
• People with higher demand will still consume
• Creating new equilibrium
Advantages of Price
• Price System is “Free”– No cost to administer price– Unlike central planning– Soviet Union employed thousands of people
to organize the economy
• A farmer can decide what to plan based on what he thinks will be most profitable
• Prices help goods flow through the economy
Wide Choice of Goods
• Market Based Economy offers diverse goods and services
• Prices allow a “target” consumer base– Bentley
• Fewer choices in Centrally Planned– Reduce costs to meet quotas
Rationing and Shortages
• Despite being inexpensive, products were often hard to purchase in Soviet Union
• Rationing creates shortages
Rationing in the US
• During WWII Rationing existed– GOVT Intent was to ensure everyone had a
level standard of living during wartime– You needed ration points and money to
purchase products– Guns or Butter
• Resources were allocated to guns • Leaving few for butter
The Black Market
• Black Market: A market in which goods are sold illegally– Allows consumers to buy rationed products
buy paying more money
Efficient Resource Allocation
• Free market ensures resources are allocated efficiently – FOP used for most valuable purpose– Resources adjust to change in demands of
consumers– Resources go to the consumer who values
a good or service the most
Price and Profit Incentive
• What happens with a hot summer and the demand for air conditioners and fans?
• How would producers respond to this demand?
Price and Profit Incentive
Price
Air Conditioners
$100.00
500 1000 1500
$250.00
Wealth of Nations
• Adam Smith – 1776– Not because of charity that a baker or
butcher provide people food– A profit is made by providing food
• Business prospers by finding out what people want– Other systems haven’t worked…
Market Problems
• Imperfect Competition – Not enough suppliers reduces competition – Why lower price to have MR = MC
• Spillover Costs (externalities)– Costs of production that affect people who
have no control over how much of a good is produced
– Pollution
• Imperfect Information – Consumers who lack knowledge of alternatives