PRICES

Allocation and Information

P

Q

Pizza

S

PM

QE

D

Equilibrium QD=QS

“The Happy Place”Market – Clearing Price

P1

QD QS

QS > QD = Surplus

QS QD

QD > QS = Shortage

When left alone, the market will always find the optimal (market-clearing) price!

P2

Sale

Bid-up

1970’s

• Gas Shortage – gas lines• OPEC • Organization of the Petroleum Exporting

Countries• Middle East• Religious Revolutions• “Western Influence”• Sharply decreased the supply of oil to the United

States and other western countries

1970’s

P P

Q Q

OIL GAS

D

P1

Q1

D

P2

P2

Q2 Q1Q2

S

S1

Cost of producing gas

P1

SS1

Soil Poil Sgas Pgas

$2.00/g

$.25/g

1970’s

• Cars of the 70’s

– “Gas Guzzlers”– Muscle Cars– Big Engines– Heavy

Averaged 8 mi./gallon !!!!!

P

Q

Gas

S

PM

QE

D

Equilibrium QD=QS

QS QD

QD > QS = ShortagePC

Price Ceiling: A maximum legal price, below market price

What the government did to solve the problem with gas prices….

$2.00

$1.00

Effects of the Gas Shortage

• Short-term effects:– Gas lines / gas rationing– “Black Market” for gas– Gas related crime

• Long-term effects:– Nearly destroyed the US auto industry– Delayed the development of alternative fuel

sources

1980’s

• “Cold War”• US v. USSR• War of ideology – capitalism v. communism• Arms race• Invaded Afghanistan

– Boycotted Olympics– Armed the resistance

• Led by Osama Bin Laden

– Instituted full economic embargo

P

Q

Wheat

S

PM

QE

D

Effects of the Embargo against the Soviet Union….

P1

Q1

S1

$30/b

$10/b

P

Q

Wheat

PF

QD

D

What the government did to help the farmers……

P1

Q1

S1

$20/b

$10/b

QS

Price Floor:

A minimum legal price, above market price

QS > QD = Surplus

Effects of the Wheat Surplus

• Farmers couldn’t sell wheat at the floor price, so government bought it

• Had the market been left alone, farmers would have reallocated resources to more profitable crops