Review! 1.What are the two main points of the Law of Demand? 2.What are the two main points of the Law of Supply? 3.What is Profit? 4.What is Elasticity of Demand? 5.What is Elasticity of Supply?

Law of Demand: As price goes up, demand goes down. As price goes down, demand goes up. Law of Supply: As price goes up, supply goes up. As price goes down, supply goes down. Profit: The difference between the cost to produce a good and what it is sold for. Elasticity of Demand: How sensitive demand is to a change in price. Elasticity of Supply: How sensitive supply is to a change in price.

Demand Curve Price per Slice of Pizza Quantity of Slices Demanded $ $ $ $ $ $3.0050

Supply Curve Price per Slice of Pizza Quantity of Slices Supplied $ $ $ $ $ $3.0050

So, What happens if we combine the two?

Equilibrium Price When the Laws of Supply and Demand Collide

Equilibrium Def. The point at which quantity demanded and quantity supplied come together.

Equilibrium Price per Slice of Pizza Quantity of Slices Supplied Quantity of Slices Demanded $ $ $ $ $

Disequilibrium If the market price or quantity supplied is anywhere but at equilibrium price, the market is in a state called Disequilibrium. Interactions between buyers and sellers will always push the market back towards equilibrium… UNLESS THE GOVERNMENT INTERFERES

Government Interference In some cases, the government steps in to control prices. These interventions appear as price ceilings and price floors.

Price Ceiling Def. A maximum price that can be legally charged for a good. Ex. Rent Control: a situation where the government sets a maximum amount that can be charged for rent in an area. Usually only in large cities, such as New York or Los Angeles

Price Floor Def. A minimum price, set by the government, that must be paid for a good or service Ex. Minimum Wage; sets a minimum price that an employer can pay a worker for an hour of labor. Ex. Luxury or “Sin” Taxes; Items like alcohol, cigarettes, and gasoline have extra taxes, creating a price floor.

Problems with Price Floors and Ceilings Price ceilings and floors prevent markets from reaching equilibrium. They prevent suppliers from producing as much as price dictates or prevent consumers from buying as much as they wish Ex. Rent control prevents landlords from getting full value for their property. Ex. Cigarette taxes prevent people from buying cigarettes, hopefully reducing the number of smokers.

Changes in Equilibrium The point where supply and demand meet can change for 3 reasons:

1. Change in Supply Excess Supply leads to a surplus (when supply is greater than demand). This leads to a decrease in price and an increase in demand. –Ex. After Christmas, stores have clearance sales to get rid of surplus merchandise A decrease in supply leads to an increase in price. This leads to a decrease in demand.

2. Changes in Demand If there is a shortage, when demand is greater than supply, price rises, which increases supply and decreases demand. –Ex. Tickle Me Elmo dolls sold out at the stores, so on Ebay price of the dolls skyrocketed When demand falls, suppliers cut prices and find a new equilibrium

3. Change in Price As prices change, supply and demand will both change.

So why are prices so important? Prices are vital in a free market economy. They help move land, labor and capital into the hands of producers and finished goods into the hands of buyers. Price is a language both consumers and producers can use to determine value.

Advantages of Prices 1.Prices as an Incentive Prices communicate to buyers and sellers whether goods or services are scarce or easily available. They encourage or discourage production. 2.Prices as Signals Prices act like a traffic light. A high price (green light) tell producers to make more, while a low price (red light) tell producers to make less.

Advantages of Price (cont.) 3. Flexibility of Prices Prices are generally more flexible than production levels and can be easily increased or decreased to reach equilibrium. 4. Price System is “Free” A distribution system based on prices costs nothing to administer, unlike in command economies.

How does scarcity of an item affect its price? If there is a scarcity of an item, then the price will be high. Ex. Gasoline

How does a boycott affect the price? If an item is being boycotted, then the price often will go down. Ex. If everyone stopped buying gas, the price of gas would drop.

How does the War in Afghanistan affect the price of certain items? Price of many items have increased. –Ex. Gas, security If the war continues, we can expect the price of many items to increase –Ex. Foods, metal