Prices Chapter 6

Combining Supply and Demand Chapter 6 Section 1

Combining Supply and Demand In a free market, prices lead to an efficient allocation of resources Resources are used in the most valuable and productive way, according to the needs of consumers and producers Balancing the market Equilibrium: when buyers will purchase exactly as much as what sellers are willing to sell

P Q Supply and Demand Together D S Equilibrium: P has reached the level where quantity supplied equals quantity demanded

D S P Q Equilibrium price: PQDQD QSQS $ The price where quantity supplied equals quantity demanded

D S P Q Equilibrium quantity: PQDQD QSQS $ The quantity supplied and quantity demanded at the equilibrium price

Combining Supply and Demand Disequilibrium: When quantity supplied is not equal to quantity demanded in a market. Can lead to either: Excess demand When quantity demanded is more than quantity supplied Excess supply When quantity supplied is more than quantity demanded

Government Intervention Price Ceiling – max. price that can be legally charged for a good Rent control was introduced to prevent inflation during a housing crisis in the early 1940s & continued after WWII Rent control was used to control the price of housing in New York City and in other cities across the country

Government Intervention Price Floor – min. price for a good or service Minimum wage – minimum price that an employer can pay a worker for an hour of labor Used for many farm products around the world; federal government responds to low commodity prices by providing emergency financial aid to farmers When wages are set above the equilibrium level by law, firms employ fewer workers than they would at the equilibrium price

Changes in Market Equilibrium Chapter 6 Section 2

Changes in Market Equilibrium Changes in Price Factors that affect price include advances in technology new government taxes & subsidies changes in the prices of raw materials & labor used to produce the good Surplus – when quantity supplied exceeds quantity demanded at a given price forces suppliers to reduce prices, resulting in quantity of demand to rise

A Shift in Supply Computer printers are an example of a good whose price goes DOWN because of improvements in technology New technological processes have reduced the price of manufacturing MP3 players. If demand is unchanged, more MP3 players will be sold at a lower price

Finding A New Equilibrium In response to rising car traffic, demand for bicycles has increased. The new equilibrium point will show more bicycles sold, but at a higher price.

Shifts in Demand Problem of Excess Demand Shortage – situation in which quantity demanded is greater than quantity supplied; also known as excess demanded Search costs – the financial and opportunity costs consumers pay when searching for a good or service Example: Elena is looking for an apartment, and she misses two days of work at the supermarket to visit several different apartments. The missed days of work are her search costs. When demand increases, BOTH the equilibrium price and equilibrium quantity also increase

Shortages Fads often lead to shortages, at least in the short term because buyers and sellers are unable to agree on a price for the good. When the supply of a nonperishable good is greater than the consumer wants to buy, either the good remains unsold or the price drops

Three Steps to Analyzing Changes in Equilibrium 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 equilibrium P and Q. 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 equilibrium P and Q. To determine the effects of any event,

EXAMPLE: The Market for Hybrid Cars P Q D1D1 S1S1 P1P1 Q1Q1 price of hybrid cars quantity of hybrid cars

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 right because high gas price makes hybrids more attractive relative to other cars. EXAMPLE 1: A Change in Demand EVENT TO BE ANALYZED: Increase in price of gas. P Q D1D1 S1S1 P1P1 Q1Q1 D2D2 P2P2 Q2Q2 STEP 3: The shift causes an increase in price and quantity of hybrid cars.

EXAMPLE 1: A Change in Demand P Q D1D1 S1S1 P1P1 Q1Q1 D2D2 P2P2 Q2Q2 Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted. Always be careful to distinguish between a shift in a curve and a movement along the curve.

Terms for Shift vs. Movement Along Curve Change in supply: a shift in the S curve occurs when a non-price determinant of supply changes (like technology or costs) Change in the quantity supplied: a movement along a fixed S curve occurs when P changes Change in demand: a shift in the D curve occurs when a non-price determinant of demand changes (like income or # of buyers) Change in the quantity demanded: a movement along a fixed D curve occurs when P changes

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 right because event reduces cost, makes production more profitable at any given price. EXAMPLE 2: A Change in Supply P Q D1D1 S1S1 P1P1 Q1Q1 S2S2 P2P2 Q2Q2 EVENT: New technology reduces cost of producing hybrid cars. STEP 3: The shift causes price to fall and quantity to rise.

The Roles of Prices Chapter 6 Section 3

The Role of Prices Prices in the Free Market Prices serve a vital role – they move land, labor, and capital into the hands of producers, and finished goods into the hands of buyers Advantages of Prices Price as an incentive Rising prices in a market will cause existing firms to produce more goods and will attract new firms to enter a market

The Advantages of Prices Advantages of Prices (continued) Prices as Signals A high price is a green light that tells producers that a specific good is in demand and that they should use their resources to produce more A low price is a red light to producers that a good is being overproduced To consumers, a low price is a green light to buy more A high price is a red light to stop and think before buying

The Advantages of Prices Advantages of Prices (continued) Flexibility Prices can be easily increased to solve a problem of excess demand, and they can be just as easily decreased to eliminate a problem of excess supply Supply shock – sudden shortage of a good Creates a problem of excess demand, suppliers cannot meet the needs of consumers Rationing – system of allocating scarce goods and services using criteria other than price

A Wide Choice of Goods One benefit of a market-based economy is the diversity of goods and services consumers can buy Rationing in the US, was a short-term hardship, that was instituted during WWII Forced US consumers to put the needs of the armed forces first, limiting consumers choices Rationing was chosen because a price-based system might have put food and housing out of the reach of some, and the government wanted to ensure every civilian a min. standard of living in wartime

Efficient Resource Allocation Efficient resource allocation means that economic resources – land, labor, and capital – will be used for their most valuable purposes Resources will flow to the uses that are most highly valued by consumers This flow is the most efficient way to use a society’s scarce resources

Prices and the Profit Incentive The Wealth of Nations, Adam Smith, 1776, explained that businesses prosper by finding out what people want, and then providing it Market Problems Imperfect competition (i.e. monopolies) can affect prices Spillover costs – costs of production that affect people who have no control over how much of a good is produced, also known as externalities Imperfect information – if all buyers and sellers not equally informed, poor decisions can result