Chapter 7 Prices

Rationing Governments have tried to operate economies where they control prices and quantities. During WWII, the U.S. did this with rationing of gasoline. People were given coupons allowing them to buy a pre-determined amount of gasoline based upon their need. The rationing coupons turned could be turned into money, which raised the price of the gasoline to the price people would have paid without rationing.

Prices Prices in our economy are determined by the amount of supply and demand for that economic product As changes occur in supply and demand, price also changes. The market in which an economic product competes will have an affect on price.

Market Equilibrium The price of an economic product will occur where the quantity demanded = the quantity supplied for that product.

Market Equilibrium Model Given: Current Level of Demand

Market Equilibrium Given: Current Level of Demand Current Level of Supply ****************************

Market Equilibrium Given: Current Level of Demand Current Level of Supply **************************** Equilibrium price occurs at Pe1 and Qe2

Economic Model The graph of supply, demand and equilibrium price is an example of an economic model. An economic model displays in graphic form some change in economic conditions.

Economic Shortage Model Given: Current level of supply and demand Equilibrium P and Q ********************************

Economic Shortage Model Given: Current level of supply and demand Equilibrium P and Q ******************************** Price drops below equilibrium to P2

Economic Shortage Model Given: Current level of supply and demand Equilibrium P and Q ******************************** Price drops below equilibrium to P2 Quantity demanded is now Qd2 Quantity supplied is now Qs2 Conclusion: When price drops below equilibrium, Qd > Qs

Economic Shortage If price drops below equilibrium in the short run, a shortage occurs. When the shortage occurs, competitors will realize that they can charge higher prices and price will go back up to equilibrium!

Economic Surplus Model Given: Current level of supply and demand Equilibrium P and Q ********************************

Economic Surplus Model Given: Current level of supply and demand Equilibrium P and Q ******************************** Price rises above equilibrium to P2

Economic Surplus Model Given: Current level of supply and demand Equilibrium P and Q ******************************** Price rises above equilibrium to P2 Quantity demanded is now Qd2 Quantity supplied is now Qs2

Economic Surplus Model Given: Current level of supply and demand Equilibrium P and Q ******************************** Price rises above equilibrium to P2 Quantity demanded is now Qd2 Quantity supplied is now Qs2 Conclusion: When price rises above equilibrium, Qs > Qd

Economic Surplus If price rises above equilibrium in the short run, a surplus occurs. When the surplus occurs, competitors will realize that if they charge too high of a price that they will not sell their product and price will go back up to equilibrium!

Change in Level of Demand – Affect on Price Review what causes demand curve to shift: Cravings for seasonal products Change is disposable income Change in price of a complement Change in price of a substitute Changes in tastes, styles, and preferences Changes in expectations

Increase in Level of Demand Given: Current level of supply and demand Equilibrium P and Q ********************************

Increase in Level of Demand Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of demand shifts to D1

Increase in Level of Demand Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of demand shifts to D1 New equilibrium price is now Pe2 New equilibrium quantity is now Qe2

Increase in Level of Demand Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of demand shifts to D1 New equilibrium price is now Pe2 New equilibrium quantity is now Qe2 Conclusion: When the level of demand increases, equilibrium P and Q both increase.

Decrease in Level of Demand Given: Current level of supply and demand Equilibrium P and Q ********************************

Decrease in Level of Demand Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of demand shifts to D2

Decrease in Level of Demand Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of demand shifts to D2 New equilibrium price is now Pe2 New equilibrium quantity is now Qe2

Decrease in Level of Demand Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of demand shifts to D2 New equilibrium price is now Pe2 New equilibrium quantity is now Qe2 Conclusion: When the level of demand decreases, equilibrium P and Q both decrease.

Changes in Level of Supply- Affect on Price Review what causes the supply curve to shift: Change in price of an input Change in productivity

Increase in Level of Supply Given: Current level of supply and demand Equilibrium P and Q ********************************

Increase in Level of Supply Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of supply shifts to S1

Increase in Level of Supply Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of supply shifts to S1 New equilibrium price is now Pe2 New equilibrium quantity is now Qe2

Increase in Level of Supply Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of supply shifts to S1 New equilibrium price is now Pe2 New equilibrium quantity is now Qe2 Conclusion: When the level of supply increases, equilibrium P decreases and equilibrium Q increases.

Decrease in Level of Supply Given: Current level of supply and demand Equilibrium P and Q ********************************

Decrease in Level of Supply Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of supply shifts to S2

Decrease in Level of Supply Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of supply shifts to S2 New equilibrium price is now Pe2 New equilibrium quantity is now Qe2

Decrease in Level of Supply Given: Current level of supply and demand Equilibrium P and Q ******************************** Level of supply shifts to S2 New equilibrium price is now Pe2 New equilibrium quantity is now Qe2 Conclusion: When the level of supply decreases, equilibrium P increases and equilibrium Q decreases.

Economic Markets A market is a place that allows buyers and sellers to deal in economic products Factors Markets: Where the factors of production (land, labor, and capital) are bought and sold Product Market: Where Goods and Services are bought and sold.

Circular Flow of Economic Activity

Circular Flow of Economic Activity

Circular Flow of Economic Activity

Circular Flow of Economic Activity

Circular Flow of Economic Activity

Circular Flow of Economic Activity

Circular Flow of Economic Activity

Circular Flow of Economic Activity

Circular Flow of Economic Activity

Importance of Circular Flow When American consumers spend money on foreign goods and services, the money leaves our economic system and becomes a part of their circular flow. The result: Prices will increase when American business tries to make up for profits lost to foreign competition.

Types of Economic Markets Pure Competition Monopolistic Competition Oligopoly Monopoly

Pure Competition Almost infinite number of buyers and sellers All competitors products are identical No brand names No advertising Buyers and sellers can leave the market without affecting price Buyers and sellers well informed so no need to be loyal to a seller No examples in real life Seller has NO CONTROL over price

Pure Competition Model In Pure Competiton the demand curve is purely elastic

Pure Competition Model In Pure Competiton the demand curve is purely elastic At P1, demand is zero

Pure Competition Model In Pure Competiton the demand curve is purely elastic At P1, demand is zero At P2, demand is zero

Monopolistic Competition Still many buyers and sellers in the market Product differentiation: sellers make their product slightly different in order to develop a brand preference Difference may be real (hamburgers, sweepers) or imaginary (aspirin, light bulbs, batteries) Seller has SLIGHT CONTROL over price

Oligopoly Few large sellers in the market Products may be differentiated Many car models (real); airlines (imaginary) Opposing price philosophies: Get a piece of “big pie” by not undercutting competition vs. looking out for own profits Normally a “market leader” will set prices and others in industry will follow suit Sellers have MUCH CONTROL over price

Oligopoly Airlines Gasoline Automobiles

Oligopoly Why few competitors in an oligopoly? Huge startup costs for new competitor Possible patents or control of resources by existing competitors Existing competitors will sacrifice profits in short run to wipe out entry of new competitors

Monopoly One seller of the product or service No close substitutes No examples in real life Seller has TOTAL CONTROL over price

Types of Monopolies Natural Monopolies Geographic Monopolies Utilities, telephones Government gives franchise exclusive rights to a territory in return for regulation Geographic Monopolies Local newspaper

Types of Monopolies Technological Monopolies Government Monopolies New technique for doing something. Government Monopolies City water, sewer, garbage, transportation

Why Allow Monopolies? Best use of resources: Imagine 10 utility poles going down the street Best way to save costs Economies of scale: larger is more efficient

Disadvantages of Monopolies No benefits of competition such as lower prices and new improved products Less efficient use of resources No need to conserve to make a profit, just raise prices.

Control of Monopolies Consumers try to find substitutes Example: Satellite dish instead of cable TV Government controls price Utility company must get permission from government to raise prices due to increased costs.

Monopolies In a Monopoly the demand curve is purely inelastic

Monopolies In a Monopoly the demand curve is purely inelastic In theory, any price could be charged and quantity demanded would remain the same.

Industry Pricing vs. Individual Firm Supply and demand determine the price for the industry.

Industry Pricing vs. Individual Firm Supply and demand determine the price for the industry. Marginal Revenue = Selling Price

Industry Pricing vs. Individual Firm Supply and demand determine the price for the industry. Marginal Revenue = Selling Price Marginal costs high at first, decrease with economies of scale, and then increase as we become inefficient.

Industry Pricing vs. Individual Firm Geyers will maximize profits if it sells Q units at the market price.

Industry Pricing vs. Individual Firm Geyers will maximize profits if it sells Q units at the market price. The shaded area represents profit at Q units sold. Profits for firm maximized where MR = MC!

Industry Pricing vs. Individual Firm If less units are sold than where MR = MC, it can be seen that profits will be lower.