Putting Supply & Demand Together ECO Foster Price Controls Distortions to the Supply & Demand Model: Price Controls

Putting Supply & Demand Together: The Market for Cameras What is the equilibrium price and quantity? What happens at P=$70? What happens at P=$25? Supply Demand $70 $50 $25 Price Quantity

The Market for Cameras What does the area under Demand represent? $79.99 $78.59 $75.99 $72.99 $70.99 Demand $50 Quantity Price $80 80 $5,200 = $50*(80) + (.5)*($30)*(80) = $ $1200 = $5,200 But, consumers paid... $4,000; so Consumer Surplus = $1,200 Area = Total consumer value

Why does it take a higher price to induce producers to increase the quantity supplied? The Market for Cameras What does the area under Supply represent? Supply 80 $50 Quantity Price $10 They need to offer higher payments to attract resources from their alternative uses… Their next best uses. And, what is that worth? Area = $10*80 + (.5)*$40*80 = $2,400 Producer Surplus = Producer Surplus = $ $2,400 = $1,600

The Market for Cameras Freely functioning markets tend to maximize the consumer and producer surplus. They maximize the value we get from our limited resources. Supply Demand 80 $50 Quantity Price Consumer Surplus Producer Surplus What is so good about markets? Markets are an efficient mechanism in determining What to produce?

Price Ceilings Distortions to the Supply & Demand Model: Price Controls – Price Ceilings A price ceiling is a maximum (legal) price. To be effective it must be set below P e What problem does this cause? How is it resolved? Quantity Price PePe P* QeQe QDQD QSQS Supply Demand

Price Ceilings Price Controls – Price Ceilings Lost surplus means lost value. Consumer payments may rise to well above P e. Sellers have incentives to charge & consumers have an incentive to pay. Quantity Price PePe P* QeQe QDQD QSQS Supply Demand

A price floor is a minimum (legal) price. To be effective it must be set above P e What problem does this cause? How is it resolved? Quantity Price PePe P* QeQe QDQD QSQS Supply Demand Price Floors Price Controls – Price Floors

Lost surplus means lost value. Example: Butter. Quantity Price PePe P* QeQe QDQD QSQS Supply Demand And, it gets even worse … Government stores surplus Resources produce goods that we cant have; we consume less; inefficient. It gets worse … Government buys surplus Price Floors Price Controls – Price Floors

Example: Min. wage. Govt doesnt buy excess. Violators are fined. Quantity Price PePe P* QeQe QDQD QSQS Supply Demand Must a minimum wage result in a surplus of unsold labor? Yes, if it is an effective price floor, it must. Price Floors Price Controls – Price Floors

Supply & Demand Problems #1. In the market for oranges, what will happen if there is great weather in Florida and California? Supply Demand Price Quantity PePe QeQe

Supply Demand Price Quantity PePe QeQe New Supply New Price New Quantity Supply increases; price falls; output rises Supply & Demand Problems #1. In the market for oranges, what will happen if there is great weather in Florida and California?

Putting Supply & Demand Together ECO Foster Price Controls Distortions to the Supply & Demand Model: Price Controls