Chapter 6 – Price Cutler – Economics

BELLRINGER What would happen if the government decided gas prices should be lowered by $2.50 per gallon?

Section 1 – Combining Supply and Demand Balancing the Market Defining Equilibrium Graphing Equilibrium Disequilibrium Excess Demand Excess Supply Government Intervention Price Ceilings The Cost of Price Ceilings Ending Rent Control Price Floors Minimum Wage Price Supports in Agriculture

Balancing the Market Market System Consumers can buy productions they want Sellers make enough profit to stay in business Sellers respond to changing needs of consumers Turning competing interests into a positive outcome for both sides

Balancing the Market Buyers and sellers come together in the market Combining Supply and Demand Review Demand Schedule Price of goods compared to how much is produced Review Supply Schedule Price of goods compared to how much is consumed

Demand and Supply Schedule Combined Supply and Demand Schedule Price of a slice of pizza Quantity demanded Quantity supplied Result $ .50 300 100 $1.00 250 150 $1.50 200 200 $2.00 150 250 $2.50 100 300 $3.00 50 350

Defining Equilibrium Equilibrium: The point at which quantity demanded and quantity supplied are equal Balance between price and quantity Market is then stable The amount produced will equal the amount consumed

Price of a slice of pizza Combined Supply and Demand Schedule Graphing Equilibrium Price per slice Equilibrium Point Finding Equilibrium Price of a slice of pizza Quantity demanded Quantity supplied Result Combined Supply and Demand Schedule $ .50 300 100 $3.50 $3.00 $2.50 $2.00 $1.50 $1.00 $.50 Slices of pizza per day 50 150 200 250 350 Supply Demand $2.00 $2.50 $3.00 150 100 50 250 300 350 Surplus from excess supply $1.00 250 150 Shortage from excess demand $1.50 200 Equilibrium Equilibrium Price a Equilibrium Quantity

Disequilibrium Disequilibrium: a point when quantity supplied does not equal quantity demanded Creates excess demand or excess supply

Excess Demand Price $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 50 100 150 200 250 300 350 Slices of Pizza

Excess Demand At $1.00 per slice Creates a Shortage QD = 250 Slices QS = 150 Slices Creates a Shortage

Excess Supply Price $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 50 100 150 200 250 300 350 Slices of Pizza

Excess Supply At $2.50 per slice Creates a Surplus QD = 100 Slices QS = 300 Slices Creates a Surplus

Combined Supply and Demand Schedule Price of a slice of pizza Analyze the Data Combined Supply and Demand Schedule Price of a slice of pizza Quantity demanded Quantity supplied Result $ .50 300 100 Shortage Occurs because QD > QS $1.00 250 150 $1.50 200 200 Equilibrium QD = QS $2.00 150 250 Surplus Occurs because QD < QS $2.50 100 300 $3.00 50 350

BELLRINGER Can you think of any products you buy that have recently changed in price?

Government Intervention Markets tend to reach equilibrium Price Ceiling: a maximum price that can be legally charged for a good or service Price Floor: a minimum price for a good or service

Price Ceilings Rent Control Housing is essential but wages might not keep up with the supply and demand of houses Reduces the quantity and quality of housing

Cost of Price Ceilings When price cannot rise to equilibrium, market determines who receives good or service By setting price below equilibrium, profits are reduced Cost cutting occurs Poor quality homes/apartments

Ending Rent Control Landlords gain an incentive to maintain buildings What affect does it have on the number of apartments? Rent Graph

Price Floors Minimum price set by the government to be paid for a good or service Minimum Wage Base level pay for work

Price Floors Minimum wage above equilibrium rate decreases employment

Price Floor Price $4.50 $5.15 2 4 6 Labor

Price Supports in Agriculture Price floors are used for many farm products Government would buy excess crops when price fell below floor

Section 2 – Changes in Market Equilibrium Changes in Price Understanding a Shift in Supply Finding a New Equilibrium Changing Equilibrium A Fall in Supply Shifts in Demand Problem of Excess Demand Return to Equilibrium A Fall in Demand

Changes in Price Excess supply will cause firms to cut prices Falling prices cause QD to rise QS will fall until they meet again These are changes ALONG the supply or demand curve… not shifts

Changes in Price What shifts the supply curve? Technology Change New taxes/Subsidies by GOVT Input costs change Because they want to be at equilibrium, curve shifts will create a new equilibrium price and quantity

Understanding a Shift in Supply Falling prices affect on supply CD players were expensive initially Now less than $100 and compete with MP3 or digital music Fall in production costs shifts supply curve to the right

Shifts in Supply Graph A: A Change in Supply $800 $600 $400 $200 Price Price Output (in millions) Graph A: A Change in Supply 1 2 3 4 5 Original supply Demand a New supply b c

Shift in Supply As we saw… The shift in the supply curve created a surplus. The price level didn’t change so now suppliers are offering more but demand hasn’t caught up!

Finding a New Equilibrium Excess supply or a surplus will cause producers to lower prices to eliminate the surplus Did the price drop change the demand curve?

New Equilibrium Graph A: A Change in Supply $800 $600 $400 $200 Price Price Output (in millions) Graph A: A Change in Supply 1 2 3 4 5 Original supply Demand a New supply b c

Change in Equilibrium Curve will keep shifting while new technology is introduced to lower production costs Equilibrium changes constantly Changes in the market Consumer wants and needs Production costs

Fall in Supply Supply curve can shift to the left with a drop in supply A strike that results in higher wages A tax by the government

Shifts in Demand New fads for Christmas New version of a product iPhone 5

Shifts in Demand Graph B: A Change in Demand Output (in thousands) $60 $50 $40 $30 $20 $10 900 800 700 600 500 400 300 200 100 Price New demand c b Supply Original demand a Graph B shows how the market finds a new equilibrium when there is an increase in demand.

Problem of Excess Demand Shifting the demand curve to the right creates shortages

Shifts in Demand Graph B: A Change in Demand New demand c b Supply Original demand a $60 $50 $40 $30 $20 $10 Price 100 200 300 400 500 600 700 800 900 Output (in thousands)

Return to Equilibrium Prices will rise by produces as a result of this change in demand Fall in demand has the opposite effect

BELLRINGER What is the “Black Market?”

Section 3 – The Role of Prices Prices in the Free Market The Advantages of Prices Price as an Incentive Price as Signals Flexibility Price System is “Free” A Wide Choices of Goods Rationing Shortages The Black Market Efficient Resource Allocation Prices and the Profit Incentive The Wealth of Nations Market Problems

Prices in Free Market Prices serve a major role in the free market economy Helps move the FOP

Advantages of Price Very Universal Price acts as an incentive Act as a standard measure of value Barter system as alternative Price acts as an incentive Think of the Law of Demand and Law of Supply

Advantages of Prices Prices as Signals – Producers Higher prices signal to producers to make more Also signals new suppliers to enter market Lower prices signal too much is produced Signals suppliers to leave the market

Advantages of Prices Prices as Signals – Consumers Low prices signal to buy more Low prices = low opportunity cost High price to stop and think about a purchase

Advantages of Prices Flexibility Prices can easily be increased to solve shortages (excess demand) Prices can easily be decreased to solve surpluses (excess supply)

Advantages of Prices Supply Shock: a sudden shortage of a good Creates excess demand Gasoline for example Rationing Allocating scare goods and services using criteria other than price How easy is it to increase supply?

Supply Shock and Rationing Price $2.50 $5.15 2 4 6 Gallons

Price Shock and Rationing Raising prices quickest way to solve shortage People with higher demand will still consume Creating new equilibrium

Advantages of Price Price System is “Free” No cost to administer price Unlike central planning Soviet Union employed thousands of people to organize the economy A farmer can decide what to plan based on what he thinks will be most profitable Prices help goods flow through the economy

Wide Choice of Goods Market Based Economy offers diverse goods and services Prices allow a “target” consumer base Bentley Fewer choices in Centrally Planned Reduce costs to meet quotas

Rationing and Shortages Despite being inexpensive, products were often hard to purchase in Soviet Union Rationing creates shortages

Rationing in the US During WWII Rationing existed GOVT Intent was to ensure everyone had a level standard of living during wartime You needed ration points and money to purchase products Guns or Butter Resources were allocated to guns Leaving few for butter

The Black Market Black Market: A market in which goods are sold illegally Allows consumers to buy rationed products buy paying more money

Efficient Resource Allocation Free market ensures resources are allocated efficiently FOP used for most valuable purpose Resources adjust to change in demands of consumers Resources go to the consumer who values a good or service the most

Price and Profit Incentive What happens with a hot summer and the demand for air conditioners and fans? How would producers respond to this demand?

Price and Profit Incentive $100.00 $250.00 500 1000 1500 Air Conditioners

Wealth of Nations Adam Smith – 1776 Not because of charity that a baker or butcher provide people food A profit is made by providing food Business prospers by finding out what people want Other systems haven’t worked…

Market Problems Imperfect Competition Spillover Costs (externalities) Not enough suppliers reduces competition Why lower price to have MR = MC Spillover Costs (externalities) Costs of production that affect people who have no control over how much of a good is produced Pollution Imperfect Information Consumers who lack knowledge of alternatives