CHAPTER 6: SECTION 1 Supply and Demand Together Moving to Equilibrium Supply and demand work together to determine price. For example, they work together to determine the price of corn at an auction. (See Transparency 6-1.) A surplus occurs when the quantity supplied of a good is greater than the quantity demanded. Surpluses occur only at prices above the equilibrium price. Prices fall when a surplus occurs, because suppliers hope to sell their inventory, or the excess stock of goods that they have on hand.

TRANSPARENCY 6-1: Supply and Demand at Work at an Auction Only at a price of $4 is the quantity demanded equal to the quantity supplied. When: Quantity supplied (Qs) > Quantity demanded (Qd) 5 Surplus Qd > Qs 5 Shortage Qd 5 Qs 5 Equilibrium

A shortage occurs when the quantity demanded of a good is greater than the quantity supplied. Shortages occur only at prices below equilibrium price. A shortage is the opposite of a surplus. Prices rise when there is a shortage. Buyers will offer to pay a higher price to get sellers to sell to them rather than to other buyers. A market is considered to be in equilibrium when the quantity of a good that buyers are willing and able to buy is equal to the quantity that sellers are willing and able to produce and offer for sale. When a market reaches equilibrium, quantity demanded equals quantity supplied.

The equilibrium quantity is the amount of a good that is bought and sold in a market that is in equilibrium. The equilibrium price is the price at which a good is bought and sold in a market that is in equilibrium.

What Causes Equilibrium Prices to Change? Either supply or demand must change in order for the equilibrium price to change. (See Transparency 6-2.) Demand can cause changes to the equilibrium price. If there is greater demand for a particular good, buyers are willing to pay a higher price to obtain that good. Supply can also cause changes to the equilibrium price. If the supply for a particular good exceeds the demand—a surplus exists—the price will decrease until it reaches an equilibrium price.

TRANSPARENCY 6-2: Moving to Equilibrium

Changes in Supply and in Demand at the Same Time So far, we have looked at situations where either supply or demand has changed. Often, both supply and demand are constantly changing. The change in equilibrium price will be determined by which changes more, supply or demand. If demand increases more than supply, the equilibrium price goes up. Does It Matter if Price Is at Its Equilibrium Level? When price is at its equilibrium level, there are no shortages or surpluses of any goods or services. All buyers and sellers are happy with the market.

Price Is a Signal Price serves as a signal that directs the allocation of resources toward producing the product with the highest demand.

What Are Price Controls? Sometimes the government prevents markets from reaching an equilibrium price. It may do so by setting a price ceiling or a price floor. (See Transparency 6-3.) A price ceiling is a price that is set lower than the equilibrium price. Buyers and sellers cannot legally buy and sell a good for more than this price. A government may set a price ceiling if it wants to make a good cheaper for consumers to buy. The government can also set a price floor, which is a price that is set above the equilibrium price. Buyers and sellers cannot legally buy and sell a good for less than this price. A government may set a price floor to assist a certain group of producers.

TRANSPARENCY 6-3: Price Controls Price ceiling Price floor A price ceiling creates a shortage and reduces the quantity of a good bought and sold. A price floor creates a surplus and reduces the quantity of the good bought and sold.

Price Controls and the Amount of Exchange Price ceilings and price floors have the unintended result of reducing the amount of trade in the economy.