Chapter 6: Prices Economics Mr. Robinson

Section 1: Combining Supply & Demand

The supply curve (S) is positively sloped--higher prices correspond with large quantities. This positive slope indicates the law of supply. The demand curve (D) is negatively sloped--higher prices correspond with smaller quantities. This negative slope indicates the law of demand.

In a market graph, like the one displayed here, the equilibrium price is found at the intersection of the demand curve and the supply curve.

Price of a slice of pizza Combined Supply and Demand Schedule Balancing the Market 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

Market Disequilibrium If the market price or quantity supplied is anywhere but at the equilibrium price, the market is in a state called disequilibrium. There are two causes for disequilibrium: Excess Demand Excess demand occurs when quantity demanded is more than quantity supplied. Excess Supply Excess supply occurs when quantity supplied exceeds quantity demanded.

Balancing the Market The point at which quantity demanded and quantity supplied come together is known as equilibrium. Qs>Qd Excess Supply Price of market balance: P - price Q - quantity of good S - supply D - demand P0 - price of market balance A - surplus of demand - when P<P0 B - surplus of supply - when P>P0 Equilibrium Qs=Qd Excess Demand Qs<Qd

Market Disequilibrium Interactions between buyers and sellers will always push the market back towards equilibrium. Excess supply = price cuts Demand will…? Excess Demand = price increases

Price Ceiling & Price Floor In some cases the government steps in to control prices. These interventions appear as price ceilings and price floors. A price ceiling is a maximum price that can be legally charged for a good. Example: rent control A price floor is a minimum price, set by the government, that must be paid for a good or service. Example: minimum wage

Section 2: Changes in Market Equilibrium

Two Simple Rules for Movements vs. Shifts Rule One When an independent variable changes and that variable does not appear on the graph, the curve on the graph will shift. Rule Two When an independent variable does appear on the graph, the curve on the graph will not shift, instead a movement along the existing curve will occur.

Change in Quantity Supplied vs. Change in Supply Movement along the supply curve. Caused by a change in the price of the product. Change in Supply A shift in the supply curve, either to the left or right. Caused by a change in a determinant other than the price. Input prices Technology Expectations

Change in Quantity Supplied Price of Ice-Cream Cone S C $3.00 A rise in the price of ice cream cones results in a movement along the supply curve. A 1.00 Quantity of Ice-Cream Cones 1 5 30

Change in Supply S3 S1 S2 Business that makes ice cream cones closes Price of Ice-Cream Cone S1 S2 Decrease in Supply Increase in Supply Technology increases production of ice cream cones Quantity of Ice-Cream Cones 30

Shifts in Supply Curve

Change in Quantity Demanded vs. Change in Demand Movement along the demand curve. Caused by a change in the price of the product. Change in Demand A shift in the demand curve, either to the left or right. Caused by a change in a determinant other than the price. Consumer income Prices of related goods Tastes Expectation

Changes in Quantity Demanded Price of Cigarettes per Pack A tax that raises the price of cigarettes results in a movement along the demand curve. C $4.00 A 2.00 D1 12 20 Number of Cigarettes Smoked per Day

Change in Demand D2 D1 An increase in income... $3.00 2.50 Increase Price of Ice-Cream Cone $3.00 An increase in income... 2.50 Increase in demand 2.00 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12

Shifts in Demand Curve

How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone 1. Hot weather increases the demand for ice cream... D2 Supply $2.50 New equilibrium 2. ...resulting in a higher price... 2.00 Initial equilibrium D1 7 10 Quantity of Ice-Cream Cones 3. ...and a higher quantity sold. 46

How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone 1. An earthquake reduces the supply of ice cream... S2 S1 New equilibrium $2.50 2. ...resulting in a higher price... 2.00 Initial equilibrium Arrange students in groups and give them hypothetical scenarios that force them to shift either supply or demand and then have them write their answers on the board. Focus on the three steps to analyze equilibrium. Demand 1 2 3 4 7 8 9 10 11 12 13 Quantity of Ice-Cream Cones 3. ...and a lower quantity sold. 46

Section 3: The Role of Prices

The Role of Prices in a Free Market Prices serve a vital role in a free market economy. Prices help move land, labor, and capital into the hands of producers, and finished goods in to the hands of buyers. Prices create efficient resource allocation for producers and a language that both consumers and producers can use. Creates a standard measure of value

Advantages of Prices 1. Prices as an Incentive Prices communicate to both buyers and sellers whether goods or services are scarce or easily available. Prices can encourage or discourage production. 2. Signals Think of prices as a traffic light. A relatively high price is a green light telling producers to make more. A relatively low price is a red light telling producers to make less. 3. Flexibility In many markets, prices are much more flexible than production levels. They can be easily increased or decreased to solve problems of excess supply or excess demand. 4. Price System is "Free" Unlike central planning, a distribution system based on prices costs nothing to administer.

A Wide Choice of Goods Consumers can choose among similar products Prices allow producers to target the audience they want

Efficient Resource Allocation A market system, with its fully changing prices, ensures that resources go to the uses that consumers value most highly. Market Problems Imperfect competition between firms in a market can affect prices and consumer decisions. Spillover costs, or externalities, are costs of production, such as air and water pollution, that “spill over” onto people who have no control over how much of a good is produced. If buyers and sellers have imperfect information on a product, they may not make the best purchasing or selling decision.