Supply and Demand

The Role of Prices Prices, or what someone is willing to pay for a good or service, and what a supplier is willing to provide, is a cornerstone of capitalism. This goes a long way to answering the three basic questions that an economic system: What do we make; How do we make it; Who gets it. While suppliers always want to get the maximum price for their goods (profit motive), buyers often are looking for the best deals.

In an open market, the buyer will find the best price for their good, and the producer that sells at that price will prosper, forcing other suppliers to either match that price, or their business might fail. Having an open market, in which suppliers are looking for products that people want, and can pay for, is considered an efficient use of resources. Because of this, an open market will provide a wide variety of goods and services. However, this is not always in the best interests of society in general.

Supply and Demand Market Balance When Supply and Demand meet, the market is said to be in balance. This point at which they meet on the graph is called the Equilibrium Point. The equilibrium point is considered very important in economics, because it is the point at which a “free market” will decide on the price of goods

The Equilibrium of Supply and Demand Price of Ice-Cream Cone Supply Demand Equilibrium Equilibrium price $2.00 Equilibrium quantity 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of Ice-Cream Cones

Disequilibrium Disequilibrium occurs when there is more supply than demand, or when there is more demand than supply. If the price of a good is higher than the equilibrium point, there will be an excess of suppliers, though little demand for the products. Conversely, if the price is lower than the equilibrium price, there is a lot of demand, though few suppliers to fill that demand.

Changes in Market Equilibrium Market equilibrium is rarely stable. Factors that affect supply and demand are constantly changing the market. Increases or decreases in supply and demand usually create shortages and surpluses in the markets, and prices change to reflect the new conditions.

Changes in Price Shortage Surplus A shortage occurs when there is an excess of demand or a decrease in supply. Typically, in response to an increase in demand, the prices of an item will rise, with a corresponding rise in supply, until new equilibrium is established. Surplus A surplus of goods occurs when there is an excess of supply. Prices of a good will fall, increasing demand, until, again, a new equilibrium is found.

Markets Not in Equilibrium (a) Excess Supply Price of Ice-Cream Supply Cone Surplus Demand $2.50 10 4 2.00 7 Quantity of Quantity demanded Quantity supplied Ice-Cream Cones

Markets Not in Equilibrium (b) Excess Demand Price of Ice-Cream Supply Cone Demand $2.00 7 1.50 10 4 Shortage Quantity of Quantity supplied Quantity demanded Ice-Cream Cones

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

How a Decrease in Supply Affects the Equilibrium Price of 1. An increase in the price of sugar reduces the supply of ice cream. . . Ice-Cream Cone S2 S1 Demand New equilibrium $2.50 4 2. . . . resulting in a higher price of ice cream . . . Initial equilibrium 2.00 7 Quantity of 3. . . . and a lower quantity sold. Ice-Cream Cones

Artificial Barriers Your book looks at different scenarios at which there is an artificial barrier that prevents the market from getting to an equilibrium point. These barriers can either fix the prices higher (Price Floor) or lower than the equilibrium point (Price Ceiling).

Price ceiling A barrier that keeps the price lower than the equilibrium point is called a price ceiling, as prices are not allowed to go higher than the price ceiling. An example of a price ceiling is rent control.

The Market for Gasoline with a Price Ceiling (a) The Price Ceiling on Gasoline Is Not Binding Price of Gasoline Demand Supply, S1 1. Initially, the price ceiling is not binding . . . Price ceiling P1 Q1 Quantity of Gasoline

The Market for Gasoline with a Price Ceiling (b) The Price Ceiling on Gasoline Is Binding Price of S2 Gasoline 2. . . . but when supply falls . . . Demand S1 P2 QS QD Price ceiling 4. . . . resulting in a shortage. 3. . . . the price ceiling becomes binding . . . P1 Q1 Quantity of Gasoline

Rent Control in the Short Run and in the Long Run (a) Rent Control in the Short Run (supply and demand are inelastic) Rental Price of Apartment Supply Demand Controlled rent Shortage Quantity of Apartments

Rent Control in the Short Run and in the Long Run (b) Rent Control in the Long Run (supply and demand are elastic) Rental Price of Apartment Supply Demand Controlled rent Shortage Quantity of Apartments

Price floor A barrier that keeps a price higher than the equilibrium point is called a price floor. In other words, the price cannot go lower than the price floor. One example of a price floor is the minimum wage.

A Market with a Price Floor (a) A Price Floor That Is Not Binding The government says that ice-cream cones must sell for at least $2; this legislation is ineffective at the current market price. Price of Ice-Cream Supply Cone Demand Equilibrium price $3 100 2 Price floor Quantity of Ice-Cream Equilibrium quantity Cones

A Market with a Price Floor (b) A Price Floor That Is Binding Price of Ice-Cream Supply Cone Demand Surplus $4 Price floor 80 120 3 Equilibrium price Quantity of Ice-Cream Quantity demanded Quantity supplied Cones

Effect of Taxes

How the Minimum Wage Affects the Labor Market Supply Labor demand Equilibrium employment wage Quantity of Labor

How the Minimum Wage Affects the Labor Market Supply Labor demand Labor surplus (unemployment) Minimum wage Quantity demanded Quantity supplied Quantity of Labor

Minimum Wage Ideology These are contentious issues, where many businesses and economists claim that having a minimum wage destroys jobs and depresses the economy. Others feel that these claims are not entirely true, and that having a minimum wage improves the quality of life for low wage workers and can stimulate the economy.

Problems in the Markets All is not well in Wonderland

Government Interference While the capitalist system goes a long way to addressing the questions of economics, there are problems. The first problem is the openness of the market, and government regulation of that market. While businesses and economists often rail that government interference in the market causes higher prices and inefficiencies, it is usually these very businesses that use government to stifle or prevent competition, thus making the market much less open. Large corporations have enormous amounts of money they can use to keep competitors out of the market, or prevent competing technologies from entering the market.

Example: Sony corporation of Japan wanted to introduce a new recording format called the DAT tape as the new format for video and music recording. While this format was very good, U.S. companies used the government to prevent this format from entering the U.S. market, and instead provide subsidies for Compact Disk (CD) technology. Compact disks became the dominant format for the next decade.

Stifling or Prevention of Competition Microsoft is so large, and has so many deals with computer manufacturers, that it is nearly impossible for other software companies to try to get into the operating system business. Because Microsoft has so much money, it can offer it’s products to manufacturers at below cost, making it so that even if another company were to make a better operating system, they could not offer the prices that Microsoft can, therefore they go out of business. Microsoft has 93.8% market share in operating systems, with gross sales at $9.75 billion in 2003.

Externalities Negative Externality Positive Externality Another problem is from negative externalities, costs of business that businesses do not want to pay, and therefore the local residents or others end up paying this price in terms of direct costs, health care, and even death. Negative externalities allow companies to sell their products at a lower “cost” than it should, making the product easier to purchase and use. Positive externalities can enhance societal value, adding to other businesses (technological improvement, national park), or to the societies well being.

Imperfect Information Imperfect information is another problem. Most theories of economics assume some level of buyer information when making choices. This goes hand in hand with the Rational Actor theory. Because you do not often know what the market conditions really are, what costs are, or what competing products may be available, you often ending up making “poor” decisions.

No Inherent Morality Lastly, though certainly not least, is that capitalism may address the idea of efficient resource allocation, this allocation has no conscience. In other words, the market has no morality, and does not make adjustments for the social well being of people or of society in general.