Prices Chapter 6

Section 1: Combining Supply and Demand

Some things to remember…

BUYERS SELLERS Determine DEMAND Determine SUPPLY

Demand Quantity demanded – the amount of a good that buyers are willing and able to purchase. Law of Demand – the quantity demanded of a good falls when the price of the good rises.

Demand Curve Price of Ice-Cream Cone Quantity of Ice-Cream Cones $ A decrease in price increases quantity of cones demanded.

Change in Quantity Demanded –Movement along the demand curve. –Caused by a change in the price of the product.

Change in Quantity Demanded 0 D Price of Ice-Cream Cones Quantity of Ice-Cream Cones A tax that raises the price of ice-cream cones results in a movement along the demand curve. A B $2.00 4

Supply Quantity supplied is the amount of a good that sellers are willing and able to sell. Law of Supply – the quantity supplied of a good rises when the price of the good rises.

Supply Curve Price of Ice-Cream Cone Quantity of Ice-Cream Cones $ An increase in price increases quantity of cones.

Change in Quantity Supplied –Movement along the supply curve. –Caused by a change in the price of the product.

Change in Quantity Supplied 1 5 Price Quantity of Ice-Cream Cones 0 S 1.00 A C $3.00 A rise in the price of ice cream cones results in a movement along the supply curve.

Supply and Demand Together Equilibrium Qs = Qd

Supply and Demand Together At $2.00, the quantity demanded is equal to the quantity supplied! Demand Schedule Supply Schedule

Equilibrium of Supply and Demand Price of Ice-Cream Cone Quantity of Ice-Cream Cones 13 Equilibrium quantity Equilibrium price Equilibrium Supply Demand $2.00

Practice Problem: Donuts

Disequilibrium Describes any price or quantity not at equilibrium; when quantity supplied is not equal to quantity demanded in a market What would result?

Excess Supply When quantity supplied is more than quantity demanded Often occurs if the price is set too high and creates a surplus

What do you do to Fix the Problem? Cut prices to increase quantity demanded to the point of reaching equilibrium

Price of Ice-Cream Cone Quantity of Ice-Cream Cones 13 Supply Demand $3.00 Quantity Supplied Quantity Demanded $2.00 The Price Will Drop! If the price is too high (Qs > Qd)…

Excess Demand When quantity demanded is more than quantity supplied When the actual price in a market is below the equilibrium price, you have excess demand, because low prices encourage buyers and discourage sellers. Creates a shortage of supply.

What do you do to Fix Problem? To reach equilibrium, sellers raise prices to close the gap and will continue to charge that price until a factor (other than price) shifts the demand and/or supply.

Price of Ice-Cream Cone Quantity of Ice-Cream Cones 13 Supply Demand $1.00 Quantity Demanded Quantity Supplied $2.00 The Price Will Rise! If the price is too low (Qd > Qs)…

Disequilibrium to Equilibrium Whenever the market is in disequilibrium and prices are flexible, market forces will push the market toward the equilibrium. –Sellers do not like to waste resources on excess supply –When there is excess demand, profit seeking drives an increase in prices

Government Intervention In some cases, the government steps in to control prices.

Price Ceilings (Creates a Shortage) A MAXIMUM price set by the government that sellers can charge for a good or service Prevents prices from getting too high, enabling consumers to buy essential goods or services they wouldn’t be able to afford at the equilibrium price Example: Rent control

Price Ceiling QsQd Price Ceiling

Price Floors (Creates a Surplus) A MINIMUM price set by the government that consumers are required to pay for a good or service. Pushes price up, ensuring that producers receive a benefit for providing a good or service Example: Minimum wage

PRICE FLOOR QdQs Price Floor

Section 2: Changes in Market Equilibrium

Key Terms Surplus – when quantity supplied exceeds quantity demanded at a given price. Shortage – when quantity supplied in lower than the quantity demanded at a given price. Search costs – the financial and opportunity costs consumers pay in searching for a good or service. (ex. Driving to different stores to get a bargain)

What happens when supply or demand shifts?

REMEMBER…

What is a change in demand? Any change that alters the quantity demanded at every price. A shift in the demand curve, either to the left or right.

Shifts in the Demand Curve Price of Ice-Cream Cone Quantity of Ice-Cream Cones Increase in demand Decrease in demand D 2 DD 1 0

Factors that affect Demand Tastes & Preferences of Consumers Income of Consumers Related Goods: Substitutes & Complements Expectations of Future Price Changes Size of population/Market

What is a change supply? Any change that alters the quantity supplied at every price. A shift in the supply curve, either to the left or right.

Shifts in the Supply Curve Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 Increase in supply Decrease in supply S2S2 SS 1

Factors that affect Supply Technology International Events/Disasters Government Intervention Expectations for Future Price Changes Resource Costs # of Sellers in the Market

Problem Set: Shifting Demand/Supply

How shifting demand/supply affects equilibrium...

Four Steps to Analyzing Changes in Equilibrium Does the event shift the supply (TIGERS) or demand curve (TIRES)? Will the curve shift right ( ) or left ( )? Draw & label the new curve on your graph Locate the new equilibrium (price and qty)

If Demand Increases… D2D2 P2 P2 Q2 Q2

If Demand Decreases… D2D2 P2 P2 Q2 Q2

If Supply Increases… S2S2 P2 P2 Q2 Q2

If Supply Decreases… S2S2 P2 P2 Q2 Q2

Practice Problems

D2D2 P2 P2 Q2 Q2 Zinc Zinc was discovered to help shorten duration of colds

S2S2 P2 P2 Q2 Q2 Orange Juice Subzero temperatures destroy much of Florida’s citrus crop

S2S2 P2 P2 Q2 Q2 Red Delicious Apples Farmer invents new picking machine – Harvest apples in half the time

D2D2 P2 P2 Q2 Q2 Hotel Colorado Ski Resorts Colorado ski resorts announces 50% increase in lift ticket prices

Problem Set

Section 3: The Role of Prices

The Role of Prices Prices are a key element of equilibrium. In a free market, prices are a tool for distributing goods and resources throughout the economy.

Advantages of Prices Prices as an incentive –Prices provide information on a good’s demand and supply –Communicate to both buyers and sellers whether goods are in short supply or readily available –High prices = produce more by both existing firms and new ones entering the market

Advantages of Prices CONSUMERS –RED light = high price –Stop and think carefully about buying Prices as Signals SUPPLIERS –RED light = low price –A good is being overproduced –Consider using resources to produce something different

Advantages of Prices CONSUMERS –GREEN light = low price –Buy more of a good Prices as Signals SUPPLIERS –GREEN light = high price –Tells producers a specific product is in demand and to produce more –New suppliers join the market

Advantages of Prices Flexibility –Prices can be easily increased to solve the problem of excess demand, and just as easily decreased to eliminate a problem of excess supply –Supply shock – a sudden shortage of a good –Increasing prices is the easiest way to solve supply shock; only those who can afford the new price will still be in the market, allowing a new equilibrium to settle

Advantages of Prices Price System is “Free” –A distribution system based on price costs nothing to administer VS. –Central planning - - requires central planners to collect information on production and decide how resources are to be distributed

A Wide Choice of Goods Prices give suppliers a way to allow consumers to choose among similar products. VS. In a command economy, one organization decides what goods are produced (low variety) and how much stores will charge for these good.

Efficient Resource Allocation A market system, with its freely changing prices, ensures that resources go to the uses that consumers value most highly. Efficient resource allocation means that economic resources – land, labor, and capital – are used for their most valuable purposes. Resource use will also adjust to changing demand of consumers.

Prices and Profit Incentive Landowners tend to use their scarce property in the most profitable manner. Workers usually move toward high-paying jobs. Capital will be invested in the firms that pay the highest returns.

The Wealth of Nations Published in 1776, Adam Smith concluded that businesses prosper by finding out what people want, and then providing it.

Market Problems Imperfect competition can affect prices and higher prices can affect consumer decisions. Spillover costs – (a.k.a externalities) costs of production that affect people who have no control over how much of a good is produced; ex: water and air pollution Imperfect information – not having all the information/enough information can lead suppliers and buyers to make choices that may not be the best for them