1. Demand, Supply, and Prices

2. The Interaction of Demand and Supply
Seeking Equilibrium: Demand and Supply
The Interaction of Demand and Supply
KEY CONCEPTS
Market equilibrium
at a certain price, quantity demanded and quantity supplied are equal
Equilibrium price
price at which quantity demanded and quantity supplied are equal

3. Reaching the Equilibrium Price
EXAMPLE: Surplus, Shortage, and Equilibrium
Surplus – Qs > Qd
Shortage – Qd > Qs
Surplus, shortage shown above and below point of equilibrium
Surplus, shortage measured by horizontal distance between two curves
With surplus, prices tend to fall; producers cut back production
With shortage, prices rise; producers increase quantity supplied

4. Reaching the Equilibrium Price
EXAMPLE: Holiday Toys
Marketers sometimes overestimate popularity, others underestimate
Tickle Me Elmo doll introduced for holidays in 1996
at first sold slowly at $30; seemed stores would have surplus
fad caught on; shortage developed, price went up
by spring, supply doubled; demand decreased, price dropped to $25

5. Equilibrium Price in Real Life
KEY CONCEPTS
disequilibrium
imbalance between quantity demanded and quantity supplied

6. How the Price System Works
Prices as Signals and Incentives
How the Price System Works
KEY CONCEPTS
Competitive pricing—selling products at lower prices than others
lures customers away from rival producers
maintains overall profits by selling more units

7. How the Price System Works
EXAMPLE: Competitive Pricing
Elm Street Hardware prices snow shovels at $20
Uptown Automotive enters market, sells shovels at $13
has lower profit margin, but hopes to sell more units
Elm Street must choose to lower price or risk losing customers

8. How the Price System Works
EXAMPLE: Characteristics of the Price System
Neutral: interaction of consumers, producers sets equilibrium price
Market driven: market forces, not central planners determine prices
Flexible: surpluses, shortages lead producers to change prices
Efficient: prices adjust until maximum number of products sold

9. Prices Motivate Producers and Consumers
KEY CONCEPTS
Prices motivate consumers and producers in different ways
Incentive encourages people to take a certain action
In price system, incentives move producers and consumers
both act in ways consistent with own best interests

10. Prices Motivate Producers and Consumers
EXAMPLE: Prices and Producers
Prices signal whether it is good time to enter or leave a market
Rising prices create expectation of profits, leading producers to enter
Falling prices and possibility of losses lead producers to leave

11. Prices Motivate Producers and Consumers
EXAMPLE: Prices and Consumers
Surpluses result in lower prices that motivate consumers to buy
producers signal to consumers through advertising, store displays
High prices usually encourage consumers to buy substitutes
may signal shortage of a product
may signal product has a higher status than others

12. Michael Dell: Using Price to Beat the Competition
Lowering Costs to Reduce Prices
Dell bypassed retailers, sold directly over telephone
Each computer built to customer requirements after ordered
this lowered costs, Dell became low-price leader in market
Internet sales pioneer—close customer contact, easy to adjust prices
Dell now entering consumer electronics market

13. Imposing Price Ceilings
Intervention in the Price System
Imposing Price Ceilings
KEY CONCEPTS
Government interferes to keep some prices from going too high
Price ceiling—legal maximum price a seller may charge for a product
set below the equilibrium price, so shortage results

14. Imposing Price Ceilings
EXAMPLE: Football Tickets and Price Ceilings
College sells 30,000 football tickets at $15
60,000 fans want tickets
College could resolve shortage by raising price to reach equilibrium
College wants to keep price affordable for students
On game day, some people sell tickets for $50 or more

15. Imposing Price Ceilings
EXAMPLE: Rent Control as a Price Ceiling
Rent-control laws kept housing affordable for low-income families
Rents did not match market, so shortage of rental housing developed
Landlords unwilling to increase own costs by maintaining properties
City of Santa Monica solution: let market set initial rent
rent control board regulates yearly increases

16. Setting Price Floors KEY CONCEPTS
Government intervenes to increase income to certain producers
Price floor—legal minimum price buyers may pay for product
Various programs protect agricultural products
encourage farmers to produce abundant supply of food

17. Setting Price Floors EXAMPLE: Minimum Wage as a Price Floor
Minimum wage—least amount employer may pay for one hour of work
set by government
If set above equilibrium price for job, employers may employ fewer workers
unemployment increases
If set below equilibrium price, minimum wage has no effect

18. Rationing Resources and Products
KEY CONCEPTS
In national emergency, government may distribute products, resources
Rationing—way of allocating products using factors other than price
Black market—illegal buying and selling of products
violates price controls, rationing

19. Rationing Resources and Products
EXAMPLE: Rationing Resources
During WWII, U.S. rationed consumer goods so all could afford them
allocated resources toward war effort, not consumers
From 1946–2002, North Korea strict rationing; system inefficient, corrupt
In 1996–2000, widespread famine; people set up unofficial markets
In 2002, markets legalized; prices, wages rose; government may turn back

20. Rationing Resources and Products
EXAMPLE: Black Markets—An Unplanned Result of Rationing
Black markets common result of rationing;
in U.S. during WWII, black market for scarce goods developed
Pre-2002 North Korea, trade of most products forbidden or restricted
on the whole, black market prices very high
post-2002 black market continues since many products still illegal