1. Chapter 8 Section 4
P.O.D. 1

2. Objectives Explain how the equilibrium price is determined
Explain how shortages and surpluses affect price
Describe how shifts in the equilibrium price occur
Discuss how the forces underlying supply and demand affect prices

3. Supply and Demand TogetherP Q
Equilibrium: P has reached the level where quantity supplied equals quantity demanded S D
We now return to the latte example to illustrate the concepts of equilibrium, shortage and surplus.

4. Equilibrium In the real world demand and supply operate together
As Price of a good goes down Quantity Demanded goes up and Supply goes down
As Price goes up—QD goes down and Supply goes up

5. Equilibrium (cont.)
Equilibrium Price  Price at which the QD and the QS meet
The price of any good or service will find the level at which the QD and the QS are balanced
At this price there is enough of the good to satisfy consumers

6. Surplus: when quantity supplied is greater than quantity demanded P Q
when quantity supplied is greater than quantity demanded P Q
Example: If P = $5, S D
Surplus
then QD = 9 lattes
and QS = 25 lattes
resulting in a surplus of 16 lattes

7. Surplus: when quantity supplied is greater than quantity demanded P Q
when quantity supplied is greater than quantity demanded P Q
Facing a surplus, sellers try to increase sales by cutting the price. S D
Surplus
This causes QD to rise
and QS to fall…
…which reduces the surplus.

8. Surplus: when quantity supplied is greater than quantity demanded P Q
when quantity supplied is greater than quantity demanded P Q
Facing a surplus, sellers try to increase sales by cutting the price. S D
Surplus
Falling prices cause QD to rise and QS to fall.
Prices continue to fall until market reaches equilibrium.

9. Surplus
At prices above the equilibrium price, suppliers produce more than consumers want to purchase
Suppliers end up with large inventories of goods
This and other forces put pressure on the price to drop to the equilibrium price
When price drops:
Producers have less incentive to supply as much as before
Consumers begin to purchase greater quantity

10. Shortage: when quantity demanded is greater than quantity supplied P Q
when quantity demanded is greater than quantity supplied P Q
Example: If P = $1, S D
then QD = 21 lattes
and QS = 5 lattes
resulting in a shortage of 16 lattes
Shortage

11. Shortage: when quantity demanded is greater than quantity supplied P Q
when quantity demanded is greater than quantity supplied P Q
Facing a shortage, sellers raise the price, S D
causing QD to fall
and QS to rise,
…which reduces the shortage.
Shortage

12. Shortage: when quantity demanded is greater than quantity supplied P Q
when quantity demanded is greater than quantity supplied P Q
Facing a shortage, sellers raise the price, S D
causing QD to fall
and QS to rise.
Prices continue to rise until market reaches equilibrium.
Shortage

13. Shortages
Shortages occur when at the going price the QD is greater than the QS
Shortages will put pressure on prices to rise
Consumers will reduce their purchases while suppliers increase the quantity they supply

14. Shifts in Equilibrium Price

15. Change in Equilibrium Price

16. Change in Equilibrium Price

17. Price Ceilings
Occurs when the government puts a legal limit on how high the price of a product can be
In order for a price ceiling to be effective it must be set BELOW the natural market equilibrium
When a price ceiling is set (effectively) a shortage will occur

18. Price Ceilings

19. Price Ceilings

20. Price Floors The lowest legal price a commodity can be sold at
Government uses price floors to prevent prices from being too low
Most Common Price Floor = Minimum Wage
Also often used in agriculture to try to protect farmers
For a price floor to be effective it must be set ABOVE the equilibrium price
If a price floor is set effectively there will be a surplus

21. Price Floor

22. Price Floor

23. Demand Curve Shifters: # of buyersP Q
Suppose the number of buyers increases.
Then, at each price, quantity demanded will increase (by 5 in this example).
Beginning economics students often have trouble understanding the difference between a movement along the curve and a shift in the curve. Here, the animation has been carefully designed to help students see that a shift in the curve results from an increase in quantity at each price.
(A more realistic scenario would involve a non-parallel shift, where the horizontal distance of the shift would be greater for lower prices than higher ones. However, to remain consistent with the textbook, and to keep things simple, this slide shows a parallel shift.)

24. Summary: Variables That Affect Demand
Variable A change in this variable…
Price …causes a movement along the D curve
No. of buyers …shifts the D curve
Income …shifts the D curve
Price of related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve
Students should notice that the only determinant of quantity demanded that causes a movement along the curve is price. Also notice: price is one of the variables measured along the axes of the graph.
Here’s a handy “rule of thumb” to help students remember whether the curve shifts: If the variable causing demand to change is measured on one of the axes, you move along the curve. If the variable that’s causing demand to change is NOT measured on either axis, then the curve shifts.
This rule of thumb works with all curves in economics that involve an X-Y relationship. (I.e., it works for the supply curve, the marginal cost curve, the IS and LM curves, among many others, but it doesn’t apply to curves drawn on time series graphs.)

25. Supply Curve Shifters: input pricesP Q
Suppose the price of milk falls.
At each price, the quantity of Lattes supplied will increase (by 5 in this example).
Again, the animation here is carefully designed to help make clear that a shift in the supply curve means that there is a change in the quantity supplied at each possible price. If it seems tedious, you can turn it off. In any case, be assured that, by the end of this chapter, the animation of curve shifts will be streamlined and simplified.

26. Summary: Variables That Affect Supply
Summary: Variables That Affect Supply
Variable A change in this variable…
Price …causes a movement along the S curve
Input prices …shifts the S curve
Technology …shifts the S curve
No. of sellers …shifts the S curve
Expectations …shifts the S curve
Again, the price is the only determinant of quantity supplied that causes a movement along the curve. A change in any of the other determinants causes the supply curve to shift.

27. CONCLUSION: How Prices Allocate Resources
In market economies, prices adjust to balance supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.
In the textbook, the conclusion of this chapter offers some very nice elaboration on the second bullet point.