1. Ch. 6: Demand, Supply and Prices

2. The Interaction of Demand and Supply
Market equilibrium – a situation in which the quantity demanded of a good or service at a particular price is equal to the quantity supplied at that price
Equilibrium price – is the price at which the quantity of a product demanded by consumers and the quantity supplied by producers are equal

3. Example: Market Demand and Supply Schedule
Karen – sandwich shop near office park
new lunch line – salads
makes 40, offers for $10 – sells 10
next makes 15, offers for $4 – sells all but 35 customers want more
continues to experiment until - makes 25, offers for $6 – sells all
Market equilibrium – quantity demanded and quantity supplied are in balance
Price per Salad ($)
Quantity Demanded
Quantity Supplied 10 40 8 15 35 6 25 4 2

4. Figure 6.1 – shows data gathered
combined market demand and supply schedule
where #’s are the same – market equilibrium at $6
Karen wants to make more profit – but she will not make much profit if any if she sold at the price the office workers want and vice versa

5. Example: Market Demand and Supply Curves
Possible to graph a combined market demand and supply schedule
figure 6.2 – Karen’s market demand and supply schedule
vertical – various prices salads sold at
horizontal – quantity of salads (quantity demanded or quantity supplied)
demand curve is plotted using prices and quantities demanded
supply curve is plotted using the prices and quantities supplied from combined schedule
curves intersect at one point – market equilibrium

6. Market Demand and Supply Curve

7. Reaching the Equilibrium Price
Markets do not arrive at equilibrium price instantly – need trial and error
Surplus – which is the result of quantity supplied being greater than quantity demanded – usually b/c prices are too high
Shortage – the result of quantity demanded being greater than quantity supplied – usually b/c prices are too low

8. Example: Surplus, Shortage, and Equilibrium
Figure 6.3. – equilibrium when neither a shortage nor a surplus
surplus shown in the orange area – measured by horizontal distance between the curves
when a surplus, prices tend to fall until surplus is sold and equilibrium reached
shortage show in the blue area – measured by horizontal distance between the curves
when a shortage, producers raise prices to try to balance quantity supplied and quantity demanded
also may try to increase quantity supplied to meet the quantity demanded at the lower price

9. Surplus, Shortage & Equilibrium

10. Example: Holiday Toys
Shortage most apparent for toys during holiday season
toys are fads and tastes change rapidly
difficult to know how much to supply and at what price
overestimate – surplus, underestimate – shortage
1996 – Tickle Me Elmo by Tyco Toys Inc.
expected toy to be popular
ordered 500,000 at $30 – sales started slow
then TV personalities promote it
sales took off – ran into a shortage

11. Equilibrium Price in Real Life
Disequilibrium – when there is an imbalance between quantity demanded and quantity supplied
real world relationship between demand and supply is very complex

12. Example: Change in Demand and Equilibrium Price
Price for athletic shoes
change in demand for one of 6 reasons : income, market size, consumer expectations, consumer taste, substitute goods, and complementary goods – prompts consumers to change the quantity demanded at every price

13. Figure – 6.4 – equilibrium at $75 and 3000 shoes
change in taste causes a ↓in demand – curve shifts left – new EP - $65
when consumers demand fewer goods and services at every price, EP will fall and suppliers will sell fewer units – even though the price is lower

14. Figure 6.5 - equilibrium at $75 and 3000 shoes
change in # of young adults causes ↑ in demand – curves shifts right – new EP - $90
when consumers demand more goods and services at every price – EP will ↑ and suppliers will sell more, even at higher prices

15. Example: Change in Supply and Equilibrium Price
Change in supply for one of 6 reasons: input costs, labor productivity, technology, govt. action, producer expectations, number of producers
figure 6.6 – equilibrium at $75 and 3,000 shoes
price of raw materials ↑, then a ↓ in supply – curve shifts left – new EP - $90
fewer goods and services at every price – EP will rise

16. Figure 6.7 - equilibrium at $75 and 3,000 shoes
new technology causes ↑ in supply – curve shifts right – new EP - $55
when more goods and services available at every price, EP will fall
EP falls when there is an ↓ in demand or an ↑ in supply
when consumers want less or producers supply more – prices ↓
EP rises when there is an ↑ in demand or a ↓ in supply
when consumers want more or producers a supply less – prices ↑

17. Sec. 2 : Prices as Signals and Incentives

18. How the Price System Works
Competitive pricing – occurs when producers sell goods and services at prices that best balance the twin desires of making the highest profit and luring customers away from rival producers
by entering at lower prices – a new supplier can add customers and maintain overall profits by selling more units

19. Example: Competitive Pricing
Snow shovels at Elm Street Hardware - $20
Uptown Automotive enters market – increases supply – price $13
lower profit margin but hopes to sell more to maintain profit
Elm Street can lower price or lose customers

20. Example: Characteristics of the Price System
1. It is neutral – prices do not favor either the producer or consumer b/c both make choices that help to determine the EP. The free interaction of the producers and consumers determines the EP in the market
2. It is market driven – market forces determine prices – so the system has no oversight or administration. The price system runs itself.

21. 3. It is flexible – when market conditions change, prices are able to change quickly in response. Surpluses and shortages motivate producers to change prices to reach equilibrium.
4. It is efficient – prices will adjust until the maximum # of goods and services are sold. Producers choose to use their resources to produce certain goods and services based on the profit they can make by doing so.

22. Prices Motivate Producers and Consumers
Consumers and producers have different attitudes toward price
consumers want low prices and producers want high prices
incentives encourage consumers and producers to act in certain ways consistent with their best interests

23. Example: Prices and Producers
For producers – price system has 2 advantages:
information – by acting as a signals to producers whether good time to enter or leave a particular market
motivation – rising prices and expectations of profit – motivate producer to enter
Falling prices and possibility or losses motivate to leave a market

24. Example: Prices and Producers
Shortage signals that consumer demand is not being met by existing suppliers
producers see shortage as opportunity to raise prices
higher prices act as incentive for producers to enter a market
Example – the prospect of selling goods at higher prices encourages producers to offer products for that market

25. Example: Prices and Producers
More producers motivated by higher prices to enter market – quantity supplied ↑
prices too high relative to consumer demand – surplus
Producers can reduce prices or reduce production to bring in line with quantity demanded at particular price
falling prices signal good time to leave a market
Some producers leave market completely due to increased competition and lower prices drive them out of business
most shift their business to focus on opportunities in markets with higher potential profits

26. Example: Prices and Producers
When a market is growing and there is unmet demand – producer may enter with a price lower than competitor
new producer can still earn profit by selling more units at lower price
it is expectation of profits or possibilities of losses that motivate producers to enter or leave a market

27. Economic Pacesetters: Michael Dell: Using Price to Beat the Competition
b. – Feb. 23, 1965 – Chairman of Dell
Began assembling and selling computers as a freshman in college
1984 – so successful – quit college to focus on business – sales worth $6 million 1st year
Approach to marketing and production was key to success
Sold over the phone to knowledgeable computer users & govt.
computers built to customer requirement & assembled after ordered
lower costs – low price leader in the market

28. Sales in 1986 - $69.5 million to $258 million in 1989
pioneer in internet sales as well
Maintained close contact with customers, adjusts prices as per market
competitors in retail stores had higher costs
By 2005 – leading supplier of PC’s – sales at $50 billion a yr.
Now looking to move into consumer electronics

29. Sec. 3: Intervention in the Price System

30. Imposing Price Ceilings
Some think it is a good idea to interfere with the pricing system to keep the price of a good or service from going too high
Price ceiling – an established maximum price that sellers may charge for a good or service
is set below the market equilibrium so a shortage will result

31. Example: Football Tickets and Price Ceiling
Ticket prices for college football games
Trenton U. – prints 30,000 tickets for each game for $15 each – 60,000 fans want them, shortage of 30,000 for every game
could let the price rise until quantity demanded and quantity supplied are equal
president wants tickets affordable for students
Game day – scalpers sell tickets for $50 or more

32. Example: Rent Control as a Price Ceiling
In the past – rent control laws to keep housing affordable for low income families
control when rent can be raised, by how much, no matter the market
unexpected consequences from rent control
no incentive to increase the supply of rental housing – shortage occurs
Landlords reluctant to invest money in property maintenance – conditions worsen
By 2005 – rent control less common due to making housing shortages worse

33. Example: Rent Control as a Price Ceiling
Santa Monica – late 1990’s – new law on rent controls
law allows property owners to let market determine initial rent on new tenant
city would regulate yearly rent increases
Effect – rents increases 40% to 85% - showing apartments had been priced artificially low

34. Setting Price Floors
Govt. sometimes intervenes in the price system to increase income to certain producers
Price floor – is an established minimum price that buys must pay for a good or service
goal – is to encourage farmers to produce an abundant supply of food

35. Example: Minimum Wage as a Price Floor
Minimum wage – the minimum legal price that an employer may pay a worker for one hour of work
1st minimum wage started in 1938 – 1930s a period of low wages – govt. hoped to increase the income of workers
if minimum wage set above equilibrium price for jobs in a market, employers may decide paying higher wages is not profitable – may employ fewer workers – unemployment increase
if minimum wage below equilibrium price – no effect

36. Rationing Resources and Products
Market uses prices to allocate goods and services
Rationing – is a system in which the govt. allocates goods and services using factors other than price
can be rationed on first come first served basis, a lottery
generally – a system of coupons allowing a person a certain amount of a good
Some try to skirt the rules to get goods and services – creating a black market
Black market – goods and services are illegally bought and sold in violation of price controls or rationing

37. Example: Rationing Resources
During WWII – US govt. empowered Office of Price Administration (1941) to ration scarce goods
hope to distribute goods to everyone, not just those who could afford the higher market prices of a shortage
allocated resources in ways that favored the war effort
led consumers to look for substitutes – ex. – margarine

38. Example: Rationing Resources
North Korea maintained strict rationing from to 2002
staples – meat, rice, cabbage strictly rationed – but system inefficient & corrupt
amount of rationing depended on who you knew, where you lived, your occupation
govt. officials in cities often got more than their allotment, while majority of people got by with less

39. Example: Rationing Resources
Between – famine made situation worse
ration coupons given but the rations were not
a million may have died due to the famine
The people established market to trade handicrafts for food
govt. legalized in 2002 – result – prices rose, wages increased
2005 – skeptical govt. considering going back to rationing

40. Example: Black Markets – An Unplanned Result of Rationing
When rationing starts – black markets start
during WWII – meat, sugar, gas – using stolen or counterfeit ration coupons
North Korea – free trade in grain forbidden – prices high in markets that did exist
1985 – cost half the average monthly salary to by a chicken on the black market
even after 2002 – black market flourished b/c forms of private property were illegal
some start to smuggle items from China to sell in North Korea