1. Unit 2 – Demand and Supply Price Ceilings and Price Floors
Economics 12
Unit 2 – Demand and Supply
Price Ceilings and Price Floors

2. More on Demand and Supply
Under what circumstances do the forces of demand and supply determine the price of products?
Only in a “perfectly competitive” market
Existence of bigness in the marketplace limits the efficient working of the market.
Laws of demand and supply are not scientific laws.
Alfred Marshall said “Economic laws are social laws – statements of tendencies, more or less certain, more or less definite”
Perfectly competitive – a market in which there are no big dominant firms and no interference by the government
Bigness – big corporations, big trade unions, big governments
Whenever there is a powerful participant or a group of participants buying or selling in the market, the benefits of competition will be seriously reduced.
Big firms cannot ignore the market and charge whatever prices they want. SUV example.

3. Determinants of Demand and Supply
Consumer preference
Consumer incomes
Prices of related producers
Expectations of future prices, incomes, or availability
Population
Its size, income distribution, and age distribution
Determinants of Supply
Prices of productive resources
Business taxes
Technology
Prices pf substitutes in production
Future expectations of suppliers
Number of suppliers
These all cause the Demand and Supply curves to shift either left (decrease) or right (increase).

4. Increases in Demand and Supply
D P Q
S P Q
Both changes tend to push up the quantity traded. However, the increase in demand will push the price up , whereas the increase in supply will push the price down.
Therefore, increases (decreases) in both demand and supply will cause the quantity to increase (decrease), but the effect on the price is indeterminate.
Higher demand leads to higher equilibrium price and higher equilibrium quantity.
Higher supply leads to lower equilibrium price and higher equilibrium quantity.

5. Increases in Demand and Supply
Both changes in isolation, tend to push up the quantity traded. However, the increase in demand will push the price up, whereas the increase in supply will push the price down.
Therefore, increases (decreases) in both demand and supply will cause the quantity to increase (decrease), but the effect on the price is indeterminate.

6. Demand and Supply Moving in Opposite Directions
When demand and supply move in opposite directions, the price will always move in the same direction as the demand change, but the effect on the quantity is indeterminate.

7. The Price System
The market system, also called the price system, performs two important and closely related functions :
Price Rationing
Resource Allocation

8. Price Rationing
Price rationing is the process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied.

9. Price Rationing
A decrease in supply creates a shortage at P0. Quantity demanded is greater than quantity supplied. Price will begin to rise.
The lower total supply is rationed to those who are willing and able to pay the higher price.

10. Price Rationing There is some price that will clear any market.
The price of a rare painting will eliminate excess demand until there is only one bidder willing to buy the single available painting.

12. Price Controls
Governments introduce price controls to correct what they see as undesirable market prices.
A price ceiling is a maximum price that sellers may charge for a good, usually set by government.
Price ceilings cause shortages.
Government believes present market price too high for many buyers
Rent control
National emergencies
Government establishing limits; not establishing a fixed price.

13. Allocation Mechanisms
Allocation mechanisms are used to allocate products that are in short supply.
The market
First come, first served
Queuing is a nonprice rationing system that uses waiting in line as a means of distributing goods and services.

14. Allocation Mechanisms
Producers’ preferences
Favored customers are those who receive special treatment from dealers during situations when there is excess demand.
Rationing
Ration coupons are tickets or coupons that entitle individuals to purchase a certain amount of a given product per month.
The problem with these alternatives is that excess demand is created but not eliminated.

15. Allocation Mechanisms
In 1974, the government used an alternative rationing system to distribute the available supply of gasoline.
At an imposed price of 57 cents per gallon, the result was excess demand.

16. Allocation Mechanisms
A black market is a market in which illegal trading takes place at market-determined prices.

17. Allocation Mechanisms
No matter how good the intentions of private organizations and governments, it is very difficult to prevent the price system from operating and to stop the willingness to pay from asserting itself.
With favored customers and black markets, the final distribution may be even more unfair than that which would result from simple price rationing.

18. Prices and the Allocation of Resources
Price changes resulting from shifts of demand in output markets cause profits to rise or fall.
Profits attract capital; losses lead to disinvestment.
Higher wages attract labor and encourage workers to acquire skills.
At the core of the system, supply, demand, and prices in input and output markets determine the allocation of resources and the ultimate combinations of things produced.

19. Supply and Demand Analysis: An Oil Import Fee
At a world price of $18, imports are 5.9 million barrels per day.
The tax on imports causes an increase in domestic production, and quantity imported falls.

20. Price Floors
A price floor is a minimum price that sellers may charge for a good, usually set by government.
Price floors cause surpluses
Government assisting producers and not the consumer
Agriculture
Another price control but with the opposite effect.

21. Dealing with a Surplus
How do you get rid of the surplus that a price floor inevitably produces?
Store it
Convert it
Likely to be expensive
Sell it abroad at reduced pricing
Termed dumping
Forbidden by many international conventions
Donate it
Destroy it

22. The Minimum Wage Another type of price floor
Minimum wage is the lowest rate of pay per hour for workers, as set by government.
Scenario:
Higher wage means employers are forced to economize on labour and will cut back on employment (quantity of labour demanded falls)
Higher wage attracts more workers (quantity of labour supplied increases)
Net result = surplus of labour (unemployment)
All methods of allocation, whether done by government or by the market, impose costs. These costs are not always obvious. What economic analysis does is to help us identify and understand the nature of these costs.

23. Stop Here for Today For a recap of today’s lesson, try: