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CH. 6: DEMAND, SUPPLY AND PRICES
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
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 Demand
ed
Quantity Supplied
10 10 408 15 356 25 254 35 152 40 10
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
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
Market Demand and Supply Curve
10 15 25 35 400
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DemandSupply
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
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
Surplus, Shortage & Equilibrium
10 15 25 35 400
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DemandSupply
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
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
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
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 0.5 1.5 3 4 5
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0.5 2 3 4.5 5.5 70
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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
Example: Change in Supply and Equilibrium Price
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DS2S1
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
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 ↑
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SEC. 2 : PRICES AS SIGNALS AND INCENTIVES
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
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
Example: Characteristics of the Price System
-4 characteristics 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.
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.
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
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
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
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
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
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
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
Sec. 3: Intervention in the Price System
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
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
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
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
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
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
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
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
Example: Rationing Resources
North Korea maintained strict rationing from 1946 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
Example: Rationing Resources
Between 1996 -2000 – 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
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