EconomicsChapter 6

Prices

Chapter 6Section 1

Combining SupplyAnd

Demand

A market Equilibrium is the point at which quantity supplied and quantity demanded are equal.

At equilibrium the market for a good is stable.

At that point, buyers are willing to buy at the same price and quantity at which sellers are willing to sell.

This price is the equilibrium price.

On a graph, the equilibrium point is located at the point where the supply curve and demand curve intersect. A market is said to be in disequilibrium when the quantity supplied does not equal the quantity demanded at a certain price.

Balancing the Market• Equilibrium

Price

Quantity

Supply

Demand

Equilibrium

Price

Quantity

Supply

Demand

Equilibrium

Equilibrium on the combined demand and supply curve is where

quantity demanded is equal to quantity supplied.

Disequilibrium occurs when quantity supplied is

not equal to quantity demanded in a market.

Disequilibrium can produce one of two outcomes – excess

demand or excess supply.

Market DisequilibriumThese are also the two causes for

disequilibrium:

• Excess Demand

• Excess Supply

The problem of excess demand occurs when quantity demanded is more than quantity supplied.A price lower than the equilibrium price will encourage buyers and discourage sellers. Prices will rise because sellers hope to increase their profits.

The problem of excess supply occurs when quantity supplied exceeds quantity demanded.Prices will fall because sellers need to sell their supply.

Whenever there is excess in supply or demand, market forces work to create equilibrium.

Sometimes governments attemptto control prices in a market.

In some cases the government steps in to control prices. These interventions appear as price ceilings and price floors.

Rent control is a program put in place by government to prevent inflation during a housing crisis.

It is a type of program called a price ceiling, which is set by law, making essentials available to buyers.

Rent Control = Price Ceiling

One well known price floor is the minimum wage, which sets the minimum price an employer can pay an employee.

The Federal Government sets the level for the minimum wage in response to rising costs and income.

Minimum Wage= Price Floor

Chapter 6Section 2

Changes inMarket

Equilibrium

Section 1 described disequilibrium that occurs along a demand or supply curve.

If a price is higher or lower that equilibrium price, market forces push prices back towards equilibrium.

Sometimes, however, changes in market conditions lead to the shift of an entire demand curve or supply curve.

This means that the quantity demanded or supplied is now different at all prices levels.

These changes also push a market in disequilibrium, and market forces tend to bring it back to equilibrium. • Shifts in Supply

– Technology, Cost, Government, Imports, Expectations, # of suppliers

• Shifts in Demand– Income, Expectations, Population,

Trends/Advertising, Substitutes, Complements

Shifts in Supply

• Understanding a Shift

Old Equilibrium

New Equilibrium

Excess Supply

Surplus

Producers react to the surplus by lowering prices, and eventually price and quantity reached a new equilibrium.

A Fall in Supply

An outward shift in demand can be caused by a fad, such as the surge in popularity of a new toy.

Buyers want more toys than are supplied, and a shortage occurs.

During a shortage, producers and stores tend to raise prices.

A shortage is when quantity demanded is greater than quantity supplied.

The market price will rise until quantity supplied equals the quantity demanded, and a new equilibrium is established.

Shifts in Demand

Excess Demand–shortage –Search Costs

A Fall in Demand

Analyzing Shifts in Supply and Demand

$800

$600

$400

$200

0

Pric

e

Output (in millions)

Graph A: A Change in Supply

1 2 3 4 5

Original supply

Demand

a

New supply

b

c

Analyzing Shifts in Supply and Demand

Graph B: A Change in Demand

Output (in thousands)

$60

$50

$40

$30

$20

$10

0

900800700600500400300200100

Pric

e

Supply

Original demand

a

New demand

c

b

Chapter 6Section 3

TheRole of Prices

The Role of Prices in a Free Market

Advantages of Prices

Prices provide a language for buyers and sellers.

4 Advantages:

Four Advantages:

A low price is a signal to reduce the supply or leave the market.

First, prices are like signals that send information to buyers and sellers.

For buyers, a low price is a signal to buy, and a high price is a signal to think before buying.

Second, the advantage of prices is that they are flexible.

Prices can usually change more quickly than production levels.

A supply shock occurs when there is a sudden shortage of a good, such as wheat or gasoline.

So, Third, the advantage of prices is that they are their own incentive.

Because supply usually cannot be increased quickly, increasing prices helps resolve excess demand.

Fourth, the Price system is free for all, as the system adjusts itself under the correct actions.

Rationing is a system for allocating goods and services using tools other than price.

Centrally planned communities use rationing, not price to distribute goods and services.

Rationing is expensive to administer and it tends to lead to only a few products; not variety.

Efficient Resource Allocation

• Resource Allocation

Market Problems

Imperfect competition – Prices do not always work

efficiently in markets in which there is not much competition, or in which buyers and sellers do not have enough information.

Spillover costs –

Another problem is spillover costs, such as air and water pollution, that “spill over” onto other people who have no control over how much of a good is produced.

Another problem with price correction is making decisions after receiving imperfect information

Producers do not usually pay spillover costs, and the extra costs will be paid by consumers.

The graphic above demonstrates using price as a signal by which to make market decisions.