Download Prices - Greater Atlanta Christian Schools

Impact of Prices
Chapter 6
Shortage
• Let’s say that Loony’s uptown decides to sell
their CDs for $3 each.
• More than likely there will be a lot more
people wanting to buy CDs than Loony’s has
to sell.
• Why? Because at such a low price, the
quantity demanded is quite high. But Loony’s
does not want to sell that many at such a low
price.
Shortage
• This situation is called a shortage
• Shortage - when Qd > Qs at current market
price.
– Amount of Shortage = Qd – Qs
Shortage
Result of Shortage:
• If you are the manager of Loony’s and you find
that you are selling out of CDs at $3, what do
you want to do?
– Raise the price
• Buyers can’t get all they want. Therefore,
competition among buyers drive prices up.
• P will increase
Shortage
Shortage
P
0
Q
Shortage
P
D
0
Q
Shortage
P
S
D
0
Q
Shortage
P
S
Psh
D
0
Qs
Qd
Amount of Shortage
Q
Results of Shortage
P
S
Psh
D
0
Qs
Qd
Q
Results of Shortage
P
S
E
P*
Psh
D
0
Qs
Q* Qd
Q
Surplus
• Let’s say that as the manager, you raised the
prices of CDs to $20.
• At $20 you would love to sell a lot of CDs, but
not a lot of people are willing to pay $20 for a
CD.
• So the CDs keep piling up as they come in
from your supplier, but they don’t seem to be
going out the door in sales.
Surplus
• This situation is called a surplus
• Surplus - when Qs > Qd at current market
price.
• Amount of surplus = Qs - Qd
• Note - not correct to say Supply exceeds
Demand, but rather that quantity supplied
exceeds quantity demanded.
Results of Surplus
Result of Surplus:
• As manager you have to decide what do with
all these CDs that are piling up and not selling.
What do you do?
– Have a sale!
Results of Surplus
• Firms have more than they can sell.
Therefore, firms lower price to sell the
product.
• As price decreases, Qd increases and Qs
decreases
• P will decrease
Surplus
Surplus
P
0
Q
Surplus
P
S
0
Q
Surplus
P
S
D
0
Q
Surplus
Amount of
Surplus
P
S
Psur
D
0
Qd
Qs
Q
Results of Surplus
Amount of
Surplus
P
S
Psur
D
0
Qd
Qs
Q
Results of Surplus
Amount of
Surplus
P
S
Psur
E
P*
D
0
Qd
Q*
Qs
Q
Equilibrium in the Market
• Note that if the price is below P* then there
will be a shortage causing price to rise
• If the price is above P* then there will be a
surplus causing price to fall
• It’s as if P* is a magnet that keeps drawing
price to it (and consequently quantity to Q*)
• This magnet is sometimes called “The Invisible
Hand”
Equilibrium in the Market
• Equilibrium - where quantity demanded
equals quantity supplied.
• Equilibrium Price (P*) - price where
equilibrium occurs.
Equilibrium
P
S
E
P*
D
0
Q*
Q
Changes in Equilibrium
• Remember that Supply and Demand are
drawn under the ceteris paribus assumption.
• Any factors which cause Supply and/or
Demand to change will affect equilibrium
price and quantity.
Change in Demand
• Demand will change for any of the factors
discussed previously.
• For instance, let’s say the demand for CDs
increased due to an increase in income
Increase in Demand
Increase in Demand
P
0
Q
Increase in Demand
P
D
0
Q
Increase in Demand
P
S
D
0
Q
Increase in Demand
P
S
P*
E
D
0
Q*
Q
Increase in Demand
P
S
P*
E
D’
D
0
Q*
Q
Increase in Demand
P
S
P*’
P*
E’
E
D’
D
0
Q* Q*’
Q
Change in Supply
• Supply will change for any of the factors
discussed previously.
• For instance, let’s say that the government
lowers taxes on CDs
Increase in Supply
Increase in Supply
P
0
Q
Increase in Supply
P
D
0
Q
Increase in Supply
P
S
D
0
Q
Increase in Supply
P
S
P*
E
D
0
Q*
Q
Increase in Supply
P
S
S’
P*
E
D
0
Q*
Q
Increase in Supply
P
S
S’
P*
E
P*’
E’
D
0
Q* Q*’
Q
Increase in Supply and Demand
Increase in Supply and Demand
P
0
Q
Increase in Supply and Demand
P
S
0
Q
Increase in Supply and Demand
P
S
D
0
Q
Increase in Supply and Demand
P
S
E
P*
D
0
Q*
Q
Increase in Supply and Demand
P
S
E
P*
D’
D
0
Q*
Q
Increase in Supply and Demand
P
S
S’
E
P*
D’
D
0
Q*
Q
Increase in Supply and Demand
P
S
S’
P*’
P*
E
E’
D’
D
0
Q*
Q*’
Q
Increase in Supply and Demand
Increase in Supply and Demand
P
0
Q
Increase in Supply and Demand
P
D
0
Q
Increase in Supply and Demand
P
S
D
0
Q
Increase in Supply and Demand
P
S
P*
E
D
0
Q*
Q
Increase in Supply and Demand
P
S
S’
P*
E
D
0
Q*
Q
Increase in Supply and Demand
P
S
S’
P*
E
D’
D
0
Q*
Q
Increase in Supply and Demand
P
S
S’
P*
P*’
0
E
E’
D’
D
Q*
Q*’
Q
Increase in Supply and Demand
Increase in Supply and Demand
P
0
Q
Increase in Supply and Demand
P
S
0
Q
Increase in Supply and Demand
P
S
D
0
Q
Increase in Supply and Demand
P
S
E
P*
D
0
Q*
Q
Increase in Supply and Demand
P
S
S’
E
P*
D
0
Q*
Q
Increase in Supply and Demand
P
S
S’
E
P*
D’
D
0
Q*
Q
Increase in Supply and Demand
P
S
S’
E
E’
P*’= P*
D’
D
0
Q*
Q*’
Q
Price Controls
Government can sometimes step in to control
prices
There are two types of price controls - Price
Ceilings and Price Floors
Price Ceilings
• Price Ceiling - sets a maximum price that is
allowed by law.
• Result of Price Ceiling:
– Stay at a permanent shortage situation
• Note that a price ceiling can be any price the
government chooses. It is, however only
effective if it is below the equilibrium price
Price Ceiling
• Example of Price Ceiling
• Rent controlled apartments
• In New York City, San Francisco, Boston, and
other cities the city or state determines the
maximum amount that can be charged for
rent on many apartments.
• A maximum price is a price ceiling
Rent Controlled Apartments
Rent Controlled Apartments
P
0
Q
Rent Controlled Apartments
P
S
0
Q
Rent Controlled Apartments
P
S
D
0
Q
Rent Controlled Apartments
P
S
P*
D
0
Q*
Q
Rent Controlled Apartments
P
S
P*
($900)
Pceiling
($600)
D
0
Qs
(20)
Q* Qd
Q
(40)
Amount of Shortage (In Thousands)
Winners and Losers
Who gains and loses with price ceilings:
• 1. Benefit - those who get rent controlled
apartments
• 2. Loses - those who can’t find apartments
due to the shortage.
• 3. Loses - landlords who must accept lower
rent.
Price Floors
• Price Floor - sets a minimum price that is
allowed by law.
• Result of Price Floor
• Stay at a permanent surplus situation
• Note that a price floor can be set at any price,
but is only effective if it is above the
equilibrium price
Price Floors
• Example of Price Floor
• Minimum Wage Legislation
• The minimum wage is a lowest price the
government will allow firms to pay for
labor.
• A minimum price is a price floor
Price Floors
• When we look at the labor market it is similar
to other supply and demand diagrams except
for the labels.
• L - quantity of workers
• w - wages (the price we pay workers)
• It is also different because the suppliers of
labor are households, not firms and the
demanders of labor are firms, not households
Minimum Wage Legislation
Minimum Wage Legislation
Wage
0
# of Workers
Minimum Wage Legislation
Wage
S
0
# of Workers
Minimum Wage Legislation
Wage
S
D
0
# of Workers
Minimum Wage Legislation
Wage
S
w*
D
0
L*
# of Workers
Minimum Wage Legislation
Amount of Unemployed
Workers
Wage
S
Wfloor
($5.15)
w*
($4.50)
D
0
Ld (2) L*(4)
Ls (6)
# of Workers
(millions of workers)
Winners and Losers
Who gains and loses with price floors:
• 1. Benefit - those who get higher wages
• 2. Loses - those who can’t find jobs at the
higher wage
• 3. Loses - firms who must pay higher
wages.
Prices as Signals
• The laws of supply & demand describe how
people and firms respond to a change in price.
• Prices are a signal that tell a
consumer/producer how to adjust. (if goods
are in short supply or available)
Price as Signals - Producers
Green Light- A high price is a
green light that tells producers
a specific good is in demand
and they should produce more
New suppliers produce more
Red Light - a low price is a red
light to producers that a good
is being overproduced
Price as Signals - Consumers
Green Light – a low price
is a green light to buy
more of a good. It has a
low opportunity cost
for the consumer
Red Light – A high price is
a red light to stop and
think carefully before
buying.
Elastic vs. Inelastic
• When talking about the demand and the price of
goods (services) certain goods are considered to be
elastic or inelastic.
– Elastic means that certain goods (luxury) are
sensitive to changes in price.
• Ex: Chocolate syrup
• At the same note, certain goods are inelastic.
– Inelastic means that the good (necessity) is not
sensitive to price changes.
• Ex: Bread, milk, etc.
Equilibrium
P
S
E
P*
D
0
Q*
Q