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Demand and Supply
Applications
Chapter 4
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES

price rationing The process by which the
market system allocates goods and services
to consumers when quantity demanded
exceeds quantity supplied.
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
PRICE RATIONING
The Market for Lobsters
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
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When supply is fixed or something for sale is
unique, its price is demand determined. Price is
what the highest bidder is willing to pay.
The adjustment of price is the rationing mechanism
in free markets.
Price rationing means that whenever there is a need
to ration a good—that is, when a shortage exists—in
a free market, the price of the good will rise until
quantity supplied equals quantity demanded—that
is, until the market clears.
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
Market for a Rare Painting
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
CONSTRAINTS ON THE MARKET AND
ALTERNATIVE RATIONING MECHANISMS

On occasion, both governments and private firms
decide to use some mechanism other than the
market system to ration an item for which there is
excess demand at the current price.
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
Oil, Gasoline, and OPEC
price ceiling A maximum price that sellers may
charge for a good, usually set by government.
Excess Demand (Shortage) Created by
a Price Ceiling
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
PRICES AND THE ALLOCATION OF RESOURCES
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Thinking of the market system as a mechanism for allocating
scarce goods and services among competing demanders is
very revealing, but the market determines much more than
just the distribution of final outputs.
It also determines what gets produced and how resources are
allocated among competing uses.
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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.
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
PRICE FLOORS
 price floor A minimum price below which
exchange is not permitted.
 minimum wage A price floor set under the
price of labor.
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SUPPLY AND DEMAND ANALYSIS:
AN OIL IMPORT FEE
The basic logic of supply and
demand is a powerful tool of
analysis.
The U.S. Market for Crude Oil, 1989
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
CONSUMER SURPLUS
 consumer surplus The difference between
the maximum amount a person is willing to
pay for a good and its current market price.
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
Market Demand and Consumer Surplus
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
PRODUCER SURPLUS
 producer surplus The difference between
the current market price and the full cost of
production for the firm.
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
Market Supply and Producer Surplus
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
COMPETITIVE MARKETS MAXIMIZE THE SUM OF
PRODUCER AND CONSUMER SURPLUS
Total Producer and Consumer Surplus
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
deadweight loss The net loss of
producer and consumer surplus from
underproduction or overproduction.
Deadweight Loss
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
POTENTIAL CAUSES OF DEADWEIGHT
LOSS FROM UNDER- AND
OVERPRODUCTION
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When supply and demand interact freely,
competitive markets produce what people
want at least cost, that is, they are efficient.
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