Download Economics: Principles in Action

Combining Supply and Demand
• How do supply and demand create balance in the
marketplace?
• What are differences between a market in equilibrium
and a market in disequilibrium?
• What are the effects of price ceilings and price floors?
Chapter 6
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Balancing the Market
The point at which quantity demanded and
quantity supplied come together is known as
equilibrium.
Finding Equilibrium
Equilibrium Point
Combined Supply and Demand Schedule
$3.50
$2.50
$2.00
Equilibrium
Price
$1.50
$1.00
$.50
Supply
0
Chapter 6
50
a
Equilibrium
Quantity
Price per slice
$3.00
Demand
100 150 200 250 300
Slices of pizza per day
Section
Price of
a slice
of pizza
Quantity
demanded
Quantity
supplied
$ .50
300
100
$1.00
250
150
$1.50
200
200
$2.00
150
250
$2.50
100
300
$3.00
50
350
350
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Result
Shortage from
excess demand
Equilibrium
Surplus from
excess supply
Market Disequilibrium
If the market price or quantity supplied is
anywhere but at the equilibrium price, the market
is in a state called disequilibrium. There are two
causes for disequilibrium:
Excess Demand
Excess Supply
• Excess demand occurs
when quantity demanded
is more than quantity
supplied.
• Excess supply occurs when
quantity supplied exceeds
quantity demanded.
Interactions between buyers and sellers will
always push the market back towards
equilibrium.
Chapter 6
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Shortage:
•P
$6.00
when quantity demanded is greater than quantity
supplied
•S
•D
$5.00
$4.00
$3.00
$2.00
$1.00
•Shortage
$0.00
0
Chapter 6
•Example:
If P = $1,
•then
QD = 21 lattes
•and
QS = 5 lattes
•resulting in a
shortage of 16 lattes
5
Section
•Q
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Shortage:
•P
$6.00
when quantity demanded is greater than
quantity supplied
•S
•D
$5.00
•Facing a shortage,
sellers raise the price,
•causing QD to fall
•and QS to rise,
•…which reduces the
shortage.
$4.00
$3.00
$2.00
$1.00
•Shortage
•Q
$0.00
0
Chapter 6
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Shortage:
•P
$6.00
when quantity demanded is greater than quantity
supplied
•S •Facing a shortage,
sellers raise the price,
•D
$5.00
•causing QD to fall
•and QS to rise.
$4.00
•Prices continue to
rise until market
reaches equilibrium.
$3.00
$2.00
$1.00
•Shortage
•Q
$0.00
0
Chapter 6
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Surplus:
•P
$6.00
•D
when quantity supplied is greater than quantity
demanded
•Surplus
•Example:
If P = $5,
•S
•then
QD = 9 lattes
$5.00
$4.00
•and
QS = 25 lattes
$3.00
$2.00
•resulting in a
surplus of 16 lattes
$1.00
•Q
$0.00
0
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Surplus:
•P
$6.00
•D
$5.00
$4.00
•Surplus •S •Facing a surplus,
sellers try to increase
sales by cutting the price.
•Falling prices cause
QD to rise and QS to fall.
$3.00
•Prices continue to fall until
market reaches
equilibrium.
•Q
$2.00
$1.00
$0.00
0
Chapter 6
when quantity supplied is greater than quantity
demanded
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Surplus:
•P
$6.00
•D
$5.00
$4.00
$3.00
$2.00
$1.00
when quantity supplied is greater than quantity
demanded
•Surplus
•Facing a surplus,
•S
sellers try to
increase sales by
cutting the price.
•This causes
QD to rise •and QS to
fall…
•…which reduces the
surplus.
•Q
$0.00
0
Chapter 6
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Price Ceilings
In some cases the government steps in to
control prices. These interventions appear as
price ceilings and price floors.
• A price ceiling is a maximum price that can be
legally charged for a good.
• An example of a price ceiling is rent control, a
situation where a government sets a maximum
amount that can be charged for rent in an area.
Chapter 6
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Price Floors
• A price floor is a minimum
price, set by the government,
that must be paid for a good
or service.
Chapter 6
Section
• One well-known price floor is
the minimum wage, which
sets a minimum price that an
employer can pay a worker for
an hour of labor.
Main Menu
Section 1 Assessment
1. Equilibrium in a market means which of the following?
(a) the point at which quantity supplied and quantity demanded are the
same
(b) the point at which unsold goods begin to pile up
(c) the point at which suppliers begin to reduce prices
(d) the point at which prices fall below the cost of production
2. The government’s price floor on low wages is called the
(a) market equilibrium
(b) base wage rate
(c) minimum wage
(d) employment guarantee
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Chapter 6
Section
Main Menu
Section 1 Assessment
1. Equilibrium in a market means which of the following?
(a) the point at which quantity supplied and quantity demanded are the same
(b) the point at which unsold goods begin to pile up
(c) the point at which suppliers begin to reduce prices
(d) the point at which prices fall below the cost of production
2. The government’s price floor on low wages is called the
(a) market equilibrium
(b) base wage rate
(c) minimum wage
(d) employment guarantee
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Chapter 6
Section
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Changes in Market Equilibrium
• How do shifts in supply affect market equilibrium?
• How do shifts in demand affect market equilibrium?
• How can we use supply and demand curves to
analyze changes in market equilibrium?
Chapter 6
Section
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Shifts in Supply
• Understanding a Shift
– Since markets tend toward equilibrium, a change in
supply will set market forces in motion that lead the
market to a new equilibrium price and quantity sold.
• Excess Supply
– A surplus is a situation in which quantity supplied is
greater than quantity demanded. If a surplus occurs,
producers reduce prices to sell their products. This
creates a new market equilibrium.
• A Fall in Supply
– The exact opposite will occur when supply is decreased.
As supply decreases, producers will raise prices and
demand will decrease.
Chapter 6
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Shifts in Demand
• Excess Demand
– A shortage is a situation in which quantity demanded
is greater than quantity supplied.
• Search Costs
– Search costs are the financial and opportunity costs
consumers pay when searching for a good or service.
• A Fall in Demand
– When demand falls, suppliers respond by cutting
prices, and a new market equilibrium is found.
Chapter 6
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Analyzing Shifts in Supply and Demand
Graph A: A Change in Supply
Graph B: A Change in Demand
$800
$60
a
Supply
$50
b
Original
supply
$40
c
Price
Price
$600
$400
c
$30
a
b
$20
$200
New
supply
Demand
New
demand
Original
demand
$10
0
1
2
3
4
5
0
100
200
Output (in millions)
300
400
500
600
700
800
Output (in thousands)
• Graph A shows how the market finds a new equilibrium
when there is an increase in supply.
• Graph B shows how the market finds a new equilibrium
when there is an increase in demand.
Chapter 6
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900
Three Steps to Analyzing Changes in Equilibrium
To determine the effects of any event,
1. Decide whether event shifts S curve,
D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see
how the shift changes equilibrium P and Q.
Chapter 6
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EXAMPLE: The Market for Hybrid Cars
•price of
hybrid cars
•P
•S
1
•P1
•D
•Q1
1
•Q
•quantity of
hybrid cars
Chapter 6
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EXAMPLE 1:
EVENT TO BE
A Change in Demand ANALYZED:
Increase in price of gas.
STEP 1:
D curve shifts
because price of gas affects
demand for hybrids.
S curve does not shift, because
price of gas does not affect cost
of producing hybrids.
STEP 2:
D shifts right
because high gas price makes
hybrids more attractive relative to
other cars.
•P
•S
1
•P2
•P1
•D
STEP 3:
The shift causes an increase in
price
and quantity of hybrid cars.
Chapter 6
Section
•Q1 •Q2
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1
•D
2
•Q
EXAMPLE 1: A Change in Demand
Notice:
When P rises,
producers supply
a larger quantity
of hybrids, even
though the S curve
has not shifted.
Always be careful
to distinguish b/w
a shift in a curve
and a movement
along the curve.
Chapter 6
Section
•P
•S
1
•P2
•P1
•D
•Q1 •Q2
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1
•D
2
•Q
Terms for Shift vs. Movement Along Curve
• Change in supply: a shift in the S curve
– occurs when a non-price determinant of supply changes
(like technology or costs)
• Change in the quantity supplied:
a movement along a fixed S curve
– occurs when P changes
• Change in demand: a shift in the D curve
– occurs when a non-price determinant of demand
changes (like income or # of buyers)
• Change in the quantity demanded:
a movement along a fixed D curve
– occurs when P changes
Chapter 6
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EXAMPLE 2:
A Change in Supply
EVENT: New technology reduces cost of producing hybrid cars.
STEP 1:
S curve shifts
because event affects cost of
production.
D curve does not shift, because
production technology is not one
of the factors that affect demand.
STEP 2:
S shifts right
because event reduces cost,
makes production more profitable
at any given price.
•P
•S
1
2
•P1
•P2
•D
STEP 3:
The shift causes price to fall
and quantity to rise.
Chapter 6
•S
Section
•Q1•Q2
Main Menu
1
•Q
EXAMPLE 3:
A Change in Both Supply
and Demand
•P
STEP 1:
Both curves shift.
STEP 2:
Both shift to the right.
EVENTS:
price of gas rises AND
new technology reduces production
costs
1
2
•D
•Q1
Section
•S
•P2
STEP 3:
•P1
Q rises, but effect
on P is ambiguous:
If demand increases more than
supply, P rises.
Chapter 6
•S
Main Menu
1
•Q2
•D
2
•Q
Supply and Demand Together
•P
$6.00
•D
•S
$5.00
$4.00
$3.00
$2.00
•Equilibrium:
P has reached
the level where
quantity supplied
equals
quantity demanded
$1.00
•Q
$0.00
0
Chapter 6
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EXAMPLE 1: A Change in Demand
STEP 1:
D curve shifts
because price of gas affects
demand for hybrids.
S curve does not shift, because
price of gas does not affect cost
of producing hybrids.
STEP 2:
D shifts right
because high gas price makes
hybrids more attractive relative to
other cars.
STEP 3:
The shift causes an increase in
price
and quantity of hybrid cars.
Chapter 6
Section
EVENT TO BE
ANALYZED:
Increase in price of gas.
•P
•S
1
•P2
•P1
•D
•Q1 •Q2
Main Menu
1
•D
2
•Q
EXAMPLE 1: A Change in Demand
Notice:
When P rises,
producers supply
a larger quantity
of hybrids, even
though the S curve
has not shifted.
Always be careful
to distinguish b/w
a shift in a curve
and a movement
along the curve.
Chapter 6
Section
•P
•S
1
•P2
•P1
•D
•Q1 •Q2
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1
•D
2
•Q
EXAMPLE 2: A Change in Supply
STEP 1:
S curve shifts
because event affects cost of
production.
D curve does not shift, because
production technology is not one
of the factors that affect demand.
STEP 2:
S shifts right
because event reduces cost,
makes production more profitable
at any given price.
STEP 3:
EVENT: New technology
reduces cost of producing
hybrid cars.
•P
1
2
•P2
•D
•Q1•Q2
Section
•S
•P1
The shift causes price to fall
and quantity to rise.
Chapter 6
•S
Main Menu
1
•Q
Terms for Shift vs. Movement Along Curve
• Change in supply: a shift in the S curve
– occurs when a non-price determinant of supply
changes (like technology or costs)
• Change in the quantity supplied:
a movement along a fixed S curve
– occurs when P changes
• Change in demand: a shift in the D curve
– occurs when a non-price determinant of demand
changes (like income or # of buyers)
• Change in the quantity demanded:
a movement along a fixed D curve
– occurs when P changes
Chapter 6
Section
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Section 2 Assessment
1. When a new equilibrium is reached after a fall in demand, the new equilibrium has a
(a) lower market price and a higher quantity sold.
(b) higher market price and a higher quantity sold.
(c) lower market price and a lower quantity sold.
(d) higher market price and a lower quantity sold.
2. What happens when any market is in disequilibrium and prices are flexible?
(a) market forces push toward equilibrium
(b) sellers waste their resources
(c) excess demand is created
(d) unsold perishable goods are thrown out
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Chapter 6
Section
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Section 2 Assessment
1. When a new equilibrium is reached after a fall in demand, the new equilibrium has a
(a) lower market price and a higher quantity sold.
(b) higher market price and a higher quantity sold.
(c) lower market price and a lower quantity sold.
(d) higher market price and a lower quantity sold.
2. What happens when any market is in disequilibrium and prices are flexible?
(a) market forces push toward equilibrium
(b) sellers waste their resources
(c) excess demand is created
(d) unsold perishable goods are thrown out
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Chapter 6
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The Role of Prices
• What role do prices play in a free market system?
• What advantages do prices offer?
• How do prices allow for efficient resource
allocation?
Chapter 6
Section
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The Role of Prices in a Free Market
• Prices serve a vital role in a free market economy.
• Prices help move land, labor, and capital into the
hands of producers, and finished goods in to the
hands of buyers.
• Prices create efficient resource allocation for
producers and a language that both consumers
and producers can use.
Chapter 6
Section
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Advantages of Prices
Prices provide a language for buyers and sellers.
1. Prices as an Incentive
Prices communicate to both buyers and sellers whether goods or
services are scarce or easily available. Prices can encourage or
discourage production.
2. Signals
Think of prices as a traffic light. A relatively high price is a green light
telling producers to make more. A relatively low price is a red light
telling producers to make less.
3. Flexibility
In many markets, prices are much more flexible than production levels.
They can be easily increased or decreased to solve problems of excess
supply or excess demand. Supply shock could result in rationing.
4. Price System is "Free"
Unlike central planning, a distribution system based on prices costs
nothing to administer.
Chapter 6
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Efficient Resource Allocation
• Resource Allocation
– A market system, with its fully changing prices, ensures
that resources go to the uses that consumers value most
highly.
• Market Problems
– Imperfect competition between firms in a market can affect
prices and consumer decisions.
– Spillover costs, or externalities, are costs of production,
such as air and water pollution, that “spill over” onto
people who have no control over how much of a good is
produced.
– If buyers and sellers have imperfect information on a
product, they may not make the best purchasing or selling
decision.
Chapter 6
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Section 3 Assessment
1. What prompts efficient resource allocation in a well-functioning market
system?
(a) businesses working to earn a profit
(b) government regulation
(c) the need for fair allocation of resources
(d) the need to buy goods regardless of price
2. How do price changes affect equilibrium?
(a) Price changes assist the centrally planned economy.
(b) Price changes serve as a tool for distributing goods and services.
(c) Price changes limit all markets to people who have the most money.
(d) Price changes prevent inflation or deflation from affecting the supply
of goods.
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Chapter 6
Section
Main Menu
Section 3 Assessment
1. What prompts efficient resource allocation in a well-functioning market
system?
(a) businesses working to earn a profit
(b) government regulation
(c) the need for fair allocation of resources
(d) the need to buy goods regardless of price
2. How do price changes affect equilibrium?
(a) Price changes assist the centrally planned economy.
(b) Price changes serve as a tool for distributing goods and services.
(c) Price changes limit all markets to people who have the most money.
(d) Price changes prevent inflation or deflation from affecting the supply
of goods.
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Chapter 6
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A C T I V E L E A R N I N G 3:
A. fall in price of CDs
•P
STEPS
•The market for
music downloads
•S
1
1. D curve shifts
•P1
2. D shifts left
•P2
3. P and Q both
fall.
•Q2•Q1
Chapter 6
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•D
•D
2
1
•Q
•38
A C T I V E L E A R N I N G 3:
B. fall in cost of royalties
•P
(royalties are part
of sellers’ costs)
•The market for
music downloads
•S
•S
1
2
•P1
STEPS
1. S curve shifts
•P2
2. S shifts right
•D
3. P falls,
Q rises.
Chapter 6
Section
•Q1 •Q2
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1
•Q
•39
A C T I V E L E A R N I N G 3:
C. fall in price of CDs AND fall in cost of royalties
•
STEPS
•
1. Both curves shift (see parts A & B).
•
2. D shifts left, S shifts right.
•
•
3. P unambiguously falls.
Effect on Q is ambiguous:
The fall in demand reduces Q,
the increase in supply increases Q.
Chapter 6
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•40
EXAMPLE 3: A Change in Both Supply
and Demand
•P
EVENTS:
price of gas rises AND
new technology reduces
production costs
STEP 3, cont.
But if supply
increases more
than demand,
P falls.
Chapter 6
Section
•S
•S
1
2
•P1
•P2
•D
•Q1
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1
•Q2
•D
2
•Q
A C T I V E L E A R N I N G 3:
Changes in supply and demand
Use the three-step method to
analyze the effects of each event on
the equilibrium price and quantity of
music downloads.
Event A:
A fall in the price of compact discs
Event B:
Sellers of music downloads negotiate a
reduction in the royalties they must pay for
each song they sell.
Event C:
Events A and B both occur.
Chapter 6
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•42
CONCLUSION:
How Prices Allocate Resources
• Markets are usually a good way
to organize economic activity.
 In market economies, prices adjust to balance
supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.
Chapter 6
Section
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