Download Chapter 6 Prices_Brown

CHAPTER 6:
PRICES
(SUPPLY AND DEMAND TOGETHER)
Review
• What does the law of supply state?
– As price rises, quantity supplied rises.
– Looking through the eyes of the PRODUCER!
• What does the law of demand state?
– As price rises, quantity demanded falls.
– Looking through the eyes of the CONSUMER!
Supply and Demand Together
Equilibrium Price
 The price that balances supply and
demand. Perfect price to charge for the
product. No surplus or shortages.
Equilibrium Quantity
 Quantity that balances supply and
demand.
 Both of these are located where the
supply and demand curve meet.
DEMAND and SUPPLY
TOGETHER AT LAST
Equilibrium Price
$
13
12
11
10
9
8
7
Demand
(market clearing price)
This is the perfect price to
charge for a good.
Supply
350 400 450 500 550 600 650 Quantity
What is the equilibrium price?
What is the equilibrium quantity?
Market Equilibrium
• This table and graph indicate the demand and
supply conditions for oversized playing cards.
• The Equilibrium will occur where the quantity
demanded equals the quantity supplied.
• A price of $12 in this market will result in . . .
quantity demanded of 450 and quantity
supplied of 600 . . . resulting in excess supply.
$
13
12
11
10
9
8
7
• With an excess supply present, there will be
downward pressure on price to clear the market.
Price of
Quantity
Quantity Condition Direction
Cards
Supplied
Demanded
in the
of Pressure
(Dollars) (per month) (per month) Market
on Price
<
12
600
450
10
550
550
8
500
650
Excess
Supply
Demand
Downward
Supply
350 400 450 500 550 600 650
Quantity Supplied
= 600
Quantity Demanded
= 450
Market Equilibrium
$
• A price of $8 in this market will result in . . .
quantity supplied of 500 and quantity
demanded of 650 . . . resulting in excess demand.
• With an excess demand present, there will be
upward pressure on price to clear the market.
13
12
11
10
9
8
7
Price of
Quantity
Quantity Condition Direction
Cards
Supplied
Demanded
in the
of Pressure
(Dollars) (per month) (per month) Market
on Price
600
10
550
8
500
<
12
450
Excess
Supply
Downward
550
<
650
Excess
Demand Upward
Demand
Supply
350 400 450 500 550 600 650
Quantity Supplied
= 500
Quantity Demanded
= 650
Market Equilibrium
$
• A price of $10 in this market will result in . . .
quantity supplied of 550 and quantity
demanded of 550 . . . resulting in a balance.
• With a balance present, there will be an
equilibrium and the market will clear.
13
12
11
10
9
8
7
Price of
Quantity
Quantity Condition Direction
Cards
Supplied
Demanded
in the
of Pressure
(Dollars) (per month) (per month) Market
on Price
600
10
550
8
500
<
12
=
<
450
Excess Downward
Supply
550
Balance Equilibrium
650
Excess Upward
Demand
Demand
Supply
350 400 450 500 550 600 650
Quantity Supplied
= 550
Quantity Demanded
= 550
•QS= Quantity Supplied
•QD= Quantity Demanded
•QS > QD = excess supply and downward
pressure on price
•QS = QD = Equilibrium
•QS < QD = Excess demand and upward
pressure on price
Market Equilibrium
$
• At every price above market equilibrium there
is a surplus and there will be downward
pressure on the price level.
• At every price below market equilibrium there
is a shortage and there will be upward
pressure on the price level.
• Prices will normally return to equilibrium.
13
12
11
10
9
8
7
Price of
Quantity
Quantity Condition Direction
Cards
Supplied
Demanded
in the
of Pressure
(Dollars) (per month) (per month) Market
on Price
600
10
550
8
500
<
12
=
<
450
Excess Downward
Supply
550
Balance Equilibrium
650
Excess Upward
Demand
Surplus
Equilibrium
Price
Supply
Demand
Shortage
350 400 450 500 550 600 650
Any questions
on that?
Effects of a Change in Supply
If Supply decreases, the
equilibrium price will
rise and the equilibrium
quantity will fall.
If Supply increases, the
equilibrium price will fall
and the equilibrium
quantity will rise.
$
13
12
11
10
9
8
7
Demand
Supply
350 400 450 500 550 600 650
Quantity
• Consider the market for wine.
• Prior to a season of bad weather
affecting the amount of grapes,
an equilibrium exists where Supply
equals Demand1 with a market
price of $18 and output of Q1.
• The bad weather arrives: the supply
of wine falls, decreasing the supply
from supply1 to supply2. What
happens to the equilibrium price
and output level?
• At $18 a bottle the quantity
demanded exceeds the quantity
supplied. There is upward pressure
on price inducing the existing
consumers to decrease their quantity
demanded to Q2, drawing up the
equilibrium price to $20.
• What happens to equilibrium
price and output when the weather
returns to normal?
Market Adjustment to a
Decrease in Supply
Price
($ per bottle)
Supply2
24
22
Supply1
20
18
16
Demand
Q2
Q1
Quantity
(million bottles
per week)
DEMAND AND SUPPLY
MOVEMENT ON THE CURVE vs. SHIFT OF THE CURVE
P $6
S1
S
5
4
3
2
D
1
o
10 20
35
55
80
Q
DEMAND & SUPPLY
PUTTING THE TWO CURVES TOGETHER
$
Qs Qd
$
5
$ 3 35
80
55
35
$ 4 50
20
2
$ 5 60
10
1
$1 5
$ 2 20
EQUILIBRIUM PRICE
S
4
3
o 10 20 35
D
55
80
Q
DEMAND & SUPPLY
INCREASE IN DEMAND
P
Q s Q d Q d1
$ 1 5 80 95
$ 2 20 55 75
$ 3 35 35 60
$ 4 50 20 80
$ 5 55 15 55
$
6
5
S
4
3
D1
2
1
o 10 20 35 55 80
D
Q
DEMAND & SUPPLY
DECREASE IN DEMAND
P
Q s Q d Q d1
$ 1 5 80 35
$ 2 20 55 20
$ 3 35 35 15
$ 4 50 20 10
$ 5 60 10
5
$
S
6
5
4
3
2
1
o 10 20 35
D1
55
D
80
Q
DEMAND & SUPPLY
DECREASE IN SUPPLY
P
Q s Qs Qd
1
$ 1 5 2 80
$ 2 20 10 55
$ 3 35 15 35
$ 4 50 20 20
$ 5 60 25 10
$
6
5
4
S1
S
3
2
1
o 10 20 35
D
55 80
Q
DEMAND & SUPPLY
INCREASE IN DEMAND
DECREASE IN SUPPLY
P
Q s Q s1 Q d Q d1 $
6
$1
5
2
80
95
$2
20
10
55
70
4
$3
35
15
35
50
3
50
20
$4
20
35
S1
S
5
D1
2
1
$5
60
25
10
25
o
D
10 20 35 55 80
Q
DEMAND & SUPPLY
What can the concepts of supply and demand
help us do?
 …illustrate changes in different markets.
Source: Wall Street Journal Feb 2008 (beginning signs of recession)
DEMAND & SUPPLY
What can the concepts of supply and demand
help us do?
 …illustrate changes in different markets.
The concepts help us understand the
cause of changes in price (such as
during Hurricane Katrina & Gustav)
Hurricane Ike Sept 11 2008
About 3,900 oil rigs in the gulf
Price Ceilings & Price Floors
(When prices seem unfair)
Price Ceilings & Price Floors
Supply, Demand and Government Policies
 In a “free” purely capitalist market
system, only supply and demand
establishes equilibrium prices and
quantities.
 However, in our mixed economy
sometimes equilibrium prices are set by
the government.
 These are known as price controls!
Price Ceilings & Price Floors
 When the government imposes a price
ceiling (a legal maximum price at which a good
can be sold) two outcomes are possible:
1)
The price ceiling is NOT EFFECTIVE.
2)
The price ceiling is EFFECTIVE and causes Shortages.
 When government imposes a price floor (a
legal minimum price) the two outcomes are
possible:
1)
The price floor is NOT EFFECTIVE.
2)
The price floor is EFFECTIVE and causes a Surplus.
Government Price Controls
They are usually enacted
when policymakers
believe that the market
price is unfair to buyers
and even sellers.
This results in
governmental policies,
such as price ceilings
and price floors.
Price Ceilings & Price Floors
A Price Ceiling (below equilibrium)
–
is a legally established maximum price which a
seller can charge or a buyer must pay.
–
Helps get rid of a surplus (it can cause a shortage)
–
Protects consumers
A Price Floor (above equilibrium)
–
is a legally established minimum price which a
seller can charge or a buyer must pay.
–
Helps get rid of a shortage (it causes a surplus)
–
Protects producers and workers
Price Ceilings & Price Floors
PRICE
FLOOR
$6
5
4
3
2
o
}
}
1
S
SURPLUS
SHORTAGE
PRICE
CEILING
D
10 20
35
55
80
Price Floors
Impacts of a Price Floor
One reason to establish a price floor is to
protect the producer (such as a new farmer
who is competing against larger farming
corporations).
The price floor keeps the larger companies
from charging a lower price than the new
farmer can charge.
Price floors can also be used to protect
workers (such as minimum wage)
A Effective Price Floor
EXAMPLE: Think about the poor farmer and minimum wage
Price
Supply
PF
Legal $
illegal $
PE
Price
Floor
Demand
QE
Quantity
The Labor Market:
Minimum Wage Laws &
the concept of Price
Floors
The Labor Market: Minimum Wage
Wage
Labor Supply
Equilibrium
Wage
Labor Demand
0
Equilibrium
Unemployment
Quantity of Labor
A Labor Market with an effective
price floor for Minimum Wage
Wage
Labor Supply
$10.00
Minimum
Wage
Labor Demand
0
Quantity
demanded
Quantity
supplied
Quantity of Labor
Price Ceilings
A effective Price Ceiling on Rent
EXAMPLE: Think about rent control
Rent
Supply of
Apartments
Price Ceiling
PE
illegal $
PC
Legal $
Demand for
Apartments
Shortage
QS
QE
QD
Quantity of
Apartments
Gas Market and a Price Ceiling
A Price Ceiling creates shortages.
Example:

US government set price ceilings for gasoline in 1974.

The Vietnam War was consuming much of the fuel. So
the US government established a maximum price for
gasoline to settle consumer’s fears that the war would
cause gas prices to soar.

Unfortunately, suppliers feared that the lower price
(price ceiling) would cause not only shortages, but
lower profits. (so they limited the supply of gas)

Combine the price ceiling with limited supply with the
OPEC Oil Embargo and you have massive shortages for
fuel.
1970’s Market for Gasoline
with a Price Ceiling
1. Initially, the price ceiling
was not effective...
Price of
Gasoline
S1
P1
Price ceiling
Demand
0
Q1
Quantity
1970’s Market for Gasoline
with a Price Ceiling
S2
Price of
Gasoline
2. ...but when supply
fell ...
S1
P2
P1
Price ceiling
Demand
0
Q1
Quantity
1970’s Market for Gasoline
with a Price Ceiling
S2
Price of
Gasoline
3. ...the price ceiling
causes a shortage.
S1
P2
Shortage
P1
Price ceiling
Demand
0
Q1
Quantity
QUICK QUIZ
ANSWER THE FOLLOWING ON YOUR OWN PAPER
1. What is the equilibrium price? At the equilibrium price will
you ever have a shortage or surplus?
The price where quantity supplied equals quantity demanded.
You will never have a shortage or surplus.
2. If you set the price for Good X ABOVE the equilibrium price will
you have a shortage or surplus?
Surplus
3. If you set the price for Good X BELOW the equilibrium price will you
have a shortage or surplus?
Shortage
4. Draw the Demand and Supply curves together. What will happen to
the equilibrium price & quantity if the demand curve shifts to the
left?
Decrease in price and decrease in quantity needed
5. A price ceiling will create a shortage or surplus?
Shortage
6. A price floor is designed to protect who?
Producers & Workers
ANY QUESTIONS?
QUIZ TOMORROW!
STUDY AND
GET YOUR NOTES
TOGETHER
EMAIL ME ANY
QUESTIONS