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Chapter 6—Prices
Section 1—Combining Supply + Demand
Supply and Demand work together to determine price
-consumers can buy the products they want
-producers make enough profit to stay in business
-producers respond to changing needs + tastes of consumers
Balancing the market
Combined Supply + Demand Schedule
P of a Slice of
Qd
Qs
Result
Pizza
$.50
$1.00
$1.50
$2.00
$2.50
$3.00
300
250
200
150
100
50
100
150
200
250
300
350
Shortage From
Excess Demand
Equilibrium
Surplus From
Excess Supply
-Equilibrium is the point where D + S come together—the point of balance b/t P + Q
-at E the market is stable
-buyers will purchase exactly as much of the product as firms are willing to sell
-Equilibrium can also be illustrated w/ a graph
-point at which demand curve intersects supply curve
Disequilibrium
-Qs is not = to Qd
-Excess Demand
-Qd is > Qs
-when P is below EP...b/c low P encourages buyers + discourages sellers
-buyers wait in long lines or go without
-sellers raise P
-Excess Supply
-Qd is < QS
-when P is above EP…b/c high P discourages buyers + encourages sellers
-Customers will buy less or go elsewhere
-sellers lower price
-market forces push P toward E
Government Intervention
-some cases government steps in to control prices
-Price Ceilings
-maximum price that can be legally charged for a good
-usually placed on essential goods that might become too
expensive
-excess demand and a shortage of goods
-cost
-long waiting lines…discrimination… bribery… luck are
used to allocate goods
-luck also becomes factor
-sellers try to cut costs to increase income
-long waiting lines cause little incentive to improve product
-ending price ceilings
-more supply for those looking for good
-quantity + quality improve
-sellers have incentive to improve good.
-poorer people may not be able to afford higher price
-Price Floors
-minimum price that must be paid for a good
-most well-known is minimum wage
-govt set lowest wage that must be paid for 1 hour of
work…states may set it higher
-if wage is higher than equilibrium…decrease in
employment
-excess in supply of workers
-agriculture
-until 1996 government bought excess crops creating
demand when price fell below
-Congress abolished programs in 1996
-today subsidies are used
Section 2—Changes in Market Equilibrium
Changes in Equilibrium Price
-Demand changes and Equilibrium Price Changes
-When demand increases, price rises-demand curve shifts to the right
-when demand decreases, price falls- demand curve shifts to the left
-Supply changes and Equilibrium Price Changes
-when supply increases, price decreases-supply curve shifts to the right
-when supply decreases, price increases-supply curve shifts to the left
Changes in Supply and Demand at the same time
-Demand increases and Supply increases
-increase in demand is greater than increase in supply
-demand curve shifts further right than the supply curve shifts to the right
-equilibrium price increases
-increase in supply is greater than increase in demand
-supply curve shifts further right than the demand curve shifts to the right
-equilibrium price decreases
-increase in demand is equal to increase in supply
-both supply and demand curve shift the same amount to the right
-equilibrium price remains constant
-Demand decreases and Supply decreases
-decrease in demand is greater than decrease in supply
-demand curve shifts further left than the supply curve shifts to the left
-equilibrium price decreases
-decrease in supply is greater than decrease in demand
-supply curve shifts further left than the demand curve shifts to the left
-equilibrium price increases
-decrease in demand is equal to decrease in supply
-both supply and demand curve shift the same amount to the left
-equilibrium price remains constant
Importance of Equilibrium Price
-keeps buyers purchasing
-keeps sellers producing
-no shortages
-no surpluses
Section 3—The Role of Prices
Prices in the free market
-move land, labor + capital to producers + finished goods to buyers
Advantages
-Prices as incentives
-let consumers know if goods are plentiful or scarce
-increase in demand lets producers know to raise
-decrease in price lets consumers know to buy
-Price as Signals
-high prices let producers know that they can produce more
-low price lets them know they should produce less
-high prices let consumers know they should buy something else
-low prices let them know to buy more
-Flexibility
-prices need to change to solve problems of surplus or shortage
-supply shock…sudden shortage of a good
-rising prices are the easiest way to solve
-Price system is free
-distribution based on decisions of consumers
Wide choice of goods
-allows consumers to choose from similar goods
-rationing + shortages
-food, metal, rubber during WWII…gasoline in the 1970s….
-short lived hardships
-the Black Market
-when people do business w/o regard for government controls on price or quantity
-allows consumers to buy goods at a higher price when rationing makes it otherwise unavailable
Efficient resource allocation
-land, labor, capital will be used for their most valuable purposes
Prices + the profit incentive
-An Inquiry into the Nature and Causes of the Wealth of Nations (1776)
-A Smith
-explained that it is not b/c of charity that the baker + the butcher provide people w/ food
-business find out what people want + then provide it to them
-Market Problems
-imperfect competition affects prices…higher prices affect decisions to buy
-one or few sellers not enough competition to keep prices at costs of production level
-spillover costs
-externalities…costs of production such as air pollution + water pollution
-affects people who have no control over how much of a good is produced
-producers don’t pay spillover costs so price is artificially low
-imperfect information
-when buyers don’t have enough information to make an informed decision