Economics 12

Unit 2 – Demand and SupplyPrice Ceilings and Price Floors

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

More on Demand and Supply Under what circumstances do the forces of

demand and supply determine the price of products? Only in a “perfectly competitive” market Existence of bigness in the marketplace limits

the efficient working of the market.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Determinants of Demand and SupplyDeterminants of

Demand Consumer preference Consumer incomes Prices of related

producers Expectations of future

prices, incomes, or availability

Population Its size, income

distribution, and age distribution

Determinants of Supply

Prices of productive resources

Business taxes Technology Prices pf substitutes in

production Future expectations of

suppliers Number of suppliers

These all cause the Demand and Supply curves to shift either left (decrease) or right (increase).

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Increases in Demand and Supply

Higher demand leads to higher equilibrium price and higher equilibrium quantity.

Higher supply leads to lower equilibrium price and higher equilibrium quantity.

D P Q S P Q

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Increases in Demand and Supply Both changes in isolation, tend to push up

the quantity traded. However, the increase in demand will push the price up, whereas the increase in supply will push the price down.

Therefore, increases (decreases) in both demand and supply will cause the quantity to increase (decrease), but the effect on the price is indeterminate.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Demand and Supply Moving in Opposite Directions

When demand and supply move in opposite directions, the price will always move in the same direction as the demand change, but the effect on the quantity is indeterminate.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

The Price System The market system, also called the price

system, performs two important and closely related functions : Price Rationing Resource Allocation

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Price Rationing Price rationing is the process by which

the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Price Rationing A decrease in supply

creates a shortage at P0. Quantity demanded is greater than quantity supplied. Price will begin to rise.

The lower total supply is rationed to those who are willing and able to pay the higher price.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Price Rationing There is some price

that will clear any market.

The price of a rare painting will eliminate excess demand until there is only one bidder willing to buy the single available painting.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Price Controls Governments introduce price controls to

correct what they see as undesirable market prices.

A price ceiling is a maximum price that sellers may charge for a good, usually set by government. Price ceilings cause shortages.

Government believes present market price too high for many buyers Rent control National emergencies

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Allocation MechanismsAllocation mechanisms are used to allocate

products that are in short supply. The market First come, first served

Queuing is a nonprice rationing system that uses waiting in line as a means of distributing goods and services.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Allocation Mechanisms Producers’ preferences

Favored customers are those who receive special treatment from dealers during situations when there is excess demand.

Rationing Ration coupons are tickets or coupons that

entitle individuals to purchase a certain amount of a given product per month.

The problem with these alternatives is that excess demand is created but not eliminated.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Allocation Mechanisms

In 1974, the government used an alternative rationing system to distribute the available supply of gasoline.

At an imposed price of 57 cents per gallon, the result was excess demand.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Allocation Mechanisms

A black market is a market in which illegal trading takes place at market-determined prices.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Allocation Mechanisms No matter how good the intentions of

private organizations and governments, it is very difficult to prevent the price system from operating and to stop the willingness to pay from asserting itself.

With favored customers and black markets, the final distribution may be even more unfair than that which would result from simple price rationing.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Prices and the Allocation of Resources 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.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Supply and Demand Analysis:An Oil Import Fee

At a world price of $18, imports are 5.9 million barrels per day.

The tax on imports causes an increase in domestic production, and quantity imported falls.

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Price Floors A price floor is a minimum price that

sellers may charge for a good, usually set by government. Price floors cause surpluses

Government assisting producers and not the consumer Agriculture

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Dealing with a SurplusHow do you get rid of the surplus that a

price floor inevitably produces? Store it Convert it

Likely to be expensive Sell it abroad at reduced pricing

Termed dumping Forbidden by many international conventions

Donate it Destroy it

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

The Minimum Wage Another type of price floor Minimum wage is the lowest rate of pay

per hour for workers, as set by government.

Scenario: Higher wage means employers are forced to

economize on labour and will cut back on employment (quantity of labour demanded falls)

Higher wage attracts more workers (quantity of labour supplied increases)

Net result = surplus of labour (unemployment)

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

Stop Here for Today For a recap of today’s

lesson, try: http://www.youtube.co

m/watch?v=4MMIkkG8pAQ