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7/29/2019 Lecture on Demand and Supply Applications
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Lecture 4
Demand and Supply Applications
The Price System: Rationing and Allocating Resources
Price RationingConstraints on the Market and Alternative Rationing Mechanisms
Prices and the Allocation of ResourcesPrice Floors
Supply and Demand Analysis: An Oil Import Fee
Supply and Demand and Market Efficiency
Consumer SurplusProducer SurplusCompetitive Markets Maximize the Sum of Producer and Consumer SurplusPotential Causes of DeadweightLoss from Under- and Overproduction
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
price rationing The process by which
the market system allocates goods andservices to consumers when quantitydemanded exceeds quantity supplied.
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
FIGURE 4.1 The Market for Lobsters
PRICE RATIONING
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
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 existsin a free market, the price of the good
will rise until quantity supplied equals quantity demandedthat is, until
the market clears.
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
FIGURE 4.2 Market for a Rare Painting
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
CONSTRAINTS ON THE MARKET ANDALTERNATIVE RATIONING MECHANISMS
On occasion, both governments and private firms decideto use some mechanism other than the market system toration an item for which there is excess demand at thecurrent price.
Regardless of the rationale, two things are clear:
1. Attempts to bypass price rationing in the market and touse alternative rationing devices are much more difficultand costly than they would seem at first glance.
2. Very often, such attempts distribute costs and benefitsamong households in unintended ways.
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
Oil, Gasoline, and OPEC
price ceiling A maximum price that sellers maycharge for a good, usually set by government.
FIGURE 4.3 Excess Demand
(Shortage) Created
by a Price Ceiling
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
queuing Waiting in line as a means ofdistributing goods and services: a
nonprice rationing mechanism.
favored customers Those whoreceive special treatment from dealers
during situations of excess demand.
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
Even when trading coupons is declared illegal, it is virtually impossible to stop black
markets from developing. In a black market, illegal trading takes place at market-
determined prices.
ration coupons Tickets or couponsthat entitle individuals to purchase acertain amount of a given product per
month.
black market A market in which illegaltrading takes place at market-determined prices.
C S S O G
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
NCAA March Madness: College Basketballs
National Championship
FIGURE 4.4 Supply of and Demand for a
Pair of Final Four Tickets in
2003
THE PRICE SYSTEM RATIONING
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
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.
Thinking of the market system as a mechanism forallocating scarce goods and services among competingdemanders is very revealing, but the market determinesmuch more than just the distribution of final outputs. Italso determines what gets produced and how resourcesare allocated among competing uses.
THE PRICE SYSTEM RATIONING
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THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
PRICE FLOORS
price floor A minimum price belowwhich exchange is not permitted.
minimum wage A price floor set underthe price of labor.
SUPPLY AND DEMAND ANALYSIS
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SUPPLY AND DEMAND ANALYSIS:
AN OIL IMPORT FEE
The basic logic of supply anddemand is a powerful tool ofanalysis.
FIGURE 4.5 The U.S. Market for Crude
Oil, 1989
SUPPLYANDDEMANDAND
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
CONSUMER SURPLUS
consumer surplus The differencebetween the maximum amount a
person is willing to pay for a good andits current market price.
SUPPLYANDDEMANDAND
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
FIGURE 4.6 Market Demand and Consumer Surplus
SUPPLYANDDEMANDAND
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
PRODUCER SURPLUS
producer surplus The differencebetween the current market price and
the full cost of production for the firm.
SUPPLYANDDEMANDAND
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
FIGURE 4.7 Market Supply and Producer Surplus
SUPPLYANDDEMANDAND
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
COMPETITIVE MARKETS MAXIMIZE THE SUM OF
PRODUCER AND CONSUMER SURPLUS
FIGURE 4.8 Total Producer and Consumer Surplus
SUPPLYANDDEMANDAND
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
deadweight loss The net loss of
producer and consumer surplus fromunderproduction or overproduction.
FIGURE 4.9 Deadweight Loss
SUPPLYANDDEMANDAND
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SUPPLY AND DEMAND AND
MARKET EFFICIENCY
POTENTIAL CAUSES OF DEADWEIGHT LOSSFROM UNDER- AND OVERPRODUCTION
When supply and demand interact freely,
competitive markets produce what people wantat least cost, that is, they are efficient.
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black market
consumer surplus
deadweight lossfavored customers
minimum wage
price ceiling
price floor
producer surplus
price rationingqueuing
ration coupons
REVIEW TERMS AND CONCEPTS