Chapter 6

1. Chapter 6 Prices

2. Reaching Equilibrium • Supply and Demand Meet • The point where demand and supply come together is called the equilibrium • It is the point of balance at which the quantity demanded equals the quantity supplied • At equilibrium, the market for a good is stable • Simply look for the price at which the quantity supplied equals the quantity demanded • When looking at a graph, look for the point where the supply and demand curve intersects

4. Reaching Equilibrium • Market Benefits • In any market, supply and demand will only be equal at only one price and one quantity • At the equilibrium price, buyers will purchase exactly as much of a good as firms are willing to sell • At equilibrium, both buyers and sellers benefit

5. Disequilibrium • Disequilibrium • If the market price or quantity supplied is anywhere but equilibrium, the market is in a state of disequilibrium • This occurs when quantity supplied is not equal to quantity demanded in a market • Disequilibrium can produce one of two outcomes: shortage or surplus

6. Disequilibrium • Shortage • The problem of shortage, also known as excess demand, exists when the quantity demanded in the market is more than quantity supplied • When the actual price in a market is below the equilibrium price, you have a shortage, because low prices encourages buyers and discourages sellers

7. Disequilibrium • From Shortage to Equilibrium • As long as there is a shortage and quantity demanded exceeds the quantity supplied, suppliers will keep raising the price • Once prices have risen enough to close the gap, suppliers have found the highest price that the market will bear • This will continue until a new equilibrium

8. Disequilibrium • Surplus • If the price is too high, the market will face the problem of surplus, also known as excess supply • This exists when quantity supplied exceeds quantity demanded and the actual price of a good is higher than equilibrium price • From Surplus to Equilibrium • As the price falls, the quantity demanded will rise, and more customers will buy more • Whenever the market is in disequilibrium and prices are flexible, market forces will push the market toward equilibrium

9. Price Ceiling • Price Ceiling • The government may intervene to control prices • This is the maximum price that can be legally charged for a good or service which is below equilibrium price • Rent Control • The government sets prices on some goods that are considered essential • Rent control is ceiling price placed on apartment rent, to prevent inflation during a housing crisis (1940’s New York City) • The price ceiling increases the quantity demanded but decreases the quantity supplied

10. Price Ceilings • The Cost of Rent Control • Although governments pass rent control laws to help the renters with the greatest need, few of these renters benefit from rent control • Long waiting lists, discrimination by landlords, a lottery system, and bribery may be used to get those scarce apartments • Luck becomes important or even inheriting apartments • Since rent control limits profits, landlords may cut costs

11. Price Ceilings • Impact of Ending Rent Control • Many people would be able to find a wider selection of apartments • Landlords would also have a better incentive to maintain their buildings and invest in new construction • On the other hand, renters in price controlled apartments may no be able to afford higher rents • Most economists believe that by ending rent control, the benefits will exceed the cost

12. Price Floors • Price Floor • A price floor is a minimum price, set by the government, that must be paid for a good or service • This is to ensure that sellers receive at least a minimum reward for their efforts, including labor • The Minimum Wage • Minimum wage is the minimum price that an employer can pay a worker for an hour of labor • Federal government sets it, but state’s can make it higher • Refer to graph 6.4

13. Price Floors • Price Supports in Agriculture • During the Great Depression, whenever prices fell below a certain level, the government would buy the excess crops • Supporters of price floors felt that this must happen in order for farms to survive in a competitive market • Opponents said that the government dictated what farmers should produce and in what quantities • 1996 Congress outlawed many of these programs because of the conflict with free market principles

14. An Increase in Supply • What are some of the factors that a supply curve will shift? • 1. • 2. • 3. • 4. • 5. • A shift in the supply curve to the left or right will cause a new equilibrium • Since markets tends towards equilibrium, a change in supply will set in motion market forces that lead the market to a new equilibrium price and quantity sold

15. An Increase in Supply • A Change in Market • Technology in digital cameras have greatly reduced the prices of digital cameras • Advances in production have allowed manufacturers to produce digital cameras at a lower cost • These lower costs have been passed on to consumers in the form of lower prices • Supply curve shifts to the right because of advancement in technology • Draw the shift in supply of digital cameras like in figure 6.5

16. An Increase in Supply • Finding a New Equilibrium • Producers are willing to supply a larger quantity at each price • Once inventory, or the quantity of goods that a firm has on hand, starts to pile up, there is a surplus • Suppliers will have to respond to the surplus by reducing prices • The new equilibrium point marks a lower equilibrium price and a high equilibrium quantity • Changing Equilibrium • Equilibrium is a moving target that changes with market conditions

17. A Decrease in Supply • A Decrease in Supply • Other factors make the supply curve shift to the left • If rubber and steel prices rise, manufacturers will produce fewer cars at all price levels, and shift the supply curve left • If autoworkers win higher wages, the company pays more labor to build the cars and supply will decrease • This will cause suppliers to raise their prices and the quantity demanded will fall

18. An Increase in Demand • An Increase in Demand • Almost every year we experience a fad, or a product that enjoys enormous popularity for a fairly short time • This shifts the demand curve to the right • The Shortage Problem • Shortage in a store appears as empty shelves or long lines • Also appears in search costs, or the financial and opportunity cost that consumers pay in searching for a product or service • Driving or calling to different stores • Causes first come, first serve policies

19. An Increase in Demand • Return to Equilibrium • Customers may actually push prices up on their own if there is a bidding in the market, like in real estate, antiques, fine art, and rare items • Prices will continue to rise until a new equilibrium is formed • When demand increases, equilibrium price and quantity will increase

20. A Decrease in Demand • A Decrease in Demand • When a fad passes its peak, demand can quickly fall as it rose • The shortage turns into a surplus • As demand falls, the demand curve shifts left • Suppliers will respond by cutting prices on their inventory

21. Prices in a Free Market • Free Market • Prices are nearly the most efficient way to allocate, or distribute, resources • Prices help land, labor, capital into the hands of producers and finished goods into the hands of buyers • Centrally Planned • The alternative is distributing goods and resources in a centrally planned economy that is inefficient and not based on price

22. The Advantages of Price • The Advantage of Price • Prices provide a common language for buyers and sellers • Without price, a seller would have to barter for goods • The supplier would also have no consistent and accurate way to measure demand for a product • Price as an Incentive • Buyers and sellers look at price to find info on a good’s demand and supply • Prices are signals to tell producers and buyers how to adjust • Prices tell is goods are readily available or in short supply

23. The Advantages of Price • Price as Signals • High price is a signal for producers to produce more of a good • Low price is a signal that a good is being over produced • Low prices may tell a producer to use their resources to produce another good • Consumers on the other hand, low prices tells them to buy more • A high price tells the consumer to stop and think carefully before buying

24. The Advantage of Price • Flexibility • It is very important for prices to be flexible • Prices are much more flexible then quantity • Prices can be increased to solve a shortage and be decreased to solve the problem of surplus • Supply shock is a sudden shortage of a good, such as gasoline or wheat • Creates a shortage because suppliers can no longer meet demand • How to divide up immediate supply? • Rationing, or a system of allocating goods and services using criteria other than price • Raising prices is the quickest way to reduce quantity demanded

25. The Advantage of Price • Price System is “Free” • Refer to page 151

26. Choice and Efficiency • Choice and Efficiency • Prices help consumer choose among similar products • Prices make it easy for you to make a price range • Producers get to target the audience they want for their prices • In a centrally planned economy, to cut costs, they limit the variety of a product • This makes fewer choices for the consumers

27. Choice and Efficiency • Rationing and Shortages • Read example on page 152 • The Black Market • When people conduct business without regard for government controls on price or quantity, they are said to do business on the black market • Black market allows consumers to pay more so they can buy a product when rationing makes it otherwise unavailable • Efficient Resource Allocation • Means that economic resources are used for their most valuable purpose • The people who own the land, labor, and capital sell their resources to the highest bidder

28. Prices and the Profit Incentive • Prices and the Profit Incentive • Refer to page 153 • The Wealth of Nations • Adam Smith wrote about profit incentive • Business prospers by finding out what people want, and then providing it • Market Problems • Imperfect competition can affect prices, and higher prices can affect consumer decisions • Negative externalities can include unintended costs like air and water pollution • Imperfect information can hurt the market if the consumers don’t have the right information