Determining Price

• At the beginning of this unit, we examined demand:

Price per Gadget

# Gadgets Demanded

$10 600

$9 720

$8 850

$7 990

$6 1140

$5 1300

$4 1470

$3 1650

$2 1840

$1 2040

Demand

0

2

4

6

8

10

12

0 500 1000 1500 2000 2500

Quantity

Pri

ce Quantity Demanded

• Then we examined supply:

Price per Gadget

# Gadgets Supplied

$10 1550

$9 1500

$8 1450

$7 1400

$6 1350

$5 1300

$4 1250

$3 1200

$2 1150

$1 1100

Supply

0

2

4

6

8

10

12

0 500 1000 1500 2000

Quantity Supplied

Pri

ce Quantity Supplied

• In order to determine price, supply and demand must be examined together:

Price per Gadget

# Gadgets Demanded

# Gadgets Supplied

$10 600 1550

$9 720 1500

$8 850 1450

$7 990 1400

$6 1140 1350

$5 1300 1300

$4 1470 1250

$3 1650 1200

$2 1840 1150

$1 2040 1100

Supply and Demand

0

2

4

6

8

10

12

0 500 1000 1500 2000 2500

Quantity

Pri

ce Quantity Demanded

Quantity Supplied

Equilibrium

SupplyDemand

for Gadgets

Three Possible Results

• Surplus– Because the price is too high, quantity supplied exceeds

quantity demanded at a given price.• Shortage

– Because the price is too low quantity supplied is less than quantity demanded at a given price.

• Equilibrium– Quantity supplied equals quantity demanded at a given

price. (See $5 in the previous example.)– This is the desired result.– Equilibrium price is also known as market price.

Surplus price

Quantity Demanded

Quantity Supplied

SurplusD S

Shortage price

Quantity Supplied

Quantity Demanded

ShortageD S

Adjustments

• While the equilibrium is where the price should be, it does not always work that way.

• When there is a surplus, suppliers need to attract more buyers.– They do this by lowering the price during the next

trading period.– At the same time, they decrease the quantity

supplied.– This results in a move toward equilibrium.

Adjustments, cont.

• When there is a shortage, suppliers try to meet the needs of more buyers.– They do this by increasing the quantity supplied

during the next trading period.– At the same time, they increase the price.– This results in a move toward equilibrium.

Equilibrium

• Competition is necessary for equilibrium to be reached.– Without competition, a supplier may raise the

price without worrying about a surplus, since buyers have nowhere else to go.

– In a command economy, shortages may result because prices are set too low – there is no way for equilibrium to be reached.

Price-Related Policies

• Sometimes consumers or suppliers are not actually happy with the market price, so they ask the government to step in.

• There are two main types of price-related policies:– Price ceilings– Price floors

• Both of these involve trade-offs which are not always considered.

Price Ceilings• Purpose: to keep prices low so that a product is

affordable for a greater number of people.– This is essentially what many people would like to see happen

with health care.• A price ceiling is set below the market price (which is

considered too high), or it will have no effect.• Result (unintended): shortage

– It is affordable for more people, but fewer people actually get it.• Example: rent control

– People who had cheap apartments were happy, but others had difficulty finding housing.

Price CeilingsD S

Market price (considered to be too high)

Price ceilingShortage

Price floors

• Purpose: to keep prices high so that suppliers can make more money.

• A price floor is set above the market price (which is considered too low), or it will have no effect.

• Result (unintended): surplus– Suppliers would receive a higher price, but would actually

sell less.• Example: minimum wage

– If minimum wage were increased, fewer people would have those jobs, but they would be making more money.

Price FloorsD S

Market price (considered to be too low)

Price floorSurplus