Combining Supply and

Demand

Combining Supply and Combining Supply and DemandDemand

Buyers and sellers have to meet Buyers and sellers have to meet at a certain pointat a certain point

This point is called equilibriumThis point is called equilibrium Equilibrium – price at which Qs = Equilibrium – price at which Qs =

QdQd– ““Market Clearing Price”Market Clearing Price”

At this point, the market for a At this point, the market for a good is stablegood is stable

How do we find equilibrium?How do we find equilibrium?

DisequilibriumDisequilibriumDisequilibrium – when quantity Disequilibrium – when quantity

supplied does not equal supplied does not equal quantity demandedquantity demanded–Excess Demand (Shortage) – Excess Demand (Shortage) – quantity demanded is more quantity demanded is more than quantity supplied (prices than quantity supplied (prices beneath equilibrium price)beneath equilibrium price)

DisequilibriumDisequilibrium

– Excess Supply (Surplus) – Excess Supply (Surplus) – Quantity supplied is more than Quantity supplied is more than quantity demanded (prices quantity demanded (prices above the equilibrium price)above the equilibrium price)

Think Back to Adam Smith…Think Back to Adam Smith…Adam Smith said that the Adam Smith said that the

“invisible hand” let men be “invisible hand” let men be free and still do what’s best for free and still do what’s best for all menall men

Market equilibrium is the Market equilibrium is the “invisible hand!”“invisible hand!”

Companies only produce what Companies only produce what society needs because that is society needs because that is best for their profits!best for their profits!

Government InterventionGovernment Intervention

In the American In the American mixed economy, mixed economy, government still government still takes actions to takes actions to protect protect consumers from consumers from businessesbusinesses

Examples of InterventionsExamples of Interventions

Price Ceilings – a maximum Price Ceilings – a maximum that can be legally charged that can be legally charged for a goodfor a good–Rent Control – a type of Rent Control – a type of price ceiling where the price ceiling where the government sets a government sets a maximum legal rate for rentmaximum legal rate for rent

Problems with Price CeilingsProblems with Price CeilingsWhen you set the price lower than When you set the price lower than

the market allows:the market allows:–Quantity supplied goes down, as Quantity supplied goes down, as

businesses don’t want to lose businesses don’t want to lose moneymoney

–Quantity demanded goes up, as Quantity demanded goes up, as consumers want to take consumers want to take advantage of low pricesadvantage of low prices

–This all creates shortages!This all creates shortages!

Examples of InterventionsExamples of InterventionsPrice Floors – a minimum price set Price Floors – a minimum price set

by the government that must be by the government that must be paid for a good or servicepaid for a good or service–Minimum Wage – a type of price Minimum Wage – a type of price floor where a business must pay floor where a business must pay a worker at least a certain a worker at least a certain amount for an hour of laboramount for an hour of labor

Problems with Price FloorsProblems with Price Floors If the government sets a price If the government sets a price

floor above market equilibriumfloor above market equilibrium– people reduce consumption of that people reduce consumption of that

productproduct– suppliers tend to overproducesuppliers tend to overproduce– if the government sets minimum if the government sets minimum

wage too high, for example, you wage too high, for example, you get high unemployment rates!get high unemployment rates!

The Role of PricesThe Role of Prices

The Price SystemThe Price SystemThe U.S. and other free markets The U.S. and other free markets

operate under the “price operate under the “price system”system”

The price system uses a The price system uses a monetary figure to display the monetary figure to display the value of a good, letting value of a good, letting consumers choose which goods consumers choose which goods to spend their money onto spend their money on

AdvantagesAdvantages

Price is an incentive – it tells Price is an incentive – it tells consumers and producers consumers and producers how to adjust their patternshow to adjust their patterns

Price is a signal – it tells Price is a signal – it tells people whether the market people whether the market for a good is profitable or notfor a good is profitable or not

AdvantagesAdvantagesThe Price System is Flexible – The Price System is Flexible –

prices change with supply and prices change with supply and demanddemand

The Price System is Free – the The Price System is Free – the price system does not require price system does not require large government agencies to large government agencies to oversee the distribution of oversee the distribution of goodsgoods

Problems with Other Problems with Other SystemsSystems

Rationing – the government Rationing – the government sets limits on how much of a sets limits on how much of a product you are allowed to product you are allowed to consumeconsume–Rationing causes shortages Rationing causes shortages since the government often since the government often does not set reasonable limitsdoes not set reasonable limits

Problems with Other Problems with Other SystemsSystems

The Black Market – the The Black Market – the market where goods are sold market where goods are sold illegallyillegally–Black Markets encourage Black Markets encourage higher prices, and also higher prices, and also defeat the purpose of a defeat the purpose of a command economycommand economy

Here’s Why it MattersHere’s Why it MattersThe Price System allows The Price System allows

resources to be allocated resources to be allocated (given out) efficiently(given out) efficiently

All resources are placed All resources are placed where they are most valuable where they are most valuable to consumersto consumers

All without the intrusion of All without the intrusion of the government in your life!the government in your life!

Adam Smith, Man of Astounding Adam Smith, Man of Astounding Genius and Economic Brilliance Genius and Economic Brilliance

for His Time, and for Ours as for His Time, and for Ours as well.well.

Answer this question: why do

butchers and bakers provide

people with food?

Adam Smith, Man of Astounding Adam Smith, Man of Astounding Genius and Economic Brilliance Genius and Economic Brilliance

for His Time, and for Ours as for His Time, and for Ours as well.well.

Because they will make a profit!

Adam Smith, Man of Astounding Adam Smith, Man of Astounding Genius and Economic Brilliance Genius and Economic Brilliance

for His Time, and for Ours as for His Time, and for Ours as well.well.

This is the theory in Smith’s book, The Wealth of

Nations

Possible DisadvantagesPossible Disadvantages

Imperfect Competition – if Imperfect Competition – if only a few firms sell a only a few firms sell a product, there is not enough product, there is not enough competition to keep prices competition to keep prices lowlow

Spillover Costs – costs that Spillover Costs – costs that affect people with no control affect people with no control over the production of a over the production of a good (such as pollution)good (such as pollution)

QUESTIONS?