PRICES (SUPPLY AND DEMAND TOGETHER) CHAPTER 6: PRICES (SUPPLY AND DEMAND TOGETHER)

CHAPTER 6: PRICESPRICES

(SUPPLY AND DEMAND TOGETHER)(SUPPLY AND DEMAND TOGETHER)

Review

• What does the law of supply state?– As price rises, quantity supplied rises.As price rises, quantity supplied rises.– Looking through the eyes of the PRODUCER!Looking through the eyes of the PRODUCER!

• What does the law of demand state?– As price rises, quantity demanded falls.– Looking through the eyes of the CONSUMER!

Supply and Demand TogetherSupply and Demand Together

Equilibrium PriceEquilibrium Price The price that The price that balances supply and balances supply and

demanddemand.. Perfect price to charge for the Perfect price to charge for the product. No product. No surplussurplus or or shortages.shortages.

Equilibrium QuantityEquilibrium Quantity Quantity that balances Quantity that balances supply and supply and

demand.demand. Both of these are located where the Both of these are located where the

supply and demand curve meetsupply and demand curve meet..

DEMAND and SUPPLYDEMAND and SUPPLYTOGETHER AT LAST

350 400400 450 500 550 600 650

789

10111213

Demand

Supply

$Equilibrium Price

(market clearing price)

This is the perfect price This is the perfect price to charge for a good.to charge for a good.

Quantity

What is the equilibrium price?What is the equilibrium price?What is the equilibrium quantity?What is the equilibrium quantity?

Market Equilibrium

Price of Cards

(Dollars)

Quantity Supplied

(per month)

Quantity Demanded (per month)

Condition in the

Market

Direction of Pressure

on Price

12 600 450

10 550 550

8 500 650

350 400400 450 500 550 600 650

789

10111213

Excess Supply

Downward

• This table and graph indicate the demand and supply conditions for oversized playing cards.

• The Equilibrium will occur where the quantity demanded equals the quantity supplied.

• A price of $12 in this market will result in . . . resulting in excess supply.

quantity supplied of 600 . . .

• With an excess supply present, there will be downward pressure on price to clear the market.

Demand

Supply

Quantity Demanded = 450

Quantity Supplied= 600

quantity demanded of 450 and

$

<

Price of Cards

(Dollars)

Quantity Supplied

(per month)


Condition in the

Market


on Price

12 600 450

10 550 550

8 500 650

350 400400 450 500 550 600 650

789

10111213

Excess Excess SupplySupply

• A price of $8 in this market will result in . . . resulting in excess demand.

quantity demanded of 650 . . .

• With an excess demand present, there will be upward pressure on price to clear the market.

Demand

Supply



quantity supplied of 500 and

< ExcessExcessDemandDemand UpwardUpward

$

Market Equilibrium

DownwardDownward

<

Price of Cards

(Dollars)

Quantity Supplied

(per month)


Condition in the

Market


on Price

12 600 450

10 550 550

8 500 650

350 400400 450 500 550 600 650

789

10111213

Excess Supply Downward

Demand

Supply



=<

Balance Equilibrium

ExcessDemand

Upward

• A price of $10 in this market will result in . . . resulting in a balance. quantity demanded of 550 . . .

• With a balance present, there will be an equilibrium and the market will clear.

quantity supplied of 550 and

$

Market Equilibrium

<

•QS= Quantity Supplied•QD= Quantity Demanded

•QS > QD = excess supply and downward pressure on price

•QS = QD = Equilibrium

•QS < QD = Excess demand and upward pressure on price

Price of Cards

(Dollars)

Quantity Supplied

(per month)


Condition in the

Market


on Price

12 600 450

10 550 550

8 500 650

350 400400 450 500 550 600 650

789

10111213

=<

Excess Supply Downward

Balance Equilibrium

ExcessDemand Upward

• At every price above market equilibrium there is a surplus and there will be downward pressure on the price level.• At every price below market equilibrium there is a shortage and there will be upward pressure on the price level.• Prices will normally return to equilibrium.

EquilibriumPrice

$

Market Equilibrium

ShortageSupply

Demand

Surplus<

Any questions Any questions on that?on that?

Effects of a Change in SupplyEffects of a Change in Supply

If Supply If Supply decreasesdecreases, the , the equilibrium price will equilibrium price will riserise and the equilibrium and the equilibrium quantity will quantity will fallfall..

If Supply If Supply increasesincreases, the , the equilibrium price will equilibrium price will fallfall and the equilibrium and the equilibrium quantity will rise.quantity will rise.

350350 400400400400 450450 500500 550550 600600 650650

778899

1010111112121313

DemandDemand

SupplySupply

$$

QuantityQuantity

• Consider the market for winewine.

Price($ per bottle)

24

22

20

18

16

Q1

Demand

• Prior to a season of bad weather affecting the amount of grapes, an equilibrium exists where Supply

equals Demand1 with a market

price of $18 and output of Q1.

Q2

• The bad weather arrives: the supply of wine falls, decreasing the supply

from supply1 to supply2. What

happens to the equilibrium price and output level?• At $18 a bottle the quantity

demanded exceeds the quantity supplied. There is upward pressure on price inducing the existing consumers to decrease their quantity

demanded to Q2, drawing up the

equilibrium price to $20.• What happens to equilibrium What happens to equilibrium price and output when the weather price and output when the weather returns to normal?returns to normal?

Market Adjustment to a Market Adjustment to a Decrease in SupplyDecrease in Supply

Supply2

Supply1

Quantity(million bottles

per week)

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DEMAND AND SUPPLYMOVEMENT ON THE CURVE vs. SHIFT OF THE CURVE

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PUTTING THE TWO CURVES TOGETHERPUTTING THE TWO CURVES TOGETHER

DEMAND & SUPPLYDEMAND & SUPPLY

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INCREASE IN DEMANDINCREASE IN DEMAND

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INCREASE IN DEMANDINCREASE IN DEMAND

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DEMAND & SUPPLYDEMAND & SUPPLYWhat can the concepts of supply and demand What can the concepts of supply and demand help us do?help us do? … …illustrate changes in different markets.illustrate changes in different markets.

Source: Wall Street Journal Feb 2008 (beginning signs of recession)Source: Wall Street Journal Feb 2008 (beginning signs of recession)

DEMAND & SUPPLYDEMAND & SUPPLYWhat can the concepts of supply and demand What can the concepts of supply and demand help us do?help us do? … …illustrate changes in different markets.illustrate changes in different markets.

The concepts help us understand the The concepts help us understand the cause of changes in price (such as cause of changes in price (such as during Hurricane Katrina & Gustav)during Hurricane Katrina & Gustav)

About 3,900 oil rigs in the gulfAbout 3,900 oil rigs in the gulf

Hurricane Ike Sept 11 2008Hurricane Ike Sept 11 2008

Price Ceilings Price Ceilings & & Price FloorsPrice Floors(When prices seem unfair)(When prices seem unfair)

Supply, Demand and Government PoliciesSupply, Demand and Government Policies

In a In a “free”“free” purely capitalist market purely capitalist market systemsystem, only supply and demand , only supply and demand establishes equilibrium prices and establishes equilibrium prices and quantities.quantities.

However, in our However, in our mixed economymixed economy sometimes equilibrium prices are set by sometimes equilibrium prices are set by the government. the government.

These are know as These are know as price controlsprice controls!!

Price Ceilings & Price FloorsPrice Ceilings & Price Floors

Government Price ControlsGovernment Price Controls

They are usually enacted They are usually enacted when policymakers when policymakers believe that the market believe that the market price is price is unfairunfair to buyers to buyers and even sellers. and even sellers.

This results in This results in governmental policies, governmental policies, such as such as price ceilingsprice ceilings and and price floorsprice floors. .

A Price Ceiling (below equilibrium)– is a legally established maximum price which a

seller can charge or a buyer must pay.

– Helps get rid of a surplus (it can cause a shortage)

– Protects consumers

A Price Floor (above equilibrium)– is a legally established minimum price which a

seller can charge or a buyer must pay.

– Helps get rid of a shortage (it causes a surplus)

– Protects producers and workers

Price Ceilings & Price Floors

When the government imposes a price ceiling (a legal maximum price at which a good can be sold) two outcomes are possible:

1) The price ceiling is NOT EFFECTIVE.

2) The price ceiling is EFFECTIVE and causes Shortages.

When government imposes a price floor (a legal minimum price) the two outcomes are possible:

1) The price floor is NOT EFFECTIVE.

2) The price floor is EFFECTIVE and causes a Surplus.

Price Ceilings & Price Floors

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2

3

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SURPLUS

SHORTAGE

$6

PRICEFLOOR

PRICECEILING

10 20 35 55 80

Price Ceilings & Price FloorsPrice Ceilings & Price Floors

A A effectiveeffective Price Ceiling on Rent Price Ceiling on Rent

Price CeilingPrice Ceiling

PPCC

illegal $illegal $

Legal $Legal $

RentRentSupply of Supply of

ApartmentsApartments

Demand for Demand for ApartmentsApartments

RentRent

Quantity of Quantity of ApartmentsApartments

EXAMPLE: Think about EXAMPLE: Think about rent controlrent control

PPEE

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ShortageShortage

Price FloorsPrice Floors

Impacts of a Price FloorImpacts of a Price Floor

One reason to establish a price floor is to protect the producer (such as a new farmer who is competing against larger farming corporations).

The price floor keeps the larger companies from charging a lower price than the new farmer can charge.

Price floors can also be used to protect workers (such as minimum wage)

A A EffectiveEffective Price Floor Price Floor

SupplySupply

QuantityQuantityQQEE

PricePriceFloorFloor

PPFF

EXAMPLE: Think about EXAMPLE: Think about the poor farmerthe poor farmer andand minimum wageminimum wage

illegal $illegal $

Legal $Legal $PricePrice

DemandDemand

PPEE

The Labor Market:The Labor Market:Minimum Wage Laws Minimum Wage Laws & &

the concept of the concept of Price Price FloorsFloors

Labor SupplyLabor Supply

Labor DemandLabor Demand

EquilibriumEquilibriumUnemploymentUnemployment

Quantity of LaborQuantity of Labor

WageWage

EquilibriumEquilibriumWageWage

The Labor Market: Minimum WageThe Labor Market: Minimum Wage

00

Labor Supply

Labor Demand

Wage

A Labor Market with an effective A Labor Market with an effective price floorprice floor for Minimum Wage for Minimum Wage

Quantitysupplied

Quantitydemanded

$10.00Minimum

Wage

0 Quantity of Labor

Gas Market and a Price CeilingGas Market and a Price CeilingA Price CeilingPrice Ceiling creates shortages.

ExampleExample:: US government set price ceilings for gasoline in

1974.

The Vietnam War was consuming much of the fuel. So the US government established a maximum price for gasoline to settle consumer’s fears that the war would cause gas prices to soar.

Unfortunately, suppliers feared that the lower price (price ceiling) would cause not only shortages, but lower profits. (so they limited the (so they limited the supply of gas)supply of gas)

Combine the price ceiling with limited supply with the OPEC Oil Embargo and you have massive shortages for fuel.

DemandDemand

Price ofPrice ofGasolineGasoline

QuantityQuantity

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00 QQ11

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Price ceilingPrice ceiling

1. Initially, the price ceiling1. Initially, the price ceiling was not effective...was not effective...

1970’s Market for Gasoline1970’s Market for Gasolinewith a Price Ceilingwith a Price Ceiling

DemandDemand

00 QQ11

PP22

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2. ...but when supply2. ...but when supplyfell ...fell ...



QuantityQuantity

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DemandDemand

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3. ...the price ceiling3. ...the price ceilingcauses a causes a shortageshortage..

ShortageShortage



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QuantityQuantity

QUICK QUIZANSWER THE FOLLOWING ON YOUR OWN PAPER

1. What is the equilibrium price? At the equilibrium price will you ever have a shortage or surplus?

3. If you set the price for Good X BELOW the equilibrium price will you have a shortage or surplus?

4. Draw the Demand and Supply curves together. What will happen to the equilibrium price & quantity if the demand curve shifts to the left?

Decrease in price and decrease in quantity neededDecrease in price and decrease in quantity needed

The price where quantity supplied equals quantity demanded. You will never have a shortage or surplus.

2. If you set the price for Good X ABOVE the equilibrium price will you have a shortage or surplus?

Surplus

Shortage

5. A price ceiling will create a shortage or surplus?

ShortageShortage

6. A price floor is designed to protect who?

Producers & WorkersProducers & Workers

STUDY AND GET YOUR NOTES

TOGETHER

EMAIL ME ANY QUESTIONS

ANY QUESTIONS?ANY QUESTIONS?

PRICES (SUPPLY AND DEMAND TOGETHER) CHAPTER 6: PRICES (SUPPLY AND DEMAND TOGETHER)

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Transcript of PRICES (SUPPLY AND DEMAND TOGETHER) CHAPTER 6: PRICES (SUPPLY AND DEMAND TOGETHER)