The Price System at Work•Buyers and sellers operate with opposite motives:

Buyers want low pricesSellers want high prices

•Both sides have to compromise because neither side will get what it wants. Both sides must also benefit from the compromise or the transaction will not happen.

The Price System at Work•Economists use an Economic Model that analyzes behavior and makes predictions. This model can be illustrated by a table, graph, or statement.•This model helps us to analyze how the interaction of buyers and sellers results in a price that is agreeable to all.

The Price System at Work•Market Equilibrium – occurs when prices are stable and the quantity of goods/services supplied is equal to the quantity demanded.•Surplus – situation in which the quantity supplied is greater than the quantity demanded at a given price.

Price tends to drop as a result of surplus. Small Surplus = Small drop in priceLarge Surplus = Large drop in price

The Price System at Work•Shortage – situation in which the quantity demanded is greater than the quantity supplied at a given price.

The Price System at Work•Equilibrium Price – price that “clears the market” by leaving neither a surplus nor a shortage.

Equilibrium is reached because of the pressure that surpluses and shortages have on prices. Price High = Surplus forces it downPrice Low = Shortage will force it up.

**The quantity supplied is equal to the quantity demanded**

Price Quantity Demanded

Quantity Supplied

Surplus/Shortage

$5 10 60 Surplus of 50

$4 18 52 Surplus of 34

$3 28 41 Surplus of 13

$2 38 29 Shortage of 9

$1 52 11 Shortage of 41

Consider the following demand and supply model of the world oil market (in millions of barrels per day.)

1. Is there a shortage or surplus of oil at a price of $18.00 per barrel? Why? What is the quantity of shortage or surplus?

2. Is there a shortage or surplus of oil at a price of $17.50 per barrel? Why? What is the quantity of shortage or surplus?

3. What is the equilibrium price and quantity in this market?

Explaining and Predicting Prices•Certain events such as a change in supply, a change in demand, or changes in both might result in a change in price.Changes in Supply –

Even small changes in an inelastic supply can create big changes in price.Elastic supply and demand help keep prices from changing dramatically.

The Competitive Price Theory•The Theory of Competitive Pricing represents a set of ideal conditions and outcomes. It serves as a model to measure market performance.•In theory, a competitive market allocates resources efficiently.•To be competitive, sellers are forced to lower prices, which makes them find ways to keep their costs down.•Competition among buyers keeps prices from falling too far.