Chapter 6
Prices
Combining Supply and Demand
• Equilibrium- point of
balance between price and
quantity.
– producers and consumers are
satisfied & supply and demand
are in balance. This point shows
that producers & consumers
have succeeded in
communicating effectively.
Disequilibrium – when quantity
supplied is not equal to quantity
demanded.
• Surplus- when quantity supplied
is more than the quantity
demanded at the price offered.
• Also called excess supply
• this tells producers that they are
charging too much for their product.
– To eliminate the surplus, producers
must lower their price & continue to
make a profit.
– The lowered price would help increase
the quantity demanded and decrease
the quantity supplied- this would
eliminate the surplus and help the
market achieve equilibrium
• Shortage- when quantity
demanded is more than the
quantity supplied at the
price offered.
– Also called excess demand
– To correct this situation a
producer could decide to
increase the price of their
product.
– At an increased price the
quantity demanded decreases
& the quantity supplied
increases curbing the shortage
& helping the market achieve
equilibrium.
IMPORTANT!!!
• Excess demand will lead
firms to raise
prices…AND…excess
supply will force firms to cut
prices
Market forces will push the market toward
equilibrium.
Managing Prices
• Gov’ts can become involved in setting
prices and rationing goods to help keep
the market running smoothly
• Price Ceilings- est. a max. price for a
particular good. Producers can’t set
a price above this level.
– Rent control- a price ceiling on rent.
– Consequences? can interfere with
normal interactions between supply &
demand & prevent markets from
reaching equilibrium
– Price ceilings can result in
shortages - lower prices encourage a
reduction in quantity supplied - over
time price ceilings like rent control will
actually discourage landlords from
building or maintaining new units
• Price Floors- gov’t sets a
minimum level for prices often a used w/ agricultural
products.
– If a large crop results in a huge
supply & prices are driven down,
many farmers may be unable to
make enough money to pay bills or
make a profit - which may lead to
their farms failing. The government
establishes a base price for a
product to guarantee a minimum
income for farmers.
– Consequences: the increase in the
price will encourage farmers to
maintain artificially high levels of
production (surplus) - these
artificially high prices prevent a
market from reaching equilibrium
• Minimum wage- an
example of a price floor,
maintains a certain level
of income
– the lowest amount
that an employer can
legally pay a worker
for a job. Gov’t
establishes this to
keep wages from
falling to levels that
would be too low to
allow people to earn
enough money to live
• Shifts in
Equilibrium- a shift
in the supply or
demand curve will
lead to a shift in the
equilibrium point for
a product
• Markets always
move to equilibrium
both buyers and
sellers are happy
The Role of Prices
• Prices provide a language for buyers and
sellers…it’s the MAIN FORM OF
COMMUNICATION BETWEEN
PRODUCERS AND CONSUMERS.
• Without prices as a measure of value, a
seller would have to barter for goods.
There would be no way to have an
accurate measure of demand for a
product.
Advantages of Prices
Prices provide a language for buyers and sellers.
1. Prices as an Incentive
Prices communicate to both buyers and sellers whether goods
or services are scarce or easily available. Prices can
encourage or discourage production.
2. Signals
Think of prices as a traffic light. A relatively high price is a
green light telling producers to make more. A relatively low
price is a red light telling producers to make less.
3. Flexibility
In many markets, prices are much more flexible than production
levels. They can be easily increased or decreased to solve
problems of excess supply or excess demand.
4. Price System is "Free"
Unlike central planning, a distribution system based on prices
costs nothing to administer.
Efficient Resource Allocation
• Resource Allocation
– A market system, with its fully changing prices,
ensures that resources go to the uses that consumers
value most highly.
• Rationing- if the supply of a
good is very low, the govt.
can decide to limit the
distribution of a product,
generally only happens
during war or another crisis.
– College sports tickets,
graduation tickets, etc can be
rationed to ensure priority to
certain groups.
• Consequences of
Rationing
– Unfairness- college sports
tickets- many in the general
public believe they should
have access
– Cost- it is expensive to
distribute rationing fairly
• Black Markets- goods are exchanged illegally at
prices that are higher than officially established prices.
• Rationing encourages this b/c consumers are willing to
pay more to satisfy their demand
• Problems- some people pay unfairly high prices and if
someone cheats you, you do not have much recourse
to get your money back
• Included in the GDP of Europe!