How Prices Allocate Resources…..
A. The model of supply and demand is a powerful tool for analyzing markets.
B. Supply and demand together determine the price of the economy’s goods and services.
1. These prices serve as signals that guide the allocation of scarce resources in the economy.
2. Prices determine who produces each good and how much of each good is produced.
Slope of PPF is rate at which production process trades off Wheat for Oranges (Opportunity Cost)
Slope of price line is rate at which market trades off Wheat for Oranges (Relative Prices)
W
W*
O*
O
1
(Steeper Slope as Po ↑)
W
Initial Slope = Po / Pw
W1
New Slope = Po / Pw
W2
Po
O1
O2
O
Oranges
S
P2
P1
D1
Q1
Q2
↑ D for Oranges P ↑ Q ↑
Reallocate resources toward orange production
2
D2
Q
New Slope = Po / Pw
(Steeper Slope as Pw ↓)
W2
W
Initial Slope = Po / Pw
W1
Pw
O
O
S1
Wheat
S2
P1
P2
D
Q1 Q2
Q
↑ Technology for Wheat Production
↑ S for Wheat P ↓ Q ↑
Able to produce more Wheat without giving up any Oranges
3