Prices

Supply and Demand Meet
◦ The point where demand and supply come together
is called the equilibrium
◦ It is the point of balance at which the quantity
demanded equals the quantity supplied
◦ At equilibrium, the market for a good is stable
◦ Simply look for the price at which the quantity
supplied equals the quantity demanded
◦ When looking at a graph, look for the point where
the supply and demand curve intersects
Price of a
Slice of Pizza
Quantity
Demanded
Quantity
Supplied
Result
$1.00
300
100
Shortage from
excess demand
$2.00
250
150
Shortage from
excess demand
$3.00
200
200
Equilibrium
$4.00
150
250
Surplus from
excess supply
$5.00
100
300
Surplus from
excess supply
$6.00
50
350
Surplus from
excess supply

Market Benefits
◦ In any market, supply and demand will only be
equal at only one price and one quantity
◦ At the equilibrium price, buyers will purchase
exactly as much of a good as firms are willing to
sell
◦ At equilibrium, both buyers and sellers benefit

Disequilibrium
◦ If the market price or quantity supplied is anywhere
but equilibrium, the market is in a state of
disequilibrium
◦ This occurs when quantity supplied is not equal to
quantity demanded in a market
◦ Disequilibrium can produce one of two outcomes:
shortage or surplus

Shortage
◦ The problem of shortage, also known as excess
demand, exists when the quantity demanded in the
market is more than quantity supplied
◦ When the actual price in a market is below the
equilibrium price, you have a shortage, because low
prices encourages buyers and discourages sellers

From Shortage to Equilibrium
◦ As long as there is a shortage and quantity
demanded exceeds the quantity supplied, suppliers
will keep raising the price
◦ Once prices have risen enough to close the gap,
suppliers have found the highest price that the
market will bear
◦ This will continue until a new equilibrium

Surplus
◦ If the price is too high, the market will face the
problem of surplus, also known as excess supply
◦ This exists when quantity supplied exceeds
quantity demanded and the actual price of a good
is higher than equilibrium price

From Surplus to Equilibrium
◦ As the price falls, the quantity demanded will rise,
and more customers will buy more
◦ Whenever the market is in disequilibrium and prices
are flexible, market forces will push the market
toward equilibrium

Price Ceiling
◦ The government may intervene to control prices
◦ This is the maximum price that can be legally
charged for a good or service which is below
equilibrium price

Rent Control
◦ The government sets prices on some goods that are
considered essential
◦ Rent control is ceiling price placed on apartment
rent, to prevent inflation during a housing crisis
(1940’s New York City)
◦ The price ceiling increases the quantity demanded
but decreases the quantity supplied

The Cost of Rent Control
◦ Although governments pass rent control laws to
help the renters with the greatest need, few of
these renters benefit from rent control
◦ Long waiting lists, discrimination by landlords, a
lottery system, and bribery may be used to get
those scarce apartments
◦ Luck becomes important or even inheriting
apartments
◦ Since rent control limits profits, landlords may cut
costs

Impact of Ending Rent Control
◦ Many people would be able to find a wider selection
of apartments
◦ Landlords would also have a better incentive to
maintain their buildings and invest in new
construction
◦ On the other hand, renters in price controlled
apartments may no be able to afford higher rents
◦ Most economists believe that by ending rent
control, the benefits will exceed the cost

Price Floor
◦ A price floor is a minimum price, set by the
government, that must be paid for a good or
service
◦ This is to ensure that sellers receive at least a
minimum reward for their efforts, including labor

The Minimum Wage
◦ Minimum wage is the minimum price that an
employer can pay a worker for an hour of labor
◦ Federal government sets it, but state’s can make it
higher
◦ Refer to graph 6.4

Price Supports in Agriculture
◦ During the Great Depression, whenever prices fell
below a certain level, the government would buy
the excess crops
◦ Supporters of price floors felt that this must happen
in order for farms to survive in a competitive
market
◦ Opponents said that the government dictated what
farmers should produce and in what quantities
◦ 1996 Congress outlawed many of these programs
because of the conflict with free market principles

What are some of the factors that a supply
curve will shift?
1.
2.
3.
4.
5.
A shift in the supply curve to the left or right will
cause a new equilibrium
◦ Since markets tends towards equilibrium, a change
in supply will set in motion market forces that lead
the market to a new equilibrium price and quantity
sold
◦
◦
◦
◦
◦
◦

A Change in Market
◦ Technology in digital cameras have greatly reduced
the prices of digital cameras
◦ Advances in production have allowed manufacturers
to produce digital cameras at a lower cost
◦ These lower costs have been passed on to
consumers in the form of lower prices
◦ Supply curve shifts to the right because of
advancement in technology
◦ Draw the shift in supply of digital cameras like in
figure 6.5

Finding a New Equilibrium
◦ Producers are willing to supply a larger quantity at each
price
◦ Once inventory, or the quantity of goods that a firm has
on hand, starts to pile up, there is a surplus
◦ Suppliers will have to respond to the surplus by reducing
prices
◦ The new equilibrium point marks a lower equilibrium price
and a high equilibrium quantity

Changing Equilibrium
◦ Equilibrium is a moving target that changes with market
conditions

A Decrease in Supply
◦ Other factors make the supply curve shift to the left
◦ If rubber and steel prices rise, manufacturers will
produce fewer cars at all price levels, and shift the
supply curve left
◦ If autoworkers win higher wages, the company pays
more labor to build the cars and supply will
decrease
◦ This will cause suppliers to raise their prices and
the quantity demanded will fall

An Increase in Demand
◦ Almost every year we experience a fad, or a product that
enjoys enormous popularity for a fairly short time
◦ This shifts the demand curve to the right

The Shortage Problem
◦ Shortage in a store appears as empty shelves or long
lines
◦ Also appears in search costs, or the financial and
opportunity cost that consumers pay in searching for a
product or service
 Driving or calling to different stores
 Causes first come, first serve policies

Return to Equilibrium
◦ Customers may actually push prices up on their
own if there is a bidding in the market, like in real
estate, antiques, fine art, and rare items
◦ Prices will continue to rise until a new equilibrium is
formed
◦ When demand increases, equilibrium price and
quantity will increase

A Decrease in Demand
◦ When a fad passes its peak, demand can quickly fall
as it rose
◦ The shortage turns into a surplus
◦ As demand falls, the demand curve shifts left
◦ Suppliers will respond by cutting prices on their
inventory

Free Market
◦ Prices are nearly the most efficient way to allocate,
or distribute, resources
◦ Prices help land, labor, capital into the hands of
producers and finished goods into the hands of
buyers

Centrally Planned
◦ The alternative is distributing goods and resources
in a centrally planned economy that is inefficient
and not based on price

The Advantage of Price
◦ Prices provide a common language for buyers and sellers
◦ Without price, a seller would have to barter for goods
◦ The supplier would also have no consistent and accurate
way to measure demand for a product

Price as an Incentive
◦ Buyers and sellers look at price to find info on a good’s
demand and supply
◦ Prices are signals to tell producers and buyers how to
adjust
◦ Prices tell is goods are readily available or in short
supply

Price as Signals
◦ High price is a signal for producers to produce
more of a good
◦ Low price is a signal that a good is being over
produced
◦ Low prices may tell a producer to use their
resources to produce another good
◦ Consumers on the other hand, low prices tells them
to buy more
◦ A high price tells the consumer to stop and think
carefully before buying

Flexibility
◦ It is very important for prices to be flexible
◦ Prices are much more flexible then quantity
◦ Prices can be increased to solve a shortage and be
decreased to solve the problem of surplus
◦ Supply shock is a sudden shortage of a good, such as
gasoline or wheat
 Creates a shortage because suppliers can no longer meet
demand
 How to divide up immediate supply?
◦ Rationing, or a system of allocating goods and services
using criteria other than price
◦ Raising prices is the quickest way to reduce quantity
demanded

Price System is “Free”
◦ Refer to page 151

Choice and Efficiency
◦ Prices help consumer choose among similar
products
◦ Prices make it easy for you to make a price range
◦ Producers get to target the audience they want for
their prices
◦ In a centrally planned economy, to cut costs, they
limit the variety of a product
◦ This makes fewer choices for the consumers

Rationing and Shortages

The Black Market

Efficient Resource Allocation
◦ Read example on page 152
◦ When people conduct business without regard for
government controls on price or quantity, they are said
to do business on the black market
◦ Black market allows consumers to pay more so they can
buy a product when rationing makes it otherwise
unavailable
◦ Means that economic resources are used for their most
valuable purpose
◦ The people who own the land, labor, and capital sell
their resources to the highest bidder

Prices and the Profit Incentive
◦ Refer to page 153

The Wealth of Nations
◦ Adam Smith wrote about profit incentive
◦ Business prospers by finding out what people want, and
then providing it

Market Problems
◦ Imperfect competition can affect prices, and higher
prices can affect consumer decisions
◦ Negative externalities can include unintended costs like
air and water pollution
◦ Imperfect information can hurt the market if the
consumers don’t have the right information