Learning Objectives
Discuss the essential features of the
price system
Evaluate the effects of changes in demand
and supply on the market price and
equilibrium quantity
Understand the rationing function
of prices
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Learning Objectives
Explain the effects of price ceilings
Explain the effects of price floors
Describe various types of governmentimposed quantity restrictions
on markets
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Did You Know That...
The inflation-adjusted value of the U.S.
minimum wage peaked at about $8 in 1964?
We can use supply and demand analysis to
analyze effects of the minimum wage?
The model of supply and demand can
explain instances of a gap between quantity
supplied and quantity demanded?
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The Price System and Markets
Price System or Market System
– An economic system in which relative prices
are constantly changing to reflect changes in
supply and demand
• Prices signal what is relatively scarce and relatively
abundant.
• Prices provide information to individuals
and businesses.
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The Price System
and Markets
Markets
– Emphasize voluntary exchange
– Determine the terms of exchange
– Facilitate exchange
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The Price System
and Markets
Voluntary Exchange
– Acts of trading between individuals that make
both parties to the trade better off
Terms of Exchange
– The prices we pay for the desired items
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The Price System
and Markets
Transaction Costs
– The costs associated with exchange
– Examples
•
•
•
•
•
Price shopping
Determining quality
Determining reliability
Service availability
Cost of contracting
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The Price System
and Markets
 The role of middlemen
– Middlemen (intermediaries) or brokers reduce
transaction costs by providing information to buyers
and sellers
– Examples
•
•
•
•
Real estate brokers
Stock brokers
Consignment shops
Car dealerships
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Changes in Demand and
Supply
Changes in supply and demand can create a
disequilibrium.
The market price and quantity can/will
adjust to a new equilibrium.
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Shifts in Demand and in Supply:
Determinate Results
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and Supply Analysis
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Shifts in Demand and in Supply:
Determinate Results
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Shifts in Demand and in Supply:
Determinate Results
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and Supply Analysis
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Shifts in Demand and in Supply:
Determinate Results
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Changes in Demand
and Supply
Summary
– Increases in demand increase equilibrium price
and quantity.
– Decreases in demand decrease equilibrium
price and quantity.
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Changes in Demand
and Supply
Summary
– Increases in supply decrease equilibrium price
and increase equilibrium quantity.
– Decreases in supply increase equilibrium price
and decrease equilibrium quantity.
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Changes in Demand
and Supply
When both demand and supply shift
– Simultaneous changes in demand and supply
put conflicting pressure on price or quantity.
• The resulting effect depends upon how much each
curve shifts.
 Either equilibrium price or quantity will be indeterminate.
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Changes in Demand
and Supply
When both demand and supply increase
– Change in price is indeterminate
– Quantity will increase
When both demand and supply decrease
– Change in price is indeterminate
– Quantity will decrease
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Changes in Demand
and Supply
 When supply decreases and demand increases
– Price will increase
– Change in quantity is indeterminate
 When supply increases and demand decreases
– Price will decrease
– Change in quantity is indeterminate
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Example: Why Gasoline Prices
Have Increased
One factor—an increase in demand, shown
by a rightward shift in the demand curve
Another factor—a reduction in supply,
shown by a leftward shift in the supply
curve
As a result, the market clearing price of
gasoline increased.
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The Effects of a Simultaneous Decrease in
Gasoline Supply and Increase in Gasoline
Demand
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The Rationing Function of
Prices
Synchronization of decisions of buyers and
sellers that leads to equilibrium is called the
rationing function of prices.
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The Rationing Function
of Prices
Methods of non-price rationing
– Rationing by queues (waiting in line)
– Rationing by random assignment, and/or
coupons
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The Rationing Function
of Prices
The essential role of rationing (with scarcity
rationing must occur)
– We must choose the rationing mechanism: price
or non-price.
• Price rationing leads to most efficient use of
available resources; all gains from mutually
beneficial trade are captured.
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The Rationing Function
of Prices
Question
– If price rationing is the most efficient is it the
“best” way to ration?
Answer
– Economists cannot say which system is “best.”
They can say rationing via the price system
leads to the most efficient use of available
resources.
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The Policy of GovernmentImposed Price Controls
 Price Controls
– Government-mandated minimum or maximum prices
 Price Ceiling
– A legal maximum price
 Price Floor
– A legal minimum price
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The Policy of GovernmentImposed Price Controls
Price ceiling and black markets
– Price ceilings may prevent the equilibrium price
from being achieved if it is above
the ceiling price.
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The Policy of Controlling Rents
Effects on the existing supply of housing
and current use of housing
– Property owners cannot recover costs
• Maintenance, repairs, capital improvements
– Rations the current use of housing
• Reduces mobility, e.g., New York’s
“housing gridlock”
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Price Floors in Agriculture
Support Price
– The governmentally established price floor
• Associated with agricultural products
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Agricultural Price Supports
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Price Floors in the Labor
Market
Minimum Wage
– A wage floor, legislated by government, setting
the lowest hourly wage rate that firms may
legally pay their workers
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The Effect of Minimum Wages
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Quantity Restrictions
Governments can impose quantity
restrictions, most obvious—banning
ownership or trading of a good
– Human organs
– Drugs
– Hospital beds
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Quantity Restrictions
 Government Prohibitions and
Licensing Requirements
– Some commodities cannot be purchased at all legally;
others require a license
 Import Quota
– Supply restriction that prohibits the importation of more
than a specified quantity of a particular good
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Summary Discussion
of Learning Objectives
Essential features of the price system
– A price system (market system) allows prices to
respond to changes in supply and demand for
different commodities.
– The terms of exchange—prices—are
communicated in markets that tend
to minimize transactions costs.
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Summary Discussion
of Learning Objectives
 How changes in demand and supply affect market
price and equilibrium quantity
– Increases in demand increase equilibrium price
and quantity; decreases in demand decrease equilibrium
price and quantity.
– Increases in supply decrease market price
and increase equilibrium quantity; decreases in supply
increase market price and decrease equilibrium
quantity.
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Summary Discussion
of Learning Objectives
How changes in demand and
supply affect market price and equilibrium
quantity
– When both demand and supply shift at the same
time, the result is indeterminate.
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Summary Discussion
of Learning Objectives
The rationing function of prices
– In a market system, prices ration scarce goods
and services.
– Other ways of rationing include first come, first
served; political power; physical force; random
assignment; and coupons.
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Summary Discussion
of Learning Objectives
The effects of price ceilings
– A price ceiling set below the market
(equilibrium) price results in a shortage.
• The resulting shortage can lead to non-price
rationing devices and black markets.
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Summary Discussion
of Learning Objectives
The effects of price floors
– If the price floor is set above the market price, a
surplus results.
• A price floor can take the form of a governmentimposed price support or
minimum wage.
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Summary Discussion
of Learning Objectives
Government-imposed restrictions
on market quantities
– Bans on sale or ownership
– Licensing restrictions
– Import quotas
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