CHAPTER 6: PRICES (SUPPLY AND DEMAND TOGETHER)

Review What does the law of supply state? As price rises, quantity supplied rises. Looking through the eyes of the PRODUCER! What does the law of demand state? As price rises, quantity demanded falls. Looking through the eyes of the CONSUMER!

Supply and Demand Together Equilibrium Price The price that balances supply and demand. Perfect price to charge for the product. No surplus or shortages. Equilibrium Quantity Quantity that balances supply and demand. Both of these are located where the supply and demand curve meet. 36

DEMAND and SUPPLY TOGETHER AT LAST Equilibrium Price (market clearing price) This is the perfect price to charge for a good. $ Demand Supply 13 12 11 10 9 8 7 350 400 400 450 500 550 600 650 Quantity What is the equilibrium price? What is the equilibrium quantity?

Market Equilibrium < This table and graph indicate the demand and supply conditions for oversized playing cards. $ Demand Supply 13 The Equilibrium will occur where the quantity demanded equals the quantity supplied. 12 11 10 A price of $12 in this market will result in . . . 9 quantity supplied of 600 . . . quantity demanded of 450 and resulting in excess supply. 8 7 With an excess supply present, there will be downward pressure on price to clear the market. 350 400 400 450 500 550 600 650 Downward < Excess Supply Quantity Supplied = 600 Quantity Demanded = 450

Market Equilibrium < < Demand $ Demand Supply 13 A price of $8 in this market will result in . . . 12 quantity demanded of 650 . . . resulting in excess demand. quantity supplied of 500 and 11 10 9 With an excess demand present, there will be upward pressure on price to clear the market. 8 7 350 400 400 450 500 550 600 650 < Downward Excess Supply Quantity Supplied = 500 Quantity Demanded = 650 < Excess Demand Upward

Market Equilibrium < = < Demand Supply $ Demand Supply 13 A price of $10 in this market will result in . . . 12 resulting in a balance. quantity demanded of 550 . . . quantity supplied of 550 and 11 10 9 With a balance present, there will be an equilibrium and the market will clear. 8 7 350 400 400 450 500 550 600 650 < Excess Supply Quantity Supplied = 550 Downward = Balance Equilibrium < Quantity Demanded = 550 Excess Demand Upward

QS= Quantity Supplied QD= Quantity Demanded QS > QD = excess supply and downward pressure on price QS = QD = Equilibrium QS < QD = Excess demand and upward

Market Equilibrium < = < Surplus Shortage Any questions on that? $ Supply At every price above market equilibrium there is a surplus and there will be downward pressure on the price level. 13 Surplus 12 11 Equilibrium Price At every price below market equilibrium there is a shortage and there will be upward pressure on the price level. 10 9 Demand 8 7 Shortage Prices will normally return to equilibrium. 350 400 400 450 500 550 600 650 < Excess Supply Downward Any questions on that? = Balance Equilibrium < Excess Demand Upward

Effects of a Change in Supply If Supply decreases, the equilibrium price will rise and the equilibrium quantity will fall. $ Demand Supply 13 12 11 10 9 8 If Supply increases, the equilibrium price will fall and the equilibrium quantity will rise. 7 350 400 400 450 500 550 600 650 Quantity

Market Adjustment to a Decrease in Supply Consider the market for wine. Prior to a season of bad weather affecting the amount of grapes, an equilibrium exists where Supply equals Demand1 with a market price of $18 and output of Q1. Price ($ per bottle) Supply2 24 The bad weather arrives: the supply of wine falls, decreasing the supply from supply1 to supply2. What happens to the equilibrium price and output level? 22 Demand Supply1 20 At $18 a bottle the quantity demanded exceeds the quantity supplied. There is upward pressure on price inducing the existing consumers to decrease their quantity demanded to Q2, drawing up the equilibrium price to $20. 18 16 Q2 Q1 What happens to equilibrium price and output when the weather returns to normal? Quantity (million bottles per week)

MOVEMENT ON THE CURVE vs. SHIFT OF THE CURVE DEMAND AND SUPPLY MOVEMENT ON THE CURVE vs. SHIFT OF THE CURVE P S1 $6 S 5 4 3 2 D 1 Q o 10 20 35 55 80

DEMAND & SUPPLY S D Q Q $ 1 5 80 $ 2 20 55 $ 3 35 35 $ 4 50 20 $ 5 60 PUTTING THE TWO CURVES TOGETHER Q Q $ s d $ EQUILIBRIUM PRICE S $ 1 5 80 5 $ 2 20 55 4 $ 3 35 35 3 $ 4 50 20 2 D $ 5 60 10 1 Q o 10 20 35 55 80

DEMAND & SUPPLY D1 D S P Q Q Q $ 1 5 80 95 $ 2 20 55 75 $ 3 35 35 60 INCREASE IN DEMAND P Q s Q d1 Q $ d S 6 $ 1 5 80 95 5 $ 2 20 55 75 4 D1 3 $ 3 35 35 60 2 $ 4 50 20 80 D 1 $ 5 55 15 55 o 10 20 35 55 80 Q

DEMAND & SUPPLY D1 D S P Q Q Q $ 1 5 80 35 $ 2 20 55 20 $ 3 35 35 15 DECREASE IN DEMAND P Q s Q d1 Q $ d S 6 $ 1 5 80 35 5 $ 2 20 55 20 4 3 $ 3 35 35 15 2 $ 4 50 20 10 D1 D 1 $ 5 60 10 5 o 10 20 35 55 80 Q

DEMAND & SUPPLY D S1 S P Q Q Q $ 1 5 2 80 $ 2 20 10 55 $ 3 35 15 35 DECREASE IN SUPPLY P Q s Q d Q $ S1 S s1 6 $ 1 5 2 80 5 $ 2 20 10 55 4 3 $ 3 35 15 35 2 $ 4 50 20 20 D 1 $ 5 60 25 10 o 10 20 35 55 80 Q

DEMAND & SUPPLY D S1 S D1 P 6 10 20 35 55 80 INCREASE IN DEMAND DECREASE IN SUPPLY P $ Q s Q d Q d1 Q s1 S1 S 6 $ 1 5 2 80 95 5 $ 2 20 55 70 10 4 3 $ 3 35 15 35 50 D1 2 $ 4 50 20 20 35 1 D $ 5 60 25 10 25 o 10 20 35 55 80 Q

DEMAND & SUPPLY What can the concepts of supply and demand help us do? …illustrate changes in different markets. Source: Wall Street Journal Feb 2008 (beginning signs of recession)

DEMAND & SUPPLY What can the concepts of supply and demand help us do? …illustrate changes in different markets. The concepts help us understand the cause of changes in price (such as during Hurricane Katrina & Gustav) Hurricane Ike Sept 11 2008 About 3,900 oil rigs in the gulf

Price Ceilings & Price Floors (When prices seem unfair)

Supply, Demand and Government Policies Price Ceilings & Price Floors Supply, Demand and Government Policies In a “free” purely capitalist market system, only supply and demand establishes equilibrium prices and quantities. However, in our mixed economy sometimes equilibrium prices are set by the government. These are know as price controls! 2

Government Price Controls They are usually enacted when policymakers believe that the market price is unfair to buyers and even sellers. This results in governmental policies, such as price ceilings and price floors. 3

Price Ceilings & Price Floors A Price Ceiling (below equilibrium) is a legally established maximum price which a seller can charge or a buyer must pay. Helps get rid of a surplus (it can cause a shortage) Protects consumers A Price Floor (above equilibrium) is a legally established minimum price which a seller can charge or a buyer must pay. Helps get rid of a shortage (it causes a surplus) Protects producers and workers 4

Price Ceilings & Price Floors When the government imposes a price ceiling (a legal maximum price at which a good can be sold) two outcomes are possible: The price ceiling is NOT EFFECTIVE. The price ceiling is EFFECTIVE and causes Shortages. When government imposes a price floor (a legal minimum price) the two outcomes are possible: The price floor is NOT EFFECTIVE. The price floor is EFFECTIVE and causes a Surplus. 5

Price Ceilings & Price Floors $6 } S SURPLUS 5 4 3 } PRICE CEILING 2 SHORTAGE 1 D o 10 20 35 55 80

A effective Price Ceiling on Rent EXAMPLE: Think about rent control Rent Rent Supply of Apartments Price Ceiling PE illegal $ PC Legal $ Shortage Demand for Apartments QS QE QD Quantity of Apartments 7

Price Floors

Impacts of a Price Floor One reason to establish a price floor is to protect the producer (such as a new farmer who is competing against larger farming corporations). The price floor keeps the larger companies from charging a lower price than the new farmer can charge. Price floors can also be used to protect workers (such as minimum wage) 15

A Effective Price Floor EXAMPLE: Think about the poor farmer and minimum wage Price Supply Legal $ PF illegal $ PE Price Floor Demand Quantity QE 14

The Labor Market: Minimum Wage Laws & the concept of Price Floors

The Labor Market: Minimum Wage Labor Supply Equilibrium Wage Labor Demand Quantity of Labor Equilibrium Unemployment

A Labor Market with an effective price floor for Minimum Wage Labor Supply $10.00 Minimum Wage Labor Demand Quantity of Labor Quantity demanded Quantity supplied

Gas Market and a Price Ceiling A Price Ceiling creates shortages. Example: US government set price ceilings for gasoline in 1974. The Vietnam War was consuming much of the fuel. So the US government established a maximum price for gasoline to settle consumer’s fears that the war would cause gas prices to soar. Unfortunately, suppliers feared that the lower price (price ceiling) would cause not only shortages, but lower profits. (so they limited the supply of gas) Combine the price ceiling with limited supply with the OPEC Oil Embargo and you have massive shortages for fuel. 11

1970’s Market for Gasoline with a Price Ceiling 1. Initially, the price ceiling was not effective... Price of Gasoline S1 P1 Price ceiling Demand Q1 Quantity 10

1970’s Market for Gasoline with a Price Ceiling 2. ...but when supply fell ... Price of Gasoline S1 P2 P1 Price ceiling Demand Q1 Quantity 10

1970’s Market for Gasoline with a Price Ceiling 3. ...the price ceiling causes a shortage. Price of Gasoline S1 P2 Shortage P1 Price ceiling Demand Q1 Quantity 10

ANSWER THE FOLLOWING ON YOUR OWN PAPER QUICK QUIZ ANSWER THE FOLLOWING ON YOUR OWN PAPER What is the equilibrium price? At the equilibrium price will you ever have a shortage or surplus? The price where quantity supplied equals quantity demanded. You will never have a shortage or surplus. If you set the price for Good X ABOVE the equilibrium price will you have a shortage or surplus? Surplus If you set the price for Good X BELOW the equilibrium price will you have a shortage or surplus? Shortage Draw the Demand and Supply curves together. What will happen to the equilibrium price & quantity if the demand curve shifts to the left? Decrease in price and decrease in quantity needed A price ceiling will create a shortage or surplus? Shortage 6. A price floor is designed to protect who? Producers & Workers

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