Chapter 4 The price system, supply and demand, and elasticity

The Price System: Rationing and Allocating Resources The price system performs two important and closely related functions in a society with unregulated markets. –PRICE RATIONING –ALLOCATING RESOURCES

PRICE RATIONING PRICE RATIONING: is the process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied. Consider the following example in the market for lobster...

This rationing process determines: the allocation of resources among suppliers the final mix of output to be allocated across consumers

Price Rationing in the Market for Lobsters Figure 4.1 At $3.27, the quantity demanded and quantity supplied are both 47 lobsters. Suppose the supply of lobster shifts to the left. At a price of $3.27, there is now a demand of 22 lobsters.

Equilibrium is restored. Equilibrium is restored at a price of $4.50. Quantity supplied rises and quantity demanded falls as price rises. Thirty-five million pounds of lobster is rationed to the consumers who are willing and able to pay $4.50 per pound for it.

Constraints on the market and alternative rationing mechanisms Some of these methods include: –Price ceilings: a maximum price that sellers may charge for a good, usually set by government. –Queuing: waiting in line as a means of distributing goods and services; a non price rationing mechanism. –Favored customers: those who receive special treatment from dealers during situations of excess demand. –Ration coupons: tickets or coupons that entitle individuals to purchase a certain amount of a given product per month. –Black market: a market in which illegal trading takes place at market-determined prices.

Oil supply in Figure 4.3 Congress: price ceiling Most common non price rationing system: queuing… A second device: favored customers Another way: ration coupons Black market

Price and the allocation of resources Figure 4.4

World Cup Soccer championship in Consider the market for tickets to major sporting events, like the finals of the World Cup Soccer championship in The problem with these alternatives: excess demand is created but not eliminated.

World Cup Soccer championship in $3,000 The average ticket price was set at $300 for the final game of the World Cup. $300 This price was below the equilibrium price, and scalpers made a tidy profit. Can you explain why? Scalpers profit The actual demand curve

SUPPLY AND DEMAND ANALYSIS: AN OIL IMPORT FEE An oil import fee would place a tax on all oil imported into the U.S... Why might politicians choose to impose such a tax?

The world and US markets for crude oil in 1989 (w/o tax) p q p q Sworld D.usa S.usa Dworld $18 Millions of Barrels/day

The import tax raises the price of all gasoline in the U.S. p q D.usa S.usa $18 $24 Millions of Barrels/day What is the impact of this policy on : domestic producers? foreign producers? U.S. consumers? U.S. government?

The import tax raises the price of all gasoline in the U.S. p q D.usa S.usa $ p q D.usa S.usa $ $18 Import fee Government tax revenue

Review questions What is price rationing? Apply the knowledge.