Demand, Supply, and Prices

Chapter 6: Demand, Supply, and Prices KEY CONCEPT The equilibrium price is the price at which quantity demanded and quantity supplied are the same. WHY THE CONCEPT MATTERS In a market economy, the forces of demand and supply work together to set a price that buyers and sellers find acceptable.

The Interaction of Demand and Supply Seeking Equilibrium: Demand and Supply The Interaction of Demand and Supply KEY CONCEPTS Market equilibrium at a certain price, quantity demanded and quantity supplied are equal Equilibrium price price at which quantity demanded and quantity supplied are equal

The Interaction of Demand and Supply EXAMPLE: Market Demand and Supply Schedule Laws of demand and supply interact in the market Karen sells salads at her sandwich shop wants to offer more salads at higher prices to earn more profit customers not willing to pay higher prices for salads Karen seeks highest price customers will pay so she can still make profit

The Interaction of Demand and Supply EXAMPLE: Market Demand and Supply Curve Vertical axis shows various prices Horizontal axis shows quantity of product Combined schedule gives prices, quantities for demand, supply curves Two curves intersect at point of market equilibrium

Reaching the Equilibrium Price KEY CONCEPTS Trial and error may be necessary for market to arrive at equilibrium Market may have surplus—more quantity supplied than demanded Market may have shortage—more quantity demanded than supplied

Reaching the Equilibrium Price EXAMPLE: Surplus, Shortage, and Equilibrium Surplus, shortage shown above and below point of equilibrium Surplus, shortage measured by horizontal distance between two curves With surplus, prices tend to fall; producers cut back production With shortage, prices rise; producers increase quantity supplied

Reaching the Equilibrium Price EXAMPLE: Holiday Toys Marketers sometimes overestimate popularity, others underestimate Tickle Me Elmo doll introduced for holidays in 1996 at first sold slowly at $30; seemed stores would have surplus fad caught on; shortage developed, price went up by spring, supply doubled; demand decreased, price dropped to $25

Equilibrium Price in Real Life KEY CONCEPTS disequilibrium imbalance between quantity demanded and quantity supplied

Equilibrium Price in Real Life EXAMPLE: Change in Demand and Equilibrium Price Decrease in demand at every price shifts demand curve to left demand curve intersects supply curve at lower price equilibrium price falls, fewer units sold even though price is lower With increase in demand, demand curve shifts to right equilibrium price rises, more units sold even at higher prices

Equilibrium Price in Real Life EXAMPLE: Change in Supply and Equilibrium Price If supply at every price decreases, supply curve shifts to left curves intersect at higher price: equilibrium price rises If supply increases, supply curve shifts to right equilibrium price falls as more units available at every price

Reviewing Key Concepts Explain the differences between the terms in each of these pairs: market equilibrium and disequilibrium surplus and shortage

How the Price System Works Prices as Signals and Incentives How the Price System Works KEY CONCEPTS Competitive pricing—selling products at lower prices than others lures customers away from rival producers maintains overall profits by selling more units

How the Price System Works EXAMPLE: Competitive Pricing Elm Street Hardware prices snow shovels at $20 Uptown Automotive enters market, sells shovels at $13 has lower profit margin, but hopes to sell more units Elm Street must choose to lower price or risk losing customers

How the Price System Works EXAMPLE: Characteristics of the Price System Neutral: interaction of consumers, producers sets equilibrium price Market driven: market forces, not central planners determine prices Flexible: surpluses, shortages lead producers to change prices Efficient: prices adjust until maximum number of products sold

Prices Motivate Producers and Consumers KEY CONCEPTS Prices motivate consumers and producers in different ways Incentive encourages people to take a certain action In price system, incentives move producers and consumers both act in ways consistent with own best interests

Prices Motivate Producers and Consumers EXAMPLE: Prices and Producers Prices signal whether it is good time to enter or leave a market Rising prices create expectation of profits, leading producers to enter Falling prices and possibility of losses lead producers to leave

Prices Motivate Producers and Consumers EXAMPLE: Prices and Consumers Surpluses result in lower prices that motivate consumers to buy producers signal to consumers through advertising, store displays High prices usually encourage consumers to buy substitutes may signal shortage of a product may signal product has a higher status than others

Michael Dell: Using Price to Beat the Competition Lowering Costs to Reduce Prices Dell bypassed retailers, sold directly over telephone Each computer built to customer requirements after ordered this lowered costs, Dell became low-price leader in market Internet sales pioneer—close customer contact, easy to adjust prices Dell now entering consumer electronics market

Reviewing Key Concepts Use each of the terms below in a sentence that illustrates the meaning of the term: competitive pricing incentive

Imposing Price Ceilings Intervention in the Price System Imposing Price Ceilings KEY CONCEPTS Government interferes to keep some prices from going too high Price ceiling—legal maximum price a seller may charge for a product set below the equilibrium price, so shortage results

Imposing Price Ceilings EXAMPLE: Football Tickets and Price Ceilings College sells 30,000 football tickets at $15 60,000 fans want tickets College could resolve shortage by raising price to reach equilibrium College wants to keep price affordable for students On game day, some people sell tickets for $50 or more

Imposing Price Ceilings EXAMPLE: Rent Control as a Price Ceiling Rent-control laws kept housing affordable for low-income families Rents did not match market, so shortage of rental housing developed Landlords unwilling to increase own costs by maintaining properties City of Santa Monica solution: let market set initial rent rent control board regulates yearly increases

Setting Price Floors KEY CONCEPTS Government intervenes to increase income to certain producers Price floor—legal minimum price buyers may pay for product Various programs protect agricultural products encourage farmers to produce abundant supply of food

Setting Price Floors EXAMPLE: Minimum Wage as a Price Floor Minimum wage—least amount employer may pay for one hour of work set by government If set above equilibrium price for job, employers may employ fewer workers unemployment increases If set below equilibrium price, minimum wage has no effect

Rationing Resources and Products KEY CONCEPTS In national emergency, government may distribute products, resources Rationing—way of allocating products using factors other than price Black market—illegal buying and selling of products violates price controls, rationing

Rationing Resources and Products EXAMPLE: Rationing Resources During WWII, U.S. rationed consumer goods so all could afford them allocated resources toward war effort, not consumers From 1946–2002, North Korea strict rationing; system inefficient, corrupt In 1996–2000, widespread famine; people set up unofficial markets In 2002, markets legalized; prices, wages rose; government may turn back

Rationing Resources and Products EXAMPLE: Black Markets—An Unplanned Result of Rationing Black markets common result of rationing; in U.S. during WWII, black market for scarce goods developed Pre-2002 North Korea, trade of most products forbidden or restricted on the whole, black market prices very high post-2002 black market continues since many products still illegal

Reviewing Key Concepts Explain the relationship between the terms in each of these pairs: price floor and minimum wage rationing and black market

Case Study: Prices for Concert Tickets Background Less affluent fans cannot afford concerts, yet ticket prices rising Ticket prices cover costs profit for performers, venues, distributors What’s the Issue? How do demand, supply, and pricing affect the concert ticket market?

Case Study: Prices for Concert Tickets {continued} Thinking Economically Do you think TicketMaster’s plan in document C would help or harm Pearl Jam’s wish “that no one will pay more than $20” to see them (document A)? Explain. What do you think happened to quantity supplied of tickets over the span of the graph in document B? Why? In what year in Figure 6.15 did the high price for concert tickets hit $50—the high price that Pearl Jam speaks of in document A? What year was it $20—the desired price they mention?