PRICES (SUPPLY AND DEMAND TOGETHER) 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.

DEMAND and SUPPLY DEMAND and SUPPLY TOGETHER AT LAST Demand Supply $ Equilibrium Price (market clearing price) This is the perfect price to charge for a good. Quantity What is the equilibrium price? What is the equilibrium quantity?

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

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

Excess Supply Downward Demand Supply Quantity Demanded = 550 Quantity Supplied = 550 = < Balance Equilibrium Excess Demand Upward A price of $10 in this market will result in... resulting in a balance. quantity demanded of With a balance present, there will be an equilibrium and the market will clear. quantity supplied of 550 and $ Market Equilibrium <

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

= < Excess Supply Downward Balance Equilibrium Excess Demand Upward At every price above market equilibrium there is a surplus and there will be downward pressure on the price level. At every price below market equilibrium there is a shortage and there will be upward pressure on the price level. Prices will normally return to equilibrium. Equilibrium Price $ Market Equilibrium Shortage Supply Demand Surplus < Any questions on that?

Effects of a Change in Supply If Supply decreases, the equilibrium price will rise and the equilibrium quantity will fall. If Supply increases, the equilibrium price will fall and the equilibrium quantity will rise Demand Supply $ Quantity

wine Consider the market for wine. Price ($ per bottle) Q1Q1 Demand Prior to a season of bad weather affecting the amount of grapes, an equilibrium exists where Supply equals Demand 1 with a market price of $18 and output of Q 1. Q2Q2 The bad weather arrives: the supply of wine falls, decreasing the supply from supply 1 to supply 2. What happens to the equilibrium price and output level? 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 Q 2, drawing up the equilibrium price to $20. What happens to equilibrium price and output when the weather returns to normal? Market Adjustment to a Decrease in Supply Supply 2 Supply 1 Quantity (million bottles per week)

o P S1S1S1S1 D $6 S Q DEMAND AND SUPPLY MOVEMENT ON THE CURVE vs. SHIFT OF THE CURVE

EQUILIBRIUM PRICE Q s o S Q d D $ 1 $ 2 $ 3 $ 4 $ Q $ $ PUTTING THE TWO CURVES TOGETHER DEMAND & SUPPLY

INCREASE IN DEMAND P Q d $ 1 $ 2 $ 3 $ 4 $ 5 d1Qo $ D Q S D1D1D1D1Qs DEMAND & SUPPLY

DECREASE IN DEMAND PQs Q d $ 1 $ 2 $ 3 $ 4 $ 5 d1Qo D Q S D1D1D1D1 $ DEMAND & SUPPLY

PQs Q s1s1s1s1 $ 1 $ 2 $ 3 $ 4 $ 5 dQo D Q S S1S1S1S1 $ DECREASE IN SUPPLY

Qs Q s1 $ 1 $ 2 $ 3 $ 4 $ 5 o D Q S S1S1S1S1 D1D1D1D1 $ INCREASE IN DEMAND DECREASE IN SUPPLY DECREASE IN SUPPLY DEMAND & SUPPLY dQd1QP

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) About 3,900 oil rigs in the gulf Hurricane Ike Sept

Price Ceilings & Price Floors (When prices seem unfair)

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 known as price controls! 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: 1) The price ceiling is NOT EFFECTIVE. 2) The price ceiling is EFFECTIVE and causes Shortages.  When government imposes a price floor (a legal minimum price) the two outcomes are possible: 1) The price floor is NOT EFFECTIVE. 2) The price floor is EFFECTIVE and causes a Surplus. Price Ceilings & Price Floors

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.

 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 Price Ceilings & Price Floors

o S D } } SURPLUS SHORTAGE $6 PRICE FLOOR PRICE CEILING Price Ceilings & Price Floors

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)

A Effective Price Floor Supply Quantity QEQEQEQE PriceFloor PFPFPFPF EXAMPLE: Think about the poor farmer and minimum wage illegal $ Legal $ Price Demand PEPEPEPE

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

Labor Supply Labor Demand EquilibriumUnemployment Quantity of Labor Wage EquilibriumWage The Labor Market: Minimum Wage 0

Labor Supply Labor Demand Wage A Labor Market with an effective price floor for Minimum Wage Quantity supplied Quantity demanded $10.00 Minimum Wage 0 Quantity of Labor

Price Ceilings

A effective Price Ceiling on Rent Price Ceiling PCPCPCPC illegal $ Legal $ Rent Supply of Apartments Demand for Apartments Rent Quantity of Apartments EXAMPLE: Think about rent control PEPEPEPE QEQEQEQE QSQSQSQS QDQDQDQD Shortage

Gas Market and a Price Ceiling Price Ceiling A Price Ceiling creates shortages. Example :  US government set price ceilings for gasoline in  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. (so they limited the supply of gas)  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.

Demand Price of Gasoline Quantity P1P1P1P1 0 Q1Q1Q1Q1 S1S1S1S1 Price ceiling 1. Initially, the price ceiling was not effective... was not effective ’s Market for Gasoline with a Price Ceiling

Demand 0 Q1Q1Q1Q1 P2P2P2P2 S2S2S2S2 P1P1P1P but when supply fell ’s Market for Gasoline with a Price Ceiling Price of Gasoline Quantity S1S1S1S1 Price ceiling

Demand 0 Q1Q1Q1Q1 P2P2P2P2 S2S2S2S2 P1P1P1P the price ceiling causes a shortage. Shortage Price of Gasoline 1970’s Market for Gasoline with a Price Ceiling S1S1S1S1 Price ceiling Quantity

QUICK QUIZ ANSWER THE FOLLOWING ON YOUR OWN PAPER 1.What is the equilibrium price? At the equilibrium price will you ever have a shortage or surplus? 3.If you set the price for Good X BELOW the equilibrium price will you have a shortage or surplus? 4.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 The price where quantity supplied equals quantity demanded. You will never have a shortage or surplus. 2.If you set the price for Good X ABOVE the equilibrium price will you have a shortage or surplus? Surplus Shortage 5.A price ceiling will create a shortage or surplus? Shortage 6. A price floor is designed to protect who? Producers & Workers

STUDY AND GET YOUR NOTES TOGETHER ME ANY QUESTIONS ANY QUESTIONS? QUIZ TOMORROW!