Supply and Demand - Prices Unit 6.1

The Role of Prices Prices, or what someone is willing to pay for a good or service, and what a supplier is willing to provide, is a cornerstone of capitalism. This goes a long way to answering the three basic questions that an economic system: What do we make; How do we make it; Who gets it. While suppliers always want to get the maximum price for their goods (profit motive), buyers often are looking for the best deals.

In an open market, the buyer will find the best price for their good, and the producer that sells at that price will prosper, forcing other suppliers to either match that price, or their business might fail. Having an open market, in which suppliers are looking for products that people want, and can pay for, is considered an efficient use of resources. Because of this, an open market will provide a wide variety of goods and services. However, this is not always in the best interests of society in general. When any economic system fails to set prices reasonably, this causes market failure.

Supply and Demand Market Balance –When Supply and Demand meet, the market is said to be in balance. This point at which they meet on the graph is called the Equilibrium Point. –The equilibrium point is considered very important in economics, because it is the point at which a “free market” will decide on the price of goods

The Equilibrium of Supply and Demand Price of Ice-Cream Cone Quantity of Ice-Cream Cones 13 Equilibrium quantity Equilibrium price Equilibrium Supply Demand $2.00

Changes in Price Shortage –A shortage occurs when there is an excess of demand or a decrease in supply. Typically, in response to an increase in demand, the prices of an item will rise, with a corresponding rise in supply, until new equilibrium is established. Surplus –A surplus of goods occurs when there is an excess of supply. Prices of a good will fall, increasing demand, until, again, a new equilibrium is found.

Markets Not in Equilibrium Price of Ice-Cream Cone 0 Supply Demand (a) Excess Supply Quantity demanded Quantity supplied Surplus Quantity of Ice-Cream Cones 4 $

Markets Not in Equilibrium Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones Supply Demand (b) Excess Demand Quantity supplied Quantity demanded $ Shortage

Changes in Demand and Supply The Law of Demand and the Law of Supply describe what happens when price changes. If anything other than price changes, the whole curve moves. (By the way, this is what causes the price to change on the other curve)

How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones Supply Initial equilibrium D D 3....and a higher quantity sold resulting in a higher price Hot weather increases the demand for ice cream New equilibrium $

How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones Demand New equilibrium Initial equilibrium S1S1 S2S resulting in a higher price of ice cream An increase in the price of sugar reduces the supply of ice cream and a lower quantity sold $2.50 4