Transcript The Price System, Demand and Supply, and Elasticity

CHAPTER
4
Demand and Supply
Applications
Prepared by: Fernando Quijano
and Yvonn Quijano
© 2004 Prentice Hall Business Publishing
Principles of Economics, 7/e
Karl Case, Ray Fair
C H A P T E R 4:Demand and Supply Applications
The Price System:
Rationing and Allocating Resources
• The market system, performs
two important and closely
related functions:
1. Resource allocation: the
market system determines the
allocation of resources among
produces and the final mix of
outputs.
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C H A P T E R 4:Demand and Supply Applications
The Price System:
Rationing and Allocating Resources
• The market system, performs
two important and closely
related functions:
2. Price rationing: the market
system distributes goods and
services on the basis of
willingness and ability to pay.
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C H A P T E R 4:Demand and Supply Applications
Price Rationing
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• A decrease in supply
creates a shortage at
the original price.
• The lower supply is
rationed to those who
are willing and able to
pay the higher price.
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Price Rationing
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• There is some price
that will clear any
market.
• The price of a rare
painting will eliminate
excess demand until
there is only one bidder
willing to buy the single
available painting.
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C H A P T E R 4:Demand and Supply Applications
Constraints on the Market
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• A price ceiling is a
maximum price that sellers
may charge for a good,
usually set by government.
• In 1974, the government set
a price ceiling to distribute
the available supply of
gasoline.
• At an imposed price of 57
cents per gallon, the result
was excess demand.
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C H A P T E R 4:Demand and Supply Applications
Alternative Rationing Mechanisms
• Queuing is a nonprice
rationing system that uses
waiting in line as a means of
distributing goods and
services.
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C H A P T E R 4:Demand and Supply Applications
Alternative Rationing Mechanisms
• Favored customers are those
who receive special treatment
from dealers during situations
when there is excess demand.
• Ration coupons are tickets or
coupons that entitle individuals
to purchase a certain amount
of a given product per month.
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C H A P T E R 4:Demand and Supply Applications
Alternative Rationing Mechanisms
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• Attempts to restrict
prices often result in
the evolution of a
black market.
• A black market is a
market in which illegal
trading takes place at
market-determined
prices.
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C H A P T E R 4:Demand and Supply Applications
Alternative Rationing Mechanisms
• The problem with rationing systems
is that excess demand is created but
not eliminated.
• No matter how good the intentions of
private organizations and
governments, it is very difficult to
prevent the price system from
operating and to stop the willingness
to pay from asserting itself.
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C H A P T E R 4:Demand and Supply Applications
Prices and the Allocation of Resources
• Price changes resulting from shifts of demand
cause profits to rise or fall.
• Profits attract capital; losses lead to disinvestment.
• Higher wages attract labor and encourage workers
to acquire skills.
• At the core of the system, supply, demand, and
prices in input and output markets determine the
allocation of resources and the ultimate
combinations of things produced.
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C H A P T E R 4:Demand and Supply Applications
Price Floors
• A price floor is a minimum price
below which exchange is not
permitted.
• The most common example of a price
floor is the minimum wage, which is a
floor set under the price of labor.
• The result of setting a price floor will
be excess supply, or higher quantity
supplied than quantity demanded.
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C H A P T E R 4:Demand and Supply Applications
Supply and Demand Analysis:
An Oil Import Fee
• At a world price of $18, imports • The tax on imports causes an
increase in domestic production,
are 5.9 million barrels per day.
and quantity imported falls.
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C H A P T E R 4:Demand and Supply Applications
Supply and Demand
and Market Efficiency
• Supply and demand curves
can be used to illustrate the
idea of market efficiency, an
important aspect of “normative
economics.”
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C H A P T E R 4:Demand and Supply Applications
Consumer Surplus
• Consumer surplus is
the difference between
the maximum amount a
person is willing to pay
for a good and its current
market price.
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C H A P T E R 4:Demand and Supply Applications
Consumer Surplus
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• Some consumers are
willing to pay as much
as $5 each for
hamburgers.
• Since the price is only
$2.50, they receive a
consumer surplus of
$2.50.
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C H A P T E R 4:Demand and Supply Applications
Consumer Surplus
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• Others are willing to
pay something less
than $5.00 but more
than $2.50.
• Consumer surplus is
the area below the
demand curve and
above the price level.
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C H A P T E R 4:Demand and Supply Applications
Producer Surplus
• Producer surplus is the
difference between the
maximum amount a
producer is willing to
accept to supply a good
and its current market
price.
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C H A P T E R 4:Demand and Supply Applications
Producer Surplus
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• Some producers are
willing to accept as
little as 75 cents each
for hamburgers.
• Since the price is
$2.50, they receive a
producer surplus of
$1.75 per hamburger.
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C H A P T E R 4:Demand and Supply Applications
Producer Surplus
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• Others producers are
willing to receive
something less than
$5.00 but higher than
75 cents.
• Producer surplus is
the area above the
supply curve and
below the price level.
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C H A P T E R 4:Demand and Supply Applications
Markets Maximize the Sum of
Producer and Consumer Surplus
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• Total producer and
consumer surplus is
highest where supply and
demand curves intersect
at equilibrium.
• Consumers receive
benefits in excess of what
they pay and producers
receive compensation in
excess of costs.
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C H A P T E R 4:Demand and Supply Applications
Markets Maximize the Sum of
Producer and Consumer Surplus
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• If the market produces
too little, say 4 million
instead of 7 million
hamburgers per month,
total producer and
consumer surplus is
reduced. This reduction
(triangle ABC) is called
a deadweight loss.
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C H A P T E R 4:Demand and Supply Applications
Potential Causes of Deadweight Loss
From Under- and Overproduction
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• Deadweight losses can
occur from under- and
overproduction.
• If the market produces 10
million instead of 7 million
hamburgers per month,
the cost of production rises
above the willingness of
consumers to pay,
resulting in a deadweight
loss.
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C H A P T E R 4:Demand and Supply Applications
Review Terms and Concepts
black market
price floor
consumer surplus
price rationing
deadweight loss
producer surplus
favored customers
queuing
minimum wage
ration coupons
price ceiling
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