Transcript Ch. 6: Demand, Supply and Prices

CH. 6: DEMAND, SUPPLY AND
PRICES
The Interaction of Demand and
Supply
 Market equilibrium – a situation in which the
quantity demanded of a good or service at a
particular price is equal to the quantity
supplied at that price
 Equilibrium price – is the price at which the
quantity of a product demanded by
consumers and the quantity supplied by
producers are equal
Example: Market Demand and Supply
Schedule
 Karen – sandwich shop
near office park
 new lunch line – salads
 makes 40, offers for $10 –
sells 10
 next makes 15, offers for $4 –
sells all but 35 customers
want more
 continues to experiment until
- makes 25, offers for $6 –
sells all
 Market equilibrium –
quantity demanded and
quantity supplied are in
balance
Price per
Salad ($)
Quantity
Demanded
Quantity
Supplied
10
10
40
8
15
35
6
25
25
4
35
15
2
40
10
 Figure 6.1 – shows data gathered
 combined market demand and supply schedule
 where #’s are the same – market equilibrium at $6
 Karen wants to make more profit – but she
will not make much profit if any if she sold at
the price the office workers want and vice
versa
Example: Market Demand and
Supply Curves
 Possible to graph a combined market demand
and supply schedule
 figure 6.2 – Karen’s market demand and supply
schedule
 vertical – various prices salads sold at
 horizontal – quantity of salads (quantity demanded or
quantity supplied)
 demand curve is plotted using prices and quantities
demanded
 supply curve is plotted using the prices and quantities
supplied from combined schedule
 curves intersect at one point – market equilibrium
Market Demand and Supply Curve
12
10
8
Demand
6
Supply
4
2
0
10
15
25
35
40
Reaching the Equilibrium Price
 Markets do not arrive at equilibrium price
instantly – need trial and error
 Surplus – which is the result of quantity
supplied being greater than quantity
demanded – usually b/c prices are too high
 Shortage – the result of quantity demanded
being greater than quantity supplied – usually
b/c prices are too low
Example: Surplus, Shortage, and
Equilibrium
 Figure 6.3. – equilibrium when neither a shortage
nor a surplus
 surplus shown in the orange area – measured by
horizontal distance between the curves
 when a surplus, prices tend to fall until surplus is sold and
equilibrium reached
 shortage show in the blue area – measured by
horizontal distance between the curves
 when a shortage, producers raise prices to try to balance
quantity supplied and quantity demanded
 also may try to increase quantity supplied to
meet the quantity demanded at the lower price
Surplus, Shortage &
Equilibrium
12
10
8
Demand
6
Supply
4
2
0
10
15
25
35
40
Example: Holiday Toys
 Shortage most apparent for toys
during holiday season

toys are fads and tastes change
rapidly
 difficult to know how much to
supply and at what price
 overestimate – surplus,
underestimate – shortage
 1996 – Tickle Me Elmo by Tyco
Toys Inc.


expected toy to be popular
ordered 500,000 at $30 – sales
started slow
 then TV personalities promote it
 sales took off – ran into a
shortage
Equilibrium Price in Real Life
 Disequilibrium – when there is an imbalance
between quantity demanded and quantity
supplied
 real world relationship between demand and
supply is very complex
Example: Change in Demand and
Equilibrium Price
 Price for athletic shoes
 change in demand for one of 6 reasons : income,
market size, consumer expectations, consumer
taste, substitute goods, and complementary
goods – prompts consumers to change the
quantity demanded at every price
 Figure – 6.4 – equilibrium
140
at $75 and 3000 shoes
120
 change in taste causes a
↓in demand – curve shifts
left – new EP - $65
 when consumers demand
fewer goods and services
at every price, EP will fall
and suppliers will sell
fewer units – even though
the price is lower
100
80
D1
D2
60
S
40
20
0
0.5 1.5
3
4
5
140
 Figure 6.5 - equilibrium
120
at $75 and 3000 shoes
100
 change in # of young
80
S1
D1
60
D3
40
20
0
0.5
2
3
4.5 5.5
7
adults causes ↑ in
demand – curves shifts
right – new EP - $90
 when consumers
demand more goods
and services at every
price – EP will ↑ and
suppliers will sell more,
even at higher prices
Example: Change in Supply and
Equilibrium Price
 Change in supply for one
140
120
100
80
D
S2
60
S1
40
20
0
1
1.5
2
3
3.5
4
4.5
5.5
0
of 6 reasons: input costs,
labor productivity,
technology, govt. action,
producer expectations,
number of producers
 figure 6.6 – equilibrium at
$75 and 3,000 shoes
 price of raw materials ↑,
then a ↓ in supply – curve
shifts left – new EP - $90
 fewer goods and services
at every price – EP will rise
 Figure 6.7 - equilibrium at
$75 and 3,000 shoes
 new technology causes ↑ in





supply – curve shifts right –
new EP - $55
when more goods and
services available at every
price, EP will fall
EP falls when there is an ↓ in
demand or an ↑ in supply
when consumers want less or
producers supply more –
prices ↓
EP rises when there is an ↑ in
demand or a ↓ in supply
when consumers want more
or producers a supply less –
prices ↑
140
120
100
80
D
S1
60
S3
40
20
0
1
2
4
5
6
SEC. 2 : PRICES AS SIGNALS
AND INCENTIVES
How the Price System Works
 Competitive pricing – occurs when producers
sell goods and services at prices that best
balance the twin desires of making the
highest profit and luring customers away
from rival producers
 by entering at lower prices – a new supplier can
add customers and maintain overall profits by
selling more units
Example: Competitive Pricing
 Snow shovels at Elm
Street Hardware - $20
 Uptown Automotive
enters market –
increases supply – price
$13
 lower profit margin but
hopes to sell more to
maintain profit
 Elm Street can lower
price or lose customers
Example: Characteristics of
the Price System
 -4 characteristics
 1. It is neutral – prices do not favor either the
producer or consumer b/c both make choices
that help to determine the EP. The free
interaction of the producers and consumers
determines the EP in the market
 2. It is market driven – market forces
determine prices – so the system has no
oversight or administration. The price system
runs itself.
 3. It is flexible – when market conditions
change, prices are able to change quickly in
response. Surpluses and shortages motivate
producers to change prices to reach
equilibrium.
 4. It is efficient – prices will adjust until the
maximum # of goods and services are sold.
Producers choose to use their resources to
produce certain goods and services based on
the profit they can make by doing so.
Prices Motivate Producers and
Consumers
 Consumers and
producers have
different attitudes
toward price
 consumers want low
prices and producers
want high prices
 incentives encourage
consumers and
producers to act in
certain ways consistent
with their best interests
Example: Prices and Producers
 For producers – price
system has 2 advantages:
 information – by acting as a
signals to producers whether
good time to enter or leave a
particular market
 motivation – rising prices and
expectations of profit –
motivate producer to enter
 Falling prices and
possibility or losses
motivate to leave a market
Example: Prices and Producers
 Shortage signals that
consumer demand is not
being met by existing
suppliers
 producers see shortage as
opportunity to raise prices
 higher prices act as
incentive for producers to
enter a market
 Example – the prospect
of selling goods at higher
prices encourages
producers to offer
products for that market
Example: Prices and
Producers
 More producers motivated by higher prices to
enter market – quantity supplied ↑
 prices too high relative to consumer demand – surplus
 Producers can reduce prices or reduce
production to bring in line with quantity
demanded at particular price
 falling prices signal good time to leave a market
 Some producers leave market completely due to
increased competition and lower prices drive
them out of business
 most shift their business to focus on opportunities in
markets with higher potential profits
Example: Prices and Producers
 When a market is
growing and there is
unmet demand –
producer may enter with
a price lower than
competitor
 new producer can still earn
profit by selling more units
at lower price
 it is expectation of profits
or possibilities of losses
that motivate producers to
enter or leave a market
Economic Pacesetters: Michael
Dell: Using Price to Beat the
Competition
 b. – Feb. 23, 1965 – Chairman of




Dell
Began assembling and selling
computers as a freshman in
college
1984 – so successful – quit
college to focus on business –
sales worth $6 million 1st year
Approach to marketing and
production was key to success
Sold over the phone to
knowledgeable computer users
& govt.

computers built to customer
requirement & assembled after
ordered
 lower costs – low price leader in
the market
 Sales in 1986 - $69.5 million
to $258 million in 1989
 pioneer in internet sales as well
 Maintained close contact
with customers, adjusts
prices as per market
 competitors in retail stores had
higher costs
 By 2005 – leading supplier of
PC’s – sales at $50 billion a yr.
 Now looking to move into
consumer electronics
Sec. 3: Intervention in the
Price System
Imposing Price Ceilings
 Some think it is a good idea to interfere with
the pricing system to keep the price of a good
or service from going too high
 Price ceiling – an established maximum price
that sellers may charge for a good or service
 is set below the market equilibrium so a shortage
will result
Example: Football Tickets and
Price Ceiling
 Ticket prices for college
football games
 Trenton U. – prints 30,000
tickets for each game for
$15 each – 60,000 fans
want them, shortage of
30,000 for every game
 could let the price rise until
quantity demanded and
quantity supplied are equal
 president wants tickets
affordable for students
 Game day – scalpers sell
tickets for $50 or more
Example: Rent Control as a
Price Ceiling
 In the past – rent control laws to
keep housing affordable for low
income families

control when rent can be raised,
by how much, no matter the
market
 unexpected consequences from
rent control
 no incentive to increase the supply
of rental housing – shortage occurs
 Landlords reluctant to invest
money in property maintenance
– conditions worsen
 By 2005 – rent control less
common due to making housing
shortages worse
Example: Rent Control as a
Price Ceiling
 Santa Monica – late
1990’s – new law on rent
controls
 law allows property
owners to let market
determine initial rent on
new tenant
 city would regulate yearly
rent increases
 Effect – rents increases
40% to 85% - showing
apartments had been
priced artificially low
Setting Price Floors
 Govt. sometimes intervenes in the price
system to increase income to certain
producers
 Price floor – is an established minimum price
that buys must pay for a good or service
 goal – is to encourage farmers to produce an
abundant supply of food
Example: Minimum Wage as a
Price Floor
 Minimum wage – the minimum legal price that
an employer may pay a worker for one hour of
work
 1st minimum wage started in 1938 – 1930s a period of
low wages – govt. hoped to increase the income of
workers
 if minimum wage set above equilibrium price for jobs
in a market, employers may decide paying higher
wages is not profitable – may employ fewer workers –
unemployment increase
 if minimum wage below equilibrium price – no effect
Rationing Resources and
Products
 Market uses prices to allocate goods and services
 Rationing – is a system in which the govt. allocates
goods and services using factors other than price
 can be rationed on first come first served basis, a lottery
 generally – a system of coupons allowing a person a certain
amount of a good
 Some try to skirt the rules to get goods and services –
creating a black market
 Black market – goods and services are illegally
bought and sold in violation of price controls or
rationing
Example: Rationing Resources
 During WWII – US govt.
empowered Office of Price
Administration (1941) to
ration scarce goods
 hope to distribute goods to
everyone, not just those who
could afford the higher
market prices of a shortage
 allocated resources in ways
that favored the war effort
 led consumers to look for
substitutes – ex. – margarine
Example: Rationing Resources
 North Korea maintained
strict rationing from
1946 to 2002
 staples – meat, rice,
cabbage strictly rationed –
but system inefficient &
corrupt
 amount of rationing
depended on who you
knew, where you lived,
your occupation
 govt. officials in cities
often got more than their
allotment, while majority
of people got by with less
Example: Rationing Resources
 Between 1996 -2000 – famine
made situation worse
 ration coupons given but the
rations were not
 a million may have died due to
the famine
 The people established
market to trade handicrafts
for food
 govt. legalized in 2002 – result
– prices rose, wages increased
 2005 – skeptical govt.
considering going back to
rationing
Example: Black Markets – An
Unplanned Result of
Rationing
 When rationing starts – black markets start
 during WWII – meat, sugar, gas – using stolen or
counterfeit ration coupons
 North Korea – free trade in grain forbidden –
prices high in markets that did exist
 1985 – cost half the average monthly salary to by a
chicken on the black market
 even after 2002 – black market flourished b/c forms of
private property were illegal
 some start to smuggle items from China to sell in
North Korea