Economics Chapter 6

EXAMPLE Rationing Resources

During World War II, the United States government empowered the Office of Price Administration, which was established in 1941, to ration scarce goods. The hope was that these goods would be distributed to everyone, not just those who could afford the higher market prices born of shortages. It also allocated resources in ways that favored the war effort rather than the consumer market.

EXAMPLE Competitive Pricing

Elm Street Hardware prices its snow shovels at $20. Uptown enters the snow shovel market, raising the overall supply. It also prices the shovels at $13. Uptown has a lower profit margin per shovel, but hopes to sell hundreds of them in order to maintain overall profit. Elm Street can choose to lower its prices as well or risk losing customers.

Equilibrium price and changes in demand and supply

Equilibrium price falls when there is a decrease in demand or an increase in supply. Equilibrium price rises when there is an increase in demand or a decrease in supply. In other words, when consumers want less or producers supply more, prices will fall. When consumers want more or producers supply less, prices will rise.

EXAMPLE Minimum Wage as a Price Floor

If the minimum wage is set above the equilibrium price for certain jobs in a market, employers may decide that paying the higher wages is not profitable. As a result, they may choose to employ fewer workers, and unemployment will increase. If the minimum wage is set below the equilibrium price, then it will have no effect.

EXAMPLE Holiday Toys

In 1996, for example, Tyco Toys Inc. introduced Tickle Me Elmo. ordered about 500,000 for the holiday season. It was priced at $30. after popular television personalities promoted it, Tickle Me Elmo became the hottest toy of that holiday season, and a shortage developed. Even when prices increased markedly, buyers were undeterred. They continued to purchase the toys until they were all gone. Eventually, the market reached equilibrium at a price of $25. When you see suppliers reducing prices, it is often because they have a surplus of products to sell.

EXAMPLE Rent Control as a Price Ceiling

In the past, many cities passed rent control laws in an effort to keep housing affordable for lower-income families. Without the possibility of raising rents to match the market, there is no incentive to increase the supply of rental housing, and a shortage soon develops. By 2005, rent control was becoming far less common as most cities realized it made housing shortages worse in the long run.

market driven

Market forces, not central planning, determine prices, so the system has no oversight or administration costs. In other words, the price system runs itself.

EXAMPLE Market Demand and Supply Curve

On the graph, the vertical axis shows the various prices at which salads are offered for sale and bought. The horizontal axis shows the quantity of salads, whether it is the quantity demanded or the quantity supplied. The demand curve (D) shows quantity demanded at various prices and slopes down. The supply curve (S) shows quantity supplied at various prices and slopes up. the two curves intersect at only one point; this is the point of market equilibrium.

EXAMPLE Prices and Consumers

Prices also act as signals and incentives for consumers. Surpluses that lead to lower prices tell consumers that it is a good time to buy a particular good or service. High prices generally discourage consumers from buying a particular product. A high price may signal that a particular product is in short supply or has a higher status.

neutral

Prices do not favor either the producer or consumer because both make choices that help to determine the equilibrium price. The free interactions of consumers (who favor lower prices) and producers (who favor higher prices) determines the equilibrium price in the market.

example of rationing

The goods might be rationed on a first-come, first-served basis or on the basis of a lottery. Generally, a system is set up that uses coupons allowing each person a certain amount of a particular item. Or the government may decree that certain resources be used to produce certain goods

EXAMPLE Football Tickets and Price Ceilings

The university prints 30,000 tickets for every game and sells them for $15 each. Indeed many students get tickets for $15. On game day, however, ticket scalpers stand outside the stadium and sell some tickets for $50 or more.

flexible

When market conditions change, prices are able to change quickly in response. Surpluses and shortages motivate producers to change prices to reach equilibrium.

EXAMPLE Black Markets—An Unplanned Result of Rationing

When rationing is imposed, black markets often come into existence. During World War II, black markets in meat, sugar, and gasoline developed in the United States. Some people found ways, including the use of stolen or counterfeit ration coupons, to secure more of these scarce goods. Even after the government began allowing some market activities in 2002, the black market flouished because many forms of private property, including homes and cars, were still illegal.

EXAMPLE Surplus, Shortage, and Equilibrium

When the price is above $6, quantity supplied exceeds quantity demanded, and there is a surplus (shaded in orange). When the price is below $6, quantity demanded exceeds quantity supplied, and there is a shortage (shaded in blue). At the equilibrium price, there is neither a surplus nor a shortage.

Rationing

a government system for allocating goods and services using criteria other than price.

price floor

a legal minimum price that buyers must pay for a product.

incentive

encourages people to act in certain ways.

black market

involves illegal buying or selling in violation of price controls or rationing.

minimum wage

legal minimum amount that an employer must pay for one hour of work.

EXAMPLE Characteristics of the Price System

neutral, market drive, flexible and efficient

Competitive pricing

occurs when producers sell products at lower prices to lure customers away from rival producers, while still making a profit.

Disequilibrium

occurs when quantity demanded and quantity supplied are not in balance.

Market equilibrium

occurs when the quantity demanded and the quantity supplied at a particular price are equal.

EXAMPLE Change in Demand and Equilibrium Price

the intersection of the demand curve (D1) and the supply curves (S) shows an equilibrium price of $75. change in consumer taste causes a decrease in demand for athletic shoes at every price, the demand curve shifts to the left. this new demand curve (D2) intersects the supply curve at a lower price, around $65. This becomes the new equilibrium price. quantity demanded decreases to 2,500 pairs of shoes. When there is an increase in demand, the demand curve shifts to the right. new demand curve (D3) intersects the supply curve at a higher price, around $90.

EXAMPLE Change in Supply and Equilibrium Price

the intersection of the supply curve (S1) and the demand curve (D) shows an equilibrium price of $75, with quantity supplied and demanded of 3,000 pairs of shoes. If the price of the raw materials needed to produce athletic shoes increases, the result is a decrease in supply of these shoes at every price. when there are fewer goods and services available at every price, equilibrium price will rise. When new technology allows the manufacturer to produce shoes more efficiently, supply increases, and the supply curve shifts to the right. In other words, when there are more goods and services available at every price, equilibrium price will fall.

price ceiling

the legal maximum price that sellers may charge for a product.

Equilibrium price

the price at which the quantity demanded and the quantity supplied are equal.

Shortage

the result of quantity demanded being greater than quantity supplied. usually because prices are too low.

Surplus

the result of quantity supplied being greater than quantity demanded. usually because prices are too high

what motivates producers to enter or leave the market?

while prices are the signals that are visible in the market, it is the expectation of profits or the possibility of losses that motivates producers to enter or leave a market.

EXAMPLE Prices and Producers

Prices provide information by acting as signals to producers about whether it is a good time to enter or leave a particular market. Producers will view the shortage as a signal that there is an opportunity to raise prices. Higher prices act as an incentive for producers to enter a market. When prices are too high relative to consumer demand, a surplus occurs. Producers can respond to a surplus either by reducing prices, or by reducing production. Either way, falling prices signal that it is a good time for producers to leave the market.

efficient

Prices will adjust until the maximum number 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.

EXAMPLE Market Demand and Supply Schedule

Recently, she decided to offer a new product at lunchtime—prepared salads. makes 40 salads for $10 each and only sold ten. next day makes 15 salad for $4 each. 35 customers wanted it. she discovers market equilibrium at $6 per salad. At that price, she is willing to offer 25 salads for sale, and she sells all of them. This table is a combined market demand and supply schedule that shows the quantities of salads supplied and demanded at various prices.