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Role of Prices

Role of Prices. Economics Koehn/Molter. Review. A demand schedule shows: How much consumers are willing to buy a various prices. A supply schedule shows: How much sellers are willing to sell at various prices.

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Role of Prices

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  1. Role of Prices Economics Koehn/Molter

  2. Review • A demand schedule shows: • How much consumers are willing to buy a various prices. • A supply schedule shows: • How much sellers are willing to sell at various prices. • Comparing these schedules should allow us to find common ground for the two sides of the market.

  3. Market Equilibrium The point at which quantity demanded and quantity supplied are equal is called EQUILIBRIUM. This can only occur when Quantity demand (QD) = Quantity supplied (QS)

  4. Examples • Quantity demanded = Quantity supplied occurswhere the demand curve intersects the supply curve. • This will determine the equilibrium price and quantity.Equilibrium price = $5.00 and 5,000 pounds of coffee are bought and sold at that price

  5. Picture Form

  6. P S D Q 0 Supply and Demand Together Equilibrium: P has reached the level where quantity supplied equals quantity demanded CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  7. P S D Q 0 Equilibrium price: The price that equates quantity supplied with quantity demanded CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  8. P S D Q 0 Equilibrium quantity: The quantity supplied and quantity demanded at the equilibrium price CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  9. Quantity demanded = Quantity supplied (occurswhen the demand curve intersects the supply curve) This will determine the equilibrium price and quantity.

  10. P S D Q 0 Surplus: when quantity supplied is greater than quantity demanded Example: If P = $5, Surplus thenQD = 9 lattes andQS = 25 lattes resulting in a surplus of 16 lattes CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  11. P Surplus S D Q 0 Surplus: when quantity supplied is greater than quantity demanded Facing a surplus, sellers try to increase sales by cutting price. This causes QD to rise and QS to fall… …which reduces the surplus. CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  12. P S D Q 0 Surplus: when quantity supplied is greater than quantity demanded Facing a surplus, sellers try to increase sales by cutting price. Surplus This causes QD to rise and QS to fall. Prices continue to fall until market reaches equilibrium. CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  13. P S D Q 0 Shortage: when quantity demanded is greater than quantity supplied Example: If P = $1, thenQD = 21 lattes andQS = 5 lattes resulting in a shortage of 16 lattes Shortage CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  14. P S D Shortage Q 0 Shortage: when quantity demanded is greater than quantity supplied Facing a shortage, sellers raise the price, causing QD to fall and QS to rise, …which reduces the shortage. CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  15. P S D Q 0 Shortage: when quantity demanded is greater than quantity supplied Facing a shortage, sellers raise the price, causing QD to fall and QS to rise. Prices continue to rise until market reaches equilibrium. Shortage CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  16. Three Steps to Analyzing Changes in Eq’m To determine the effects of any event, 1. Decide whether event shifts S curve, D curve, or both. 2. Decide in which direction curve shifts. 3. Use supply-demand diagram to see how the shift changes eq’m P and Q. CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  17. P price of hybrid cars S1 P1 D1 Q Q1 quantity of hybrid cars EXAMPLE: The Market for Hybrid Cars CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  18. P S1 P2 P1 D2 D1 Q Q1 Q2 EXAMPLE 1: A Change in Demand EVENT TO BE ANALYZED: Increase in price of gas. STEP 1: D curve shifts because price of gas affects demand for hybrids. S curve does not shift, because price of gas does not affect cost of producing hybrids. STEP 2: D shifts rightbecause high gas price makes hybrids more attractive relative to other cars. STEP 3: The shift causes an increase in price and quantity of hybrid cars. CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  19. P S1 P1 D2 D1 Q Q1 EXAMPLE 1: A Change in Demand Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted. P2 Always be careful to distinguish b/w a shift in a curve and a movement along the curve. Q2 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  20. P S1 S2 P1 P2 D1 Q Q1 Q2 EXAMPLE 2: A Change in Supply EVENT: New technology reduces cost of producing hybrid cars. STEP 1: S curve shifts because event affects cost of production. D curve does not shift, because production technology is not one of the factors that affect demand. STEP 2: S shifts rightbecause event reduces cost, makes production more profitable at any given price. STEP 3: The shift causes price to fall and quantity to rise. CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND

  21. Government Policies That Alter the Private Market Outcome • Price controls • Price ceiling: a legal maximum on the price of a good or service. Example: rent control. • Price floor: a legal minimum on the price of a good or service. Example: minimum wage. • Taxes • The govt can make buyers or sellers pay a specific amount on each unit bought/sold. We will use the supply/demand model to see how each policy affects the market outcome (the price buyers pay, the price sellers receive, and eq’m quantity). CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  22. P S Rental price of apts $800 D Q 300 Quantity of apartments EXAMPLE 1: The Market for Apartments Eq’m w/o price controls CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  23. P S Price ceiling $1000 $800 D Q 300 How Price Ceilings Affect Market Outcomes A price ceiling above the eq’m price is not binding – has no effect on the market outcome. CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  24. P S Price ceiling $500 shortage D Q 400 250 How Price Ceilings Affect Market Outcomes The eq’m price ($800) is above the ceiling and therefore illegal. The ceiling is a binding constrainton the price, causes a shortage. $800 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  25. P S Price ceiling $500 shortage D Q How Price Ceilings Affect Market Outcomes In the long run, supply and demand are more price-elastic. So, the shortage is larger. $800 450 150 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  26. Shortages and Rationing • With a shortage, sellers must ration the goods among buyers. • Some rationing mechanisms: (1) long lines (2) discrimination according to sellers’ biases • These mechanisms are often unfair, and inefficient: the goods do not necessarily go to the buyers who value them most highly. • In contrast, when prices are not controlled, the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair). CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  27. W S Wage paid to unskilled workers $4 D L 500 Quantity of unskilled workers EXAMPLE 2: The Market for Unskilled Labor Eq’m w/o price controls CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  28. W S Price floor $3 $4 D L 500 How Price Floors Affect Market Outcomes A price floor below the eq’m price is not binding – has no effect on the market outcome. CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  29. labor surplus W S Price floor $5 $4 D L 400 550 How Price Floors Affect Market Outcomes The eq’m wage ($4) is below the floor and therefore illegal. The floor is a binding constrainton the wage, causes a surplus (i.e., unemployment). CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  30. unemp-loyment W S Min. wage $5 $4 D L 400 550 The Minimum Wage Min wage laws do not affect highly skilled workers. They do affect teen workers. Studies: A 10% increase in the min wage raises teen unemployment by 1-3%. CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

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