Chapter 6

1. Chapter 6 Prices

2. Combining Supply and Demand • Equilibrium- point of balance between price and quantity. • producers and consumers are satisfied & supply and demand are in balance. This point shows that producers & consumers have succeeded in communicating effectively. Disequilibrium – when quantity supplied is not equal to quantity demanded.

3. Surplus-when quantity supplied is more than the quantity demanded at the price offered. • Also called excess supply • this tells producers that they are charging too much for their product. • To eliminate the surplus, producers must lower their price & continue to make a profit. • The lowered price would help increase the quantity demanded and decrease the quantity supplied- this would eliminate the surplus and help the market achieve equilibrium

4. Shortage- when quantity demanded is more than the quantity supplied at the price offered. • Also called excess demand • To correct this situation a producer could decide to increase the price of their product. • At an increased price the quantity demanded decreases & the quantity supplied increases curbing the shortage & helping the market achieve equilibrium.

5. IMPORTANT!!! • Excess demand will lead firms to raise prices…AND…excess supply will force firms to cut prices Market forces will push the market toward equilibrium.

6. Managing Prices • Gov’ts can become involved in setting prices and rationing goods to help keep the market running smoothly • Price Ceilings- est. a max. price for a particular good. Producers can’t set a price above this level. • Rent control- a price ceiling on rent. • Consequences? can interfere with normal interactions between supply & demand & prevent markets from reaching equilibrium • Price ceilings can result in shortages - lower prices encourage a reduction in quantity supplied - over time price ceilings like rent control will actually discourage landlords from building or maintaining new units

7. Price Floors- gov’t sets a minimum level for prices - often a used w/ agricultural products. • If a large crop results in a huge supply & prices are driven down, many farmers may be unable to make enough money to pay bills or make a profit - which may lead to their farms failing. The government establishes a base price for a product to guarantee a minimum income for farmers. • Consequences: the increase in the price will encourage farmers to maintain artificially high levels of production (surplus) - these artificially high prices prevent a market from reaching equilibrium

8. Minimum wage- an example of a price floor, maintains a certain level of income • the lowest amount that an employer can legally pay a worker for a job. Gov’t establishes this to keep wages from falling to levels that would be too low to allow people to earn enough money to live

9. Shifts in Equilibrium- a shift in the supply or demand curve will lead to a shift in the equilibrium point for a product • Markets always move to equilibrium both buyers and sellers are happy

10. The Role of Prices • Prices provide a language for buyers and sellers…it’s the MAIN FORM OF COMMUNICATION BETWEEN PRODUCERS AND CONSUMERS. • Without prices as a measure of value, a seller would have to barter for goods. There would be no way to have an accurate measure of demand for a product.

11. Advantages of Prices Prices provide a language for buyers and sellers. 1. Prices as an Incentive Prices communicate to both buyers and sellers whether goods or services are scarce or easily available. Prices can encourage or discourage production. 2. Signals Think of prices as a traffic light. A relatively high price is a green light telling producers to make more. A relatively low price is a red light telling producers to make less. 3. Flexibility In many markets, prices are much more flexible than production levels. They can be easily increased or decreased to solve problems of excess supply or excess demand. 4. Price System is "Free" Unlike central planning, a distribution system based on prices costs nothing to administer.

12. Efficient Resource Allocation • Resource Allocation • A market system, with its fully changing prices, ensures that resources go to the uses that consumers value most highly.

13. Rationing- if the supply of a good is very low, the govt. can decide to limit the distribution of a product, generally only happens during war or another crisis. • College sports tickets, graduation tickets, etc can be rationed to ensure priority to certain groups. • Consequences of Rationing • Unfairness- college sports tickets- many in the general public believe they should have access • Cost- it is expensive to distribute rationing fairly

14. Black Markets- goods are exchanged illegally at prices that are higher than officially established prices. • Rationing encourages this b/c consumers are willing to pay more to satisfy their demand • Problems- some people pay unfairly high prices and if someone cheats you, you do not have much recourse to get your money back • Included in the GDP of Europe!