chapter 6 – price cutler – economics. bellringer what would happen if the government decided gas...
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Chapter 6 – PriceChapter 6 – Price
Cutler – Economics
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BELLRINGERBELLRINGER
• What would happen if the government decided gas prices should be lowered by $2.50 per gallon?
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Section 1 – Section 1 – Combining Supply and Combining Supply and
Demand Demand • Balancing the
Market– Defining Equilibrium– Graphing Equilibrium
• Disequilibrium– Excess Demand– Excess Supply
• Government Intervention
• Price Ceilings– The Cost of Price
Ceilings– Ending Rent Control
• Price Floors– Minimum Wage – Price Supports in
Agriculture
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Balancing the MarketBalancing the Market
• Market System– Consumers can buy productions they want– Sellers make enough profit to stay in
business– Sellers respond to changing needs of
consumers
• Turning competing interests into a positive outcome for both sides
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Balancing the MarketBalancing the Market
• Buyers and sellers come together in the market– Combining Supply and Demand
• Review Demand Schedule– Price of goods compared to how much is
produced
• Review Supply Schedule– Price of goods compared to how much is
consumed
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Demand and Supply Demand and Supply ScheduleSchedule
Price of a slice of pizza
Quantity demanded
Quantity supplied
Result
Combined Supply and Demand Schedule
$ .50 300 100
$2.00
$2.50
$3.00
150
100
50
250
300
350
$1.50 200 200
$1.00 250 150
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Defining Equilibrium Defining Equilibrium
• Equilibrium: The point at which quantity demanded and quantity supplied are equal
• Balance between price and quantity– Market is then stable
• The amount produced will equal the amount consumed
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Graphing Equilibrium Graphing Equilibrium P
ric
e p
er
sli
ce
Equilibrium Point
Finding Equilibrium
Price of a slice
of pizza
Quantity demanded
Quantity supplied
Result
Combined Supply and Demand Schedule
$ .50 300 100
$3.50
$3.00
$2.50
$2.00
$1.50
$1.00
$.50
Slices of pizza per day
050 100 150 200 250 300 350
Supply Demand$2.00
$2.50
$3.00
150
100
50
250
300
350
Surplus from excess supply
$1.50 200 200 Equilibrium
Equilibrium Price
a
Eq
uili
briu
m
Qu
an
tity
$1.00 250 150
Shortage from excess demand
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Disequilibrium Disequilibrium
• Disequilibrium: a point when quantity supplied does not equal quantity demanded
• Creates excess demand or excess supply
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Excess DemandExcess Demand
Price
Slices of Pizza
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
50 100 150 200 250 300 350
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Excess DemandExcess Demand
• At $1.00 per slice – QD = 250 Slices– QS = 150 Slices
• Creates a Shortage
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Excess Supply Excess Supply
Price
Slices of Pizza
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
50 100 150 200 250 300 350
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Excess SupplyExcess Supply
• At $2.50 per slice – QD = 100 Slices– QS = 300 Slices
• Creates a Surplus
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Analyze the Data Analyze the Data
Price of a slice of pizza
Quantity demanded
Quantity supplied
Result
Combined Supply and Demand Schedule
$ .50 300 100
$2.00
$2.50
$3.00
150
100
50
250
300
350
$1.50 200 200
$1.00 250 150
Shortage Occurs because QD > QS
Surplus Occurs because QD < QS
Equilibrium QD = QS
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BELLRINGERBELLRINGER
• Can you think of any products you buy that have recently changed in price?
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Government InterventionGovernment Intervention
• Markets tend to reach equilibrium
• Price Ceiling: a maximum price that can be legally charged for a good or service
• Price Floor: a minimum price for a good or service
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Price CeilingsPrice Ceilings
• Rent Control – Housing is essential but wages might not
keep up with the supply and demand of houses
– Reduces the quantity and quality of housing
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Cost of Price CeilingsCost of Price Ceilings
• When price cannot rise to equilibrium, market determines who receives good or service
• By setting price below equilibrium, profits are reduced– Cost cutting occurs – Poor quality homes/apartments
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Ending Rent ControlEnding Rent Control
• Landlords gain an incentive to maintain buildings
• What affect does it have on the number of apartments?– Rent Graph
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Price FloorsPrice Floors
• Minimum price set by the government to be paid for a good or service
• Minimum Wage– Base level pay for work
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Price FloorsPrice Floors
• Minimum wage above equilibrium rate decreases employment
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Price FloorPrice Floor
Price
Labor
$4.50
$5.15
2 4 6
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Price Supports in Price Supports in AgricultureAgriculture
• Price floors are used for many farm products
• Government would buy excess crops when price fell below floor
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Section 2 – Changes in Section 2 – Changes in Market Equilibrium Market Equilibrium
• Changes in Price– Understanding a Shift in Supply– Finding a New Equilibrium – Changing Equilibrium
• A Fall in Supply• Shifts in Demand
– Problem of Excess Demand– Return to Equilibrium – A Fall in Demand
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Changes in PriceChanges in Price
• Excess supply will cause firms to cut prices
• Falling prices cause QD to rise• QS will fall until they meet again• These are changes ALONG the supply
or demand curve… not shifts
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Changes in PriceChanges in Price
• What shifts the supply curve?– Technology Change– New taxes/Subsidies by GOVT– Input costs change
• Because they want to be at equilibrium, curve shifts will create a new equilibrium price and quantity
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Understanding a Understanding a Shift in Supply Shift in Supply
• Falling prices affect on supply– CD players were expensive initially – Now less than $100 and compete with MP3
or digital music
• Fall in production costs shifts supply curve to the right
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Shifts in SupplyShifts in Supply
$800
$600
$400
$200
0
Pri
ce
Output (in millions)
Graph A: A Change in Supply
1 2 3 4 5
Original supply
Demand
a
New supply
b
c
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Shift in SupplyShift in Supply
• As we saw…• The shift in the supply curve created a
surplus.– The price level didn’t change so now
suppliers are offering more but demand hasn’t caught up!
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Finding a New EquilibriumFinding a New Equilibrium
• Excess supply or a surplus will cause producers to lower prices to eliminate the surplus
• Did the price drop change the demand curve?
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New Equilibrium
$800
$600
$400
$200
0
Pri
ce
Output (in millions)
Graph A: A Change in Supply
1 2 3 4 5
Original supply
Demand
a
New supply
b
c
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Change in Equilibrium
• Curve will keep shifting while new technology is introduced to lower production costs
• Equilibrium changes constantly– Changes in the market– Consumer wants and needs– Production costs
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Fall in Supply
• Supply curve can shift to the left with a drop in supply
• A strike that results in higher wages• A tax by the government
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Shifts in Demand
• New fads for Christmas • New version of a product
– iPhone 5
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Shifts in DemandShifts in Demand
Graph B shows how the market finds a new equilibrium when there is an increase in demand.
Graph B: A Change in Demand
Output (in thousands)
$60
$50
$40
$30
$20
$10
0
900800700600500400300200100
Pri
ce
Supply
Original demand
a
New demand
c
b
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Problem of Excess Demand
• Shifting the demand curve to the right creates shortages
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Shifts in DemandShifts in Demand
Graph B: A Change in Demand
Output (in thousands)
$60
$50
$40
$30
$20
$10
0
900800700600500400300200100
Pri
ce
Supply
Original demand
a
New demand
c
b
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Return to Equilibrium Return to Equilibrium
• Prices will rise by produces as a result of this change in demand
• Fall in demand has the opposite effect
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BELLRINGERBELLRINGER
• What is the “Black Market?”
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Section 3 – The Role of Prices
• Prices in the Free Market
• The Advantages of Prices– Price as an Incentive– Price as Signals– Flexibility– Price System is “Free”
• A Wide Choices of Goods– Rationing Shortages– The Black Market
• Efficient Resource Allocation
• Prices and the Profit Incentive– The Wealth of Nations– Market Problems
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Prices in Free Market
• Prices serve a major role in the free market economy– Helps move the FOP
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Advantages of Price
• Very Universal– Act as a standard measure of value– Barter system as alternative
• Price acts as an incentive– Think of the Law of Demand and Law of
Supply
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Advantages of Prices
• Prices as Signals – Producers – Higher prices signal to producers to make
more– Also signals new suppliers to enter market– Lower prices signal too much is produced– Signals suppliers to leave the market
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Advantages of Prices
• Prices as Signals – Consumers– Low prices signal to buy more– Low prices = low opportunity cost– High price to stop and think about a
purchase
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Advantages of Prices
• Flexibility – Prices can easily be increased to solve
shortages (excess demand)– Prices can easily be decreased to solve
surpluses (excess supply)
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Advantages of Prices
• Supply Shock: a sudden shortage of a good– Creates excess demand– Gasoline for example
• Rationing – Allocating scare goods and services using
criteria other than price– How easy is it to increase supply?
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Supply Shock and Rationing
Price
Gallons
$2.50
$5.15
2 4 6
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Price Shock and Rationing
• Raising prices quickest way to solve shortage
• People with higher demand will still consume
• Creating new equilibrium
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Advantages of Price
• Price System is “Free”– No cost to administer price– Unlike central planning– Soviet Union employed thousands of people
to organize the economy
• A farmer can decide what to plan based on what he thinks will be most profitable
• Prices help goods flow through the economy
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Wide Choice of Goods
• Market Based Economy offers diverse goods and services
• Prices allow a “target” consumer base– Bentley
• Fewer choices in Centrally Planned– Reduce costs to meet quotas
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Rationing and Shortages
• Despite being inexpensive, products were often hard to purchase in Soviet Union
• Rationing creates shortages
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Rationing in the US
• During WWII Rationing existed– GOVT Intent was to ensure everyone had a
level standard of living during wartime– You needed ration points and money to
purchase products– Guns or Butter
• Resources were allocated to guns • Leaving few for butter
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The Black Market
• Black Market: A market in which goods are sold illegally– Allows consumers to buy rationed products
buy paying more money
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Efficient Resource Allocation
• Free market ensures resources are allocated efficiently – FOP used for most valuable purpose– Resources adjust to change in demands of
consumers– Resources go to the consumer who values
a good or service the most
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Price and Profit Incentive
• What happens with a hot summer and the demand for air conditioners and fans?
• How would producers respond to this demand?
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Price and Profit Incentive
Price
Air Conditioners
$100.00
500 1000 1500
$250.00
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Wealth of Nations
• Adam Smith – 1776– Not because of charity that a baker or
butcher provide people food– A profit is made by providing food
• Business prospers by finding out what people want– Other systems haven’t worked…
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Market Problems
• Imperfect Competition – Not enough suppliers reduces competition – Why lower price to have MR = MC
• Spillover Costs (externalities)– Costs of production that affect people who
have no control over how much of a good is produced
– Pollution
• Imperfect Information – Consumers who lack knowledge of alternatives