P R I C E S

Changes in Market Equilibrium

Chapter 6 Section 2

P R I C E S• Objectives:• Identify the determinants that create

changes in price.• Explain how a market reacts to a fall in

supply by moving to a new equilibrium.• Explain how a market reacts to shifts in

demand by moving to a new equilibrium.

P R I C E S• Price Supports

– Government subsidizes an industry to help the market –most common: agricultural supports

– Gov’t. sets a target price. The farmer sells the crops on the open market and the Gov’t. subsidizes (or pays the difference) to

the farmer for what he should have gotten (according to the target price).

P R I C E S• Price Supports: example• Farmer sold 10,000 bushels of corn on the

open market at $ 3.00/bushel.• The Gov’t. had a target price of $

4.00/bushel.• Farmer gets $ 30,000 on open market and

the Gov’t. sends him a check for $ 10,000 for the difference.

P R I C E S• Price Freeze• Another type of Price Control.• A government restriction placed on

product that will keep prices from increasing.

• This happens during emergencies {911}.

P R I C E S• After 911, the airports were shut down for a few

days. People were stranded in places with no airplanes available to get them to their destination. Rental Car demand increased tremendously. Prices of rental cars sky-rocketed. The Gov’t. placed a price freeze on rental cars, saying that the prices of the rental must remain where they were as of the day before.

• This is done to prevent Price Gouging – taking advantage of a emergency situation for profit.

P R I C E S• Economists say that a market will tend to

move toward equilibrium, which means that price and quantity will gradually move toward their equilibrium levels.

P R I C E S• Shortage (excess demand) will lead firms

to raise prices, higher prices induce the Qs to rise and the Qd to fall until the

two are equal.

• Surplus (excess supply) will force firms to cut prices. Falling prices will cause

Qd to rise and Qs to fall until they are equal.

P R I C E S• Assuming that a market starts at

equilibrium, there are 2 factors that can push it into disequilibrium.– A shift in the Demand Curve– A shift in the Supply Curve

P R I C E S• Factors that shift the Supply Curve:

– Technology– New government taxes & subsidies– Changes in price of the raw materials– Labor used to produce the good

P R I C E S• Since market equilibrium occurs at the

intersection of a demand curve and a supply curve, a shift of the entire supply curve will change the equilibrium price and quantity.

• A shift in the supply curve to the left or the right creates a new equilibrium.

P R I C E S• Supply Curve shifts to the left (decrease)

or the right (increase).

P R I C E S• If there is an increase in the supply (to the

right)…EP (Equilibrium Price) will be lower and EQ (Equilibrium Quantity) will increase.

• If there is a decrease in the supply (to the left)…EP will rise and EQ will

decrease.

P R I C E S• Demand Curve shifts to the Left

(decrease) or the right (increase).

P R I C E S• If there is an increase in Demand (moves

to the right) EP will rise and EQ will increase.

• If there is a decrease in Demand (moves to the left) EP will lower and EQ will decrease.

P R I C E S• IF both curves shift, the result depends on

their relative magnitudes.• Normal Supply and Demand Curves…• IF Supply increases (moves right) and

Demand decreases (moves to the left)…• EP will fall and EQ will increase.

P R I C E S• IF we have a Vertical Demand Curve that

is inelastic… i.e. insulin– Demand would not change, Supply could

decrease/increase. • IF we have a Horizontal Demand Curve

that is elastic… i.e. garden veggies– Demand would stay the same and Supply

could decrease/increase.

P R I C E S• IF we have a Vertical Supply Curve that

has a natural restriction on product… i.e. oranges/fruit.– Supply would not change but Demand could

rise or fall.• IF we have a Horizontal Supply Curve that

has no natural restriction on product… i.e. computers.– Supply would not change, but Demand could

increase or decrease.

P R I C E S• Demand is a measure of how much a

consumer is willing and able to buy a product at every price.

• Sometimes you may get a product for less than you would have been willing to pay for it.

P R I C E S• Consumer Surplus

– The difference between what people are willing to pay and the market price.• You go to the store to buy a product. You have a

certain amount of money set aside to pay for the product. But, you end up paying less than what you had budgeted for the product. After buying the product you have money left over.

P R I C E S• Producer Surplus

– The same goes for a producer. They often willing sell an item for a price lower than what they end up receiving.

– A used car sales man haggling with a customer over the price of a used car. He may have a rock

bottom price that he won’t go below, but the buyer ends up taking the car for a price higher than that rock bottom price. The car sales man just won. He got more than he thought he would for the car.

P R I C E S• Producer Surplus

– Difference between the market price which the producer receives for their product

and the price at which they are willing to sell their goods.

P R I C E S• Tax Incidence

– Who really pays for taxes added onto the production process?

– We do in the end.– This is called incidence of tax.– After the tax is added, the producer can not

produce as much as before. – Sometimes, the producer will pay part of the

tax, other times the consumer pays all of it.

P R I C E S• Incidence of Tax is determined mostly by

the elasticity of the demand curve.• Elastic Product – Garden Veggies

– Seller pays $ .40 and consumer pays $ .60 – assuming a $ 1.00 tax is added on

• Inelastic Product – Insulin– Seller may pay $ .10 and the consumer would

pay the other $ .90 of the tax that was added on (assuming it was a $ 1.00 tax)