the price system and demand and supply

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

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Prepared by: Fernando Prepared by: Fernando Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

The Price System and Demand The Price System and Demand and Supplyand Supply

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

The Price SystemThe Price System

• The market system, also called the The market system, also called the price price system,system, performs two important and performs two important and closely related functions : closely related functions :

• Price RationingPrice Rationing

• Resource AllocationResource Allocation


Price RationingPrice Rationing

• Price rationingPrice rationing is the is the process by which the process by which the market system allocates market system allocates goods and services to goods and services to consumers when quantity consumers when quantity demanded exceeds demanded exceeds quantity supplied.quantity supplied.



• A decrease in supply A decrease in supply creates a shortage at creates a shortage at PP00. Quantity demanded . Quantity demanded

is greater than quantity is greater than quantity supplied. Price will supplied. Price will begin to rise.begin to rise.

• The lower total supply The lower total supply is is rationed to those rationed to those who are willing and who are willing and able to payable to pay the higher the higher price.price.



• There is some price There is some price that will clear any that will clear any market.market.

• The price of a rare The price of a rare painting will eliminate painting will eliminate excess demand until excess demand until there is only one bidder there is only one bidder willing to buy the single willing to buy the single available painting.available painting.


Alternative Rationing MechanismsAlternative Rationing Mechanisms

• A price ceilingprice ceiling is a maximum price that sellers may charge for a good, usually set by government.

• QueuingQueuing is a nonprice rationing system that uses waiting in line as a means of distributing goods and services.



• Favored customersFavored customers are those who receive special treatment from dealers during situations when there is excess demand.

• Ration coupons are tickets or coupons that entitle individuals to purchase a certain amount of a given product per month.

• The problem with these alternatives is that The problem with these alternatives is that excess demand is created but not eliminated.excess demand is created but not eliminated.



• In 1974, the In 1974, the government used an government used an alternative rationing alternative rationing system to distribute the system to distribute the available supply of available supply of gasoline.gasoline.

• At an imposed price of At an imposed price of 57 cents per gallon, the 57 cents per gallon, the result was excess result was excess demand.demand.



• A A black marketblack market is a is a market in which illegal market in which illegal trading takes place at trading takes place at market-determined market-determined prices.prices.



• No matter how good the intentions of private No matter how good the intentions of private organizations and governments, it is very organizations and governments, it is very difficult to prevent the price system from difficult to prevent the price system from operating and to stop the willingness to pay operating and to stop the willingness to pay from asserting itself.from asserting itself.

• With favored customers and black markets, the With favored customers and black markets, the final distribution may be even more unfair than final distribution may be even more unfair than that which would result from simple price that which would result from simple price rationing.rationing.


Prices and the Allocation of ResourcesPrices and the Allocation of Resources

• Price changes resulting from shifts of demand in output Price changes resulting from shifts of demand in output markets cause profits to rise or fall.markets cause profits to rise or fall.

• Profits attract capital; losses lead to disinvestment.Profits attract capital; losses lead to disinvestment.

• Higher wages attract labor and encourage workers to Higher wages attract labor and encourage workers to acquire skills.acquire skills.

• At the core of the system, supply, demand, and prices in At the core of the system, supply, demand, and prices in input and output markets determine the allocation of input and output markets determine the allocation of resources and the ultimate combinations of things resources and the ultimate combinations of things produced.produced.


Supply and Demand Analysis:Supply and Demand Analysis:An Oil Import FeeAn Oil Import Fee

• At a world price of $18, At a world price of $18, imports are 5.9 million barrels imports are 5.9 million barrels per day.per day.

• The tax on imports causes an The tax on imports causes an increase in domestic production, increase in domestic production, and quantity imported falls.and quantity imported falls.

the price system and demand and supply

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