6-1 Combining Supply and Demand

6-1 Combining Supply and Demand

•How do supply and demand create balance in the marketplace?

•What are differences between a market in equilibrium and a market in disequilibrium?

•What are the effects of price ceilings and price floors?

Pri

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pe

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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

Just as buyers and sellers come together in a market, demand and supply come together in this section.

The point at which quantity demanded and quantity supplied come together is known as equilibrium (QS = QD).

Balancing the Market

$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

• At the equilibrium price, buyers will purchase exactly as much as firms are willing to sell.

If the market price or quantity supplied is anywhere but at the equilibrium price, the market is in a state called

disequilibrium. There are two causes for disequilibrium:

Market Disequilibrium

1.) Excess Demand

•Excess demand occurs when quantity demanded is more than quantity supplied (when price is too low).

2.) Excess Supply

•Excess supply occurs when quantity supplied exceeds quantity demanded (when price is too high).

Market Disequilibrium

Excess Demand

Excess demand occurs when quantity demanded is more than quantity supplied (when price is too low).

Market Disequilibrium

Excess Supply

Excess supply occurs when quantity supplied exceeds quantity demanded (when price is too high).

In some cases the government steps in to control prices. These interventions appear as price ceilings and

price floors.

Price Ceilings

•A price ceiling is a maximum price that can be legally charged for a good.

• An example of a price ceiling is rent control, a situation where a government sets a maximum amount that can be charged for rent in an area.

• This leads to excess demand and many economists argue that it hurts those it intends to assist.

Are Price Ceilings Good or Bad?

At the price of $200, landlords will supply 20 apartments (QS), but renters demand 40 apartments (QD). There is a shortage of 20 apartments. Many renters will be left out.

Landlords may try and increase profits by cutting costs and apartment conditions may worsen.

Without rent control, price would rise to $300 and 10 more apartments would become available. However, some renters may not be able to afford the higher price.

Rent Control

Price Floors

•A price floor is a minimum price, set by the government, that must be paid for a good or service (minimum wage).

•One well-known price floor is the minimum wage, which sets a minimum price that an employer can pay a worker for an hour of labor. Leads to excess supply.

Are Price Floors Good or Bad?

At $4, employers demand 20 workers (QD), but there is a supply 40 workers (QS). There is an excess supply of 20 people looking for work at $4.

If the market were left alone, the market price for workers would fall to $3, but 10 more workers would find a job as employers could afford to hire more workers.

However, for many people, a lower wage would not be enough to pay bills and support a family.

Minimum Wage

Michigan’s Minimum Wage

Michigan’s minimum wage is $7.40 per hour. Imagine you are a policy maker and you must vote whether it be raised, lowered, or abolished. What will you decide? Why? Show how your decision will look when graphed.

Refer to notes as well as p.130-131 to help you with your decision and graph.

Section 1 Assessment

1. Equilibrium in a market means which of the following?

(a) the point at which quantity supplied and quantity demanded are the same

(b) the point at which unsold goods begin to pile up

(c) the point at which suppliers begin to reduce prices

(d) the point at which prices fall below the cost of production

2. The government’s price floor on low wages is called the

(a) market equilibrium

(b) base wage rate

(c) minimum wage

(d) employment guarantee

Section 1 Assessment

1. Equilibrium in a market means which of the following?

(a) the point at which quantity supplied and quantity demanded are the same

(b) the point at which unsold goods begin to pile up

(c) the point at which suppliers begin to reduce prices

(d) the point at which prices fall below the cost of production

2. The government’s price floor on low wages is called the

(a) market equilibrium

(b) base wage rate

(c) minimum wage

(d) employment guarantee

6-2 Changes in Market Equilibrium

•How do shifts in supply affect market equilibrium?

•How do shifts in demand affect market equilibrium?

•How can we use supply and demand curves to analyze changes in market equilibrium?

Shifts in Supply

•Understanding a Shift

• Since markets tend toward equilibrium, a change in supply will set market forces in motion that lead the market to a new equilibrium price and quantity sold.

•Excess Supply

• A surplus is a situation in which quantity supplied is greater than quantity demanded. If a surplus occurs, producers reduce prices to sell their products. This creates a new market equilibrium.

•A Fall in Supply

• The exact opposite will occur when supply is decreased. As supply decreases, producers will raise prices and demand will decrease.

Shifts in Demand

•Excess Demand

• A shortage is a situation in which quantity demanded is greater than quantity supplied.

•Search Costs

• Search costs are the financial and opportunity costs consumers pay when searching for a good or service.

•A Fall in Demand

• When demand falls, suppliers respond by cutting prices, and a new market equilibrium is found.

$800

$600

$400

$200

0

Pri

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Output (in millions)

Graph A: A Change in Supply

1 2 3 4 5

Analyzing Shifts in Supply and Demand

Original supply

Demand

a

New supply

b

c

When it became cheaper to make CD players, the supply curve shifted to the right. An increase in QS at the old equilibrium price is shown as a change from point (a) to point (b). However, the QD at this price has not changed, and consumers will only buy 2 million disc players. Suppliers will have to bring price down to get rid of a surplus of CD players. The price drops and we get to point (c) where equilibrium is restored.

• Graph A shows how the market finds a new equilibrium when there is an increase in supply.

When Tickle Me Elmo dolls became popular there was a sudden shift in demand to the right. This shift leads to excess demand at the original price of $24 (b). At (b), there is a shortage of 200 thousand dolls (a). Long lines and empty shelves will result. Suppliers will increase the price and a new equilibrium will naturally set at (c).

Analyzing Shifts in Supply and 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

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Supply

Original demand

a

New demand

c

b

Section 2 Assessment

1. When a new equilibrium is reached after a fall in demand, the new equilibrium has a

(a) lower market price and a higher quantity sold.

(b) higher market price and a higher quantity sold.

(c) lower market price and a lower quantity sold.

(d) higher market price and a lower quantity sold.

2. What happens when any market is in disequilibrium and prices are flexible?

(a) market forces push toward equilibrium

(b) sellers waste their resources

(c) excess demand is created

(d) unsold perishable goods are thrown out

Section 2 Assessment

1. When a new equilibrium is reached after a fall in demand, the new equilibrium has a

(a) lower market price and a higher quantity sold.

(b) higher market price and a higher quantity sold.

(c) lower market price and a lower quantity sold.

(d) higher market price and a lower quantity sold.

2. What happens when any market is in disequilibrium and prices are flexible?

(a) market forces push toward equilibrium

(b) sellers waste their resources

(c) excess demand is created

(d) unsold perishable goods are thrown out

6-3 The Role of Prices

•What role do prices play in a free market system?

•What advantages do prices offer?

•How do prices allow for efficient resource allocation?

The Role of Prices in a Free Market

•Prices serve a vital role in a free market economy.

•Prices help move land, labor, and capital into the hands of producers, and finished goods in to the hands of buyers.

•Prices create efficient resource allocation for producers and a language that both consumers and producers can use.

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: Prices are much more flexible than production levels. They can be easily increased or decreased to solve problems of excess supply or excess demand. A supply shock, or sudden shortage of a good like gas or wheat, can be solved by raising prices to thwart off excess demand.

4. Price System is "Free” Unlike central planning, a distribution system based on prices costs nothing to administer. Prices help goods flow through the economy without a central plan.

Advantages of Prices

Section 3 Assessment

1. How does a supply shock affect equilibrium price and quantity?

(a) Raises prices and decreases quantity demanded

(b) Raises prices and increases quantity demanded

(c) Lowers prices and increases quantity demanded

(d) Lowers prices and decreases quantity demanded

.

Section 3 Assessment

1. How does a supply shock affect equilibrium price and quantity?

(a) Raises prices and decreases quantity demanded

(b) Raises prices and increases quantity demanded

(c) Lowers prices and increases quantity demanded

(d) Lowers prices and decreases quantity demanded