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![Page 1: Role of Prices Economics Koehn/Molter. Review A demand schedule shows: – How much consumers are willing to buy a various prices. A supply schedule shows:](https://reader035.fdocuments.us/reader035/viewer/2022070306/5518ae08550346881f8b4dca/html5/thumbnails/1.jpg)
Role of Prices
EconomicsKoehn/Molter
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Review
• A demand schedule shows:– How much consumers are willing to buy a various
prices.• A supply schedule shows:– How much sellers are willing to sell at various
prices.• Comparing these schedules should allow us
to find common ground for the two sides of the market.
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Market Equilibrium
The point at which quantity demanded and quantity supplied are equal is called EQUILIBRIUM.
This can only occur when
Quantity demand (QD) = Quantity supplied (QS)
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Examples
• Quantity demanded = Quantity supplied occurs where the demand curve intersects the supply curve.
• This will determine the equilibrium price and quantity. Equilibrium price = $5.00 and 5,000 pounds of coffee are bought and sold at that price
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Picture Form
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Supply and Demand Together
D S Equilibrium: P has reached the level where quantity supplied equals quantity demanded
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Equilibrium price:
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The price that equates quantity supplied with quantity demanded
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Equilibrium quantity:
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The quantity supplied and quantity demanded at the equilibrium price
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Quantity demanded = Quantity supplied (occurs when the demand curve intersects
the supply curve)
This will determine the equilibrium price and quantity.
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus:when quantity supplied is greater than quantity demanded
Surplus Example: If P = $5,
then QD = 9 lattes
and QS = 25 lattes
resulting in a surplus of 16 lattes
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus:when quantity supplied is greater than quantity demanded
Facing a surplus, sellers try to increase sales by cutting price.
This causes QD to rise
Surplus
…which reduces the surplus.
and QS to fall…
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus:when quantity supplied is greater than quantity demanded
Facing a surplus, sellers try to increase sales by cutting price.
This causes QD to rise and QS to fall.
Surplus
Prices continue to fall until market reaches equilibrium.
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Shortage:when quantity demanded is greater than quantity supplied
Example: If P = $1,
then QD = 21 lattesand QS = 5 lattesresulting in a shortage of 16 lattes
Shortage
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Shortage:when quantity demanded is greater than quantity supplied
Facing a shortage, sellers raise the price,
causing QD to fall
…which reduces the shortage.
and QS to rise,
Shortage
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Shortage:when quantity demanded is greater than quantity supplied
Facing a shortage, sellers raise the price,
causing QD to falland QS to rise.
Shortage
Prices continue to rise until market reaches equilibrium.
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Three Steps to Analyzing Changes in Eq’m
To determine the effects of any event,
1. Decide whether event shifts S curve, D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see how the shift changes eq’m P and Q.
To determine the effects of any event,
1. Decide whether event shifts S curve, D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see how the shift changes eq’m P and Q.
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE: The Market for Hybrid Cars
P
QD1
S1
P1
Q1
price of hybrid cars
quantity of hybrid cars
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
STEP 1: D curve shifts because price of gas affects demand for hybrids. S curve does not shift, because price of gas does not affect cost of producing hybrids.
STEP 2:
D shifts rightbecause high gas price makes hybrids more attractive relative to other cars.
EXAMPLE 1: A Change in DemandEVENT TO BE ANALYZED: Increase in price of gas.
P
QD1
S1
P1
Q1
D2
P2
Q2
STEP 3:
The shift causes an increase in price and quantity of hybrid cars.
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE 1: A Change in Demand
P
QD1
S1
P1
Q1
D2
P2
Q2
Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.
Always be careful to distinguish b/w a shift in a curve and a movement along the curve.
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CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
STEP 1: S curve shifts because event affects cost of production. D curve does not shift, because production technology is not one of the factors that affect demand.
STEP 2:
S shifts rightbecause event reduces cost, makes production more profitable at any given price.
EXAMPLE 2: A Change in Supply
P
QD1
S1
P1
Q1
S2
P2
Q2
EVENT: New technology reduces cost of producing hybrid cars.
STEP 3:
The shift causes price to fall and quantity to rise.
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Government Policies That Alter the Private Market Outcome
• Price controls– Price ceiling: a legal maximum on the price
of a good or service. Example: rent control. – Price floor: a legal minimum on the price of
a good or service. Example: minimum wage.
• Taxes– The govt can make buyers or sellers pay a specific
amount on each unit bought/sold.
We will use the supply/demand model to see how each policy affects the market outcome
(the price buyers pay, the price sellers receive, and eq’m quantity).
We will use the supply/demand model to see how each policy affects the market outcome
(the price buyers pay, the price sellers receive, and eq’m quantity).
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
EXAMPLE 1: The Market for Apartments
Eq’m w/o price
controls
Eq’m w/o price
controls
P
QD
SRental price of
apts
$800
300Quantity of apartments
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Ceilings Affect Market Outcomes
A price ceiling above the eq’m price is not binding – has no effect on the market outcome.
P
QD
S
$800
300
Price ceiling$1000
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Ceilings Affect Market Outcomes
The eq’m price ($800) is above the ceiling and therefore illegal.The ceiling is a binding constraint on the price, causes a shortage.
P
QD
S
$800
Price ceiling$500
250 400
shortage
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Ceilings Affect Market Outcomes
In the long run, supply and demand are more price-elastic. So, the shortage is larger.
P
QD
S
$800
150
Price ceiling$500
450
shortage
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Shortages and Rationing• With a shortage, sellers must ration the goods among
buyers.
• Some rationing mechanisms: (1) long lines (2) discrimination according to sellers’ biases
• These mechanisms are often unfair, and inefficient: the goods do not necessarily go to the buyers who value them most highly.
• In contrast, when prices are not controlled, the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair).
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
EXAMPLE 2: The Market for Unskilled Labor
Eq’m w/o price
controls
Eq’m w/o price
controls
W
LD
SWage paid to
unskilled workers
$4
500
Quantity of unskilled workers
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Floors Affect Market Outcomes
W
LD
S
$4
500
Price floor$3
A price floor below the eq’m price is not binding – has no effect on the market outcome.
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Floors Affect Market Outcomes
W
LD
S
$4
Price floor$5
The eq’m wage ($4) is below the floor and therefore illegal.The floor is a binding constraint
on the wage, causes a surplus (i.e., unemployment).
400 550
labor surplus
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CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Min wage laws do not affect highly skilled workers.
They do affect teen workers.
Studies: A 10% increase in the min wage raises teen unemployment by 1-3%.
The Minimum Wage
W
LD
S
$4
Min. wage$5
400 550
unemp-loyment