Economics Chapter 6

Chapter 6 Section 1:  Seeking Equilibrium:  Demand and Supply

• Review:
  • Demand is the willingness to buy a good or service and the ability to pay for it.
  • Supply is the willingness and ability to produce and sell a product.
  • Market is the place where buyers and sellers come together.
    • It is also the place where demand and supply interact.
• The Interaction of Demand and Supply
  • Key Concepts
    • Market Equilibrium:  When the quantity demand and the quantity supplied at a particular price are equal.
    • Equilibrium Price:  The price at which the quantity demanded and the quantity supplied are equal.

• Market Demand and Supply Schedule
  • Sandwich shop
    • Let’s say you own a sandwich shop near an office park.
    • Recently you have decided to offer a new product – premade salads.
      • On the first day you may 40 salads and charge $10 each.  How did it go?
        • Not so good – only 10 salads were sold.
      • The next day you make 15 salads and charge $4 each.  How did it go?
        • Pretty good – you sold all 15 salads, BUT 35 people wanted salads.
      • You need to find the right price, and sometimes it takes some trial and error.
        • Here is what has happened after 5 days.  What do you notice?
    • Market Demand and Supply Schedule

• At prices above $6 quantity supplied is higher than quantity demanded.

• At prices below $6 the quantity demanded exceeds the quantity supplied.

• A the price of $6, the quantity demanded and the quantity supplied are equal.

• We could think of this like the story of Goldilocks and the Three Bears
  • If quantity supplied is higher than quantity demanded the porridge is too hot.
  • If quantity demanded is hither then quantity supplied the porridge is too cold.
  • If the quantity demanded and the quantities supplied are equal the porridge is just right.
• What did we learn here?
  • Our salad ideas show how the laws of supply and demand interact in the market.
  • We want to offer more salads at higher prices so we earn profit.
  • If we sold the salads for too little we may not earn profit, but if we sold the salads for too much we may not have any customers.
  • It is important to find the balance or equilibrium.
• Practice:  What is the equilibrium price of this market demand and supply schedule?

• Practice:  Create a market demand and supply schedule of your own.  I will come around and check it for participation points. 

• Market Demand and Supply Curve
  • We have drawn out supply curves. (Remember they increase)
  • We have drawn out demand curves. (Remember they decrease)
  • Is it possible to put them on the same graph? 
  • Yes!

• Blue – Demand
• Red – Supply
• Where the points meet is the equilibrium price.
• Reaching the Equilibrium Price
  • Key Concepts
    • Surplus:  The result of quantity supplied being greater then quantity demanded.
      • Quantity Supplied > Quantity Demanded
    • Shortage:  The result of quantity demanded being greater then quantity supplied.
      • Quantity Supplied < Quantity Demanded
  • Surplus, Shortage, and Equilibrium

• Equilibrium occurs where there is neither surplus nor a shortage because quantity demanded and quantity supplied are equal

• When the price is above $5 there is a surplus – too many in the market.
• When the price is below $5 there is a shortage – too few in the market.
• When there is a surplus, prices tend to go down until equilibrium is reached.
• When there is a shortage, producers raise prices in an attempt to reach equilibrium.
• Example:  Holiday Toys
  • Toys are often fads and children’s tastes can change rapidly so it is difficult for marketers to know how much to supply and at what rice to best meet the quantities demanded.
    • Sometimes a toy’s popularity is overestimated leading to a surplus.
    • Sometimes a toy’s popularity is underestimated leading to a shortage.
  • Why does a surplus suggest prices are too high?
    • Consumers are not willing to buy at those prices.
  • How can produces respond to a shortage?
    • They can raise prices or increase supply

• Equilibrium Price in Real Life
  • Key Concepts
    • Disequilibrium:  occurs when quantity demanded and quantity supplied are not in balance.
    •  

•  
• Change in Demand and Equilibrium Price
  • A change in demand occurs when one of six factors prompts consumers to change the quantity demanded at every price.
  • This will shift the demand curve.
  • The six factors that prompt consumers to change quantity demanded are:
    • Income
    • Consumer tastes
    • Consumer expectations
    • Market size
    • Substitutes
    • Compliments

• Change in Supply and Equilibrium Price
  • A change in supply occurs when something in the market prompts to offer different amounts for sale at every price.
  • This will shift the supply curve.
  • The six factors that change supply are:
    • Input costs
    • Productivity
    • Technology
    • Government action
    • Producer expectations
    • Number of producers.

THEN

If Demand Decreases OR Supply Increases                 Equilibrium price falls

                                                                                    THEN

If Demand Increases OR Supply Decreases                             Equilibrium price rises

Chapter 6 Section 2:  Prices as Signals and Incentives

• How the Price System Works
  • Competitive Pricing:  occurs when producers sell products at lower prices to lure customers away from rival producers, while still making a profit.
    • Example:  Snow Shovels
      • Lowes sells snow shovels for $20 each.
      • Menards sees this as an opportunity to take some customers from Lowes.
      • Menards decides to price their shovels at $13.
        •  They will have a lower profit margin per shovel, but they hope to sell hundreds more in order to maintain overall profit.
      • Lowes can choose to lower their price on shovels as well or risk losing customers.
  • Characteristics of the Price System
    • In a market economy, the price system has four characteristics:
      • 1. It is neutral – both the producer and the consumer make choices that determine the equilibrium price.
        • Prices do not favor either the producer or the consumer because both make choices that help to determine the equilibrium price.
        • The free interactions of consumers (who favor lower prices) and producers (who favor higher prices) determines the equilibrium price in the market.
      • 2. It is market driven – Market forces determine prices and the system runs itself.
        • Market forces determines the prices, so the system has no oversight or administrative costs.
        • The price system runs itself.
      • 3. It is flexible – when market conditions change, so do prices.
        • When market conditions change, prices are able to change quickly in response.
        • Surpluses and shortages motivate producers to change prices to reach equilibrium.
      • 4. It is efficient – resources are allocated efficiently since prices adjust until the maximum number of goods and services are sold.
        • Prices will adjust until the maximum number of goods and services are sold.
        • Producers choose to use their resources to produce certain goods and services based on the profit they can make by doing so.
• Prices Motivate Producers and Consumers
  • Key Concepts
    • The laws of demand and supply show that consumers and producers have different attitudes towards price.
      • Consumers want to buy at low prices.
      • Producers want to sell at high prices.
    • Price motivates consumers and producers in different ways.
    • Incentives:  encourage people to act in certain ways.
      • In the price system incentives encourage producers and consumers to act in certain ways consistent with their best interests.
  • Prices and Producers
    • For producers, the price system has two great advantages:
      • It provides both information and motivation.
    • Prices provide information by acting as signals to producers about whether it is a good time to enter or leave a particular market.
      • Rising prices and the expectation of profits motivate producers to enter a market.
      • Falling prices and the possibility of loses motivate producers to leave a market.
    • A shortage in a market is a signal that consumer demand is not being met by existing suppliers.
      • Shortage occurs because prices are too low relative to the quantities demanded by consumers.
      • Producers will view a shortage as a signal that there is an opportunity to raise prices.
        • Higher prices act as incentive for producers to enter a market.
          • The prospect of selling goods at higher prices encourage producers to offer products for the market.
    • As more producers are motivated by high prices to enter a market, quantity supplied increases.
      • When prices are too high relative to consumer demand a surplus can occur.
        • Producers can respond to the surplus by reducing prices, or reducing production to eliminate the surplus.
        • Falling prices indicate that producers should leave the market.
    • Competitive pricing in the market often informs the choices made by producers.
      • When a market is growing, and there is unmet demand, a producer may decide to enter the market with a prices that is lower then it’s competitors.
        • They would need to sell more units to earn a profit.
    • While prices are the signals that are visible in the market, it is the expectation of profits or the possibility of losses that motivates producers to enter or leave a market.
  • Prices and Consumers
    • Prices also act as signals and incentives to consumers.
    • Surpluses that lead to lower prices tell consumers that it is a good time to buy a particular good or service.
      • Producers often send this signal to consumers through advertising and store displays that draw consumers to certain products.
      • Producers may also suggest that the low prices won’t last encouraging consumers to buy sooner rather than later.
    • High prices generally discourage consumers from buying a particular product and may signal that it is time for them to switch to a substitute that is available for a lower price.
      • A high price may signal that the product is in short supply or has a higher status.
      • Brand marketers rely on consumer perception that a certain logo is worth a higher price.

Chapter 6 Section 3:  Intervention in the Price System

• Imposing Price Ceilings
  • Key Concepts
    • Price Ceiling: the legal maximum price that sellers may charge for a product.
      • It is set BELOW the equilibrium price so a SHORTAGE will result.
    • Why is a price ceiling set below equilibrium price rather than above it?
      • The intent is to keep the price from rising too high when equilibrium is considered too high.
  • Football tickets and price ceilings.
    • The University of Wisconsin Madison have a winning football team with many loyal fans.
    • UW–Madison prints 30,000 tickets for every game and sells them for $15 each.
    • At that price 60,000 fans want to buy tickets so there is a shortage of 30,000 tickets every game.
    • UW–Madison could resolve the shortage by  letting the price rise until quantity supplied and quantity demanded are equal (equilibrium).
      • However, when this is proposed to the UW–Madison university president says they would rather keep the tickets affordable to students.
  • Rent control as a price ceiling.
    • In the past many cities passed rent control laws in an effort to keep housing affordable for lower-income families.
      • These laws control when rents can be raised and by how much, no matter what is going on the market.
      • This is helpful to the people who live in rent controlled housing because they appreciate the lower prices in the short-term.
    • Rent control can have unexpected consequences.
      • Without the possibility of raising rents to match the market, there is no incentive to increase the supply of rental housing, and a shortage soon develops.
      • In addition, landlords are reluctant to increase their costs by investing money into property maintenance, so housing conditions often deteriorate.
      • Rent control has become less common as most cities realize that it makes housing shortages worse in the long-run.
    • What negative incentives does rent control pricing give to producers and consumers?
      • It discourages landlords from increasing supply or maintaining existing housing and discourages consumers from moving.
• Setting price floors
  • Key concepts
    • Price floor: a legal minimum price that buyers must pay for a product.
    • Here the government intervenes in the price system to increase income to certain producers.
    • Price floors are used most commonly with agricultural products because the goal is to encourage farmers to produce and abundant food supply.
    • Why is a price floor set above equilibrium price?
      • The intent is to keep the price from falling too low when equilibrium is considered too low.
  • Minimum wage as a price floor
    • Minimum wage:  a legal minimum amount that an employer must pay for one hour or work.
    • Minimum wage in Wisconsin:
      • General:  $7.25/hour
      • Tipped jobs: $2.33/hour
      • Agricultural jobs: $7.25/hour
      • Golf Caddies: 9 holes - $5.90/hour 18 holes - $10.50/hour
    • The US government established its first minimum wage in 1938.
      • The 1930s were a period of low wages, and the government hoped to increase the income of the workers.
    • If the minimum wage is set above the equilibrium price for certain jobs in the market, employers may decide to start paying the higher wages is not profitable and as a result they may choose to employ fewer workers causing unemployment to increase.
    • If the minimum wage is set below the equilibrium price it will have no effect.
    • Why might the minimum wage decrease the supply of low-wage jobs?
      • Higher wages would increase the costs of employers and may discourage them from hiring new workers.
• Rationing resources and products
  • Key concepts
    • The market uses prices to allocate goods and services.
    • Sometimes in periods of national emergency, such as wartime, the government decides to use another way to distribute scarce resources.
    • Rationing: a government system for allocating goods and services using criteria other than price.
      • The goods may be rationed on a first-come first serve basis or on the basis of a lottery.
      • Generally a system is set up that uses coupons allowing each person a certain amount of a particular item.
      • The government can also decide that certain resources can be used to produce certain goods
    • How is rationing different from the market in the way it allocates goods and services?
      • The market allocates goods and services based on price while rationing uses other criteria.
    • When this system is used some people try to skirt the rules to get the goods and services they want, creating a black market.
  • Rationing Resources
    • During WWII the US government empowered the Office of Price Administration, which was established in 1941, to ration scarce goods
    • It also allocated resources in ways that favored the war effort rather than the consumer market.
      • During WWII the government mandated that automobile factories stop making cars and start making tanks and plans.  They wanted the scarce resources to be used to support the war rather than for civilian purposes.
    • The hope was that these goods would be distributed to everyone, not just those who could afford the higher market prices born of shortage
    • Rationed goods during WWII
      • Food:  sugar, meat, butter, fats, oil, cheese, chocolate, coffee.
      • Other goods:  tires, gas, clothing, shoes..
    • Rationing also led to substitutes.
      • For example, margarine, a butter substitute, was purchased in large quantities during the war.
    • Rationing is much less efficient then the price system, which runs itself.
  • Black Markets – and unplanned result of rationing
    • Black market: involves illegal buying or selling in violation of price controls or rationing. 
    • When rationing is imposed, black markets often come into existence.
    • During WWII, black markets in meat, sugar, and gasoline developed in the US.
    • Some people found ways to secure the scarcest of goods.