Chapter 6

Prices as Signals

Reaching Equilibrium

The point where supply and demand come together is called the equilibrium

It is the point of balance at which quantity demanded equals quantity supplied

Equiliibrium

Benefits of Equilibrium

Buyers will purchase exactly as much of a good as firms are willing to sell

Both buyers and sellers benefit

Disequilibrium

Occurs when quantity supplied is not equal to quantity demanded in a merket

Disequilibrium can produce two outcomes, shortage surplus

Shortage

Shortage

Excess demand

Exists when the quantity demanded in a market is more than the quantity supplied

How do you eliminate a shortage?

Increase Price

Suppliers will keep raising the price in order to reach equilibrium

When the price has risen enough to close the gap, suppliers will have found the highest price that the market will bear

Surplus

Surplus

Exists when quantity supplied exceeds quantity demanded

Indicates that the price is too high

Must lower the price to reach equilibrium

Price Ceiling

Markets trend toward equilibrium, but in some cases the government intervenes to control prices

Maximum price that can be legally charged for a good or service

Where to Set Price?

The price ceiling is set below the equilibrium price

An example of price ceilings in our economy are rent controls

Apartments in NYC

Rent Controls

Price ceiling placed on apartment rents, to prevent inflation during a housing crisis

Helps people live in a neighborhood that they could otherwise not afford

Examine This Curve

Page 138

Turn to Page 136 to see this clearly…

Negative Aspects of Rent Control

How do you determine who gets the apartments?

Long waiting lists, discrimination, lottery systems, and bribery

Sometimes only way to get one is to inherit it

Many are Unkept

Since landlord profits are cut, it shows in the upkeep

Why would they update the painting and fix minor maintenance issues?

No incentive, long list of people who would want these apartments

Ending Rent Controls?

Landlords would make more money

Those living in rent controlled apartments would no longer be able to afford them

Economists do not like them

Price Floor

Minimum price that must be paid for a good or service

Best example of this is the minimum wage

Minimum Wage

A full time worker being paid minimum wage will earn less than the federal government says is necessary to support a couple with one child

Curve

Effects of Price Floors

Page 139

In this example, the minimum wage creates a surplus of labor

The Role of Prices

Chapter 6: Section 3

Price

Monetary value of a product as established by supply and demand

A signal that helps us make our economic decisions

4 Advantages of Prices

Neutral

Flexible

No administration cost

Familiar

Neutral

Favor neither the producer or the consumer

Due to prices being a result of competition between buyers and sellers

A compromise that both parties agree to

Flexible

Unforeseen disasters and war affect prices of many items

The price system can absorb these “shocks”

Allows market to accommodate change

No Administration Cost

Markets find their own price without outside help or interference

Will explain this in more detail later

Familiar

Have known about prices our entire lives

Allows us to make decisions quickly and efficiently

Easily understood

Alternatives to Price System?

Let’s take a look at rationing and see if it would be a viable alternative

Rationing

System under which an agency such as government decides everyone’s “fair share”

Citizens receive a ration ticket or coupon for goods and services

Ration Ticket

Entitles you to a certain amount of a product

Problems with Rationing

4 Problems

Fairness High Administration Cost Diminishing Incentive Black Markets

Problem of Fairness

Almost everyone feels that their share is too small

Almost had gas tickets in the 1970’s, but couldn’t decide how to ration them

High Administration Cost

Someone has to pay for the coupons and salaries of the people who distribute them

Always have risk of them being stolen or counterfeited

Diminishing Incentive

Has a negative incentive on people’s desire to work and produce

Working harder does not equal more ration coupons…so why do it?

Black Markets

Market in which goods are sold illegally, without regard for government controls on price or quantity

Allows consumers to pay more so they can buy a product when rationing makes it otherwise unavailable