Chapter 6, Section 2 – How Prices are Determined

The Adjustment ProcessMarket Equilibrium / Equilibrium Price

SurplusShortage

Price Adjustment – Market Equilibrium

Market Equilibrium Exists When…Prices are stable (not changing a lot) Quantity Demanded = Quantity Supplied

The Market is CLEARED of the good or service

At what quantity is the market cleared?

Econ Model for SUPPLY and DEMAND

Price QD QS Surplus or Shortage?

$10 600 1550 +950

$9 720 1500 +780

$8 850 1450 +600

$7 990 1400 +410

$6 1140 1350 +210

$5 1300 1300 EVEN MKT EQL

$4 1470 1250 -220

$3 1650 1200 -450

$2 1840 1150 -690

Price Adjustment – Equilibrium Price

At Market Equilibrium, supply meets demand for the product

The Market is CLEARED of the good or service

The Price at which supply meets demand is the Equilibrium Price

It is also called the Market Clearing Price

Econ Model for SUPPLY and DEMAND

Price QD QS Surplus or Shortage?

$10 600 1550 +950

$9 720 1500 +780

$8 850 1450 +600

$7 990 1400 +410

$6 1140 1350 +210

$5 1300 1300 EVEN MKT EQL

$4 1470 1250 -220

$3 1650 1200 -450

$2 1840 1150 -690

Price Adjustment – Surplus

Sometimes Supply is GREATER than Demand

This is called a SURPLUSThere is extra product that consumers are not buying

At what price(s) does a surplus exist?

Why might a surplus exist? Example?

Econ Model for SUPPLY and DEMAND

Price QD QS Surplus or Shortage?

$10 600 1550 +950

$9 720 1500 +780

$8 850 1450 +600

$7 990 1400 +410

$6 1140 1350 +210

$5 1300 1300 EVEN MKT EQL

$4 1470 1250 -220

$3 1650 1200 -450

$2 1840 1150 -690

Price Adjustment – Shortage

Sometimes Demand is GREATER than Supply

This is called a SHORTAGEThere is not enough of a product that

consumers want to buyAt what price(s) does a shortage exist? Why might a shortage exist? Example?

Econ Model for SUPPLY and DEMAND

Price QD QS Surplus or Shortage?

$10 600 1550 +950

$9 720 1500 +780

$8 850 1450 +600

$7 990 1400 +410

$6 1140 1350 +210

$5 1300 1300 EVEN MKT EQL

$4 1470 1250 -220

$3 1650 1200 -450

$2 1840 1150 -690

Review of Supply and Demand Graphs

Review of Demand and Supply GraphsAt what price is Market Equilibrium?

At P1, which is greater: supply or demand?

At P1, which is greater: supply or demand?

A Touch of RealismMarket Equilibrium rarely exists in Market

SystemsBuyers and Sellers come close on price with

respect to some products – gas, clothes, pizzaMore often, prices change over time to

accommodate buyer and seller understanding of the good or service, coming close to market equilibrium

Some Stores use LOSS LEADERS as a way to promote a sale – an item priced below cost to attract customers

EXAMPLE: the Walmart Opening Price Point

Price Controls

Price Ceilings, which prevent prices from exceeding a certain maximum, cause shortages.

Price Floors, which prohibit prices below a certain minimum, cause surpluses, at least for a time.

Price ControlsRent Control (ceiling)Minimum Wage (floor)

Unintended Consequences

People outraged about high prices of plywood in areas devastated by hurricanes, for example, may advocate price controls to keep the prices closer to usual levels.

An unintended consequence is that suppliers of plywood from outside the region, who would have been willing to supply plywood quickly at the higher market price, are less willing to do so at the government-controlled price. Thus results a shortage of a good where it is badly needed. Government licensing of electricians, to take another example, keeps the supply of electricians below what it would otherwise be, and thus keeps the price of electricians' services higher than otherwise. One unintended consequence is that people sometimes do their own electrical work, and, occasionally, one of these amateurs is electrocuted....