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IIntroduction
to
Econo
mics
2012 Pearson Education
Prepared by: Fernando Quijano & Shelly TefftCASE FAIR OSTER
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IIntroduction
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2012 Pearson Education
4
Demand and SupplyApplications
CHAPTER OUTLINE
The Price System: Rationing and
Allocating Resources
Price Rationing
Constraints on the Market and
Alternative Rationing Mechanisms
Prices and the Allocation of Resources
Price Floors
Supply and Demand Analysis: An
Oil Import Fee
Supply and Demand and Market
Efficiency
Consumer Surplus
Producer Surplus
Competitive Markets Maximize the Sumof Producer and Consumer Surplus
Potential Causes of Deadweight Loss
from Under- and Overproduction
Looking Ahead
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price rationing The process by which the marketsystem allocates goods and services to consumerswhen quantity demanded exceeds quantity supplied.
The Price System: Rationing and Allocating Resources
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2012 Pearson Education
FIGURE 4.1 The Market for Wheat
Fires in Russia in the summer of
2010 caused a shift in the worlds
supply of wheat to the left, causing
the price to increase from $160 per
millions of metric tons to $247.
The equilibrium moved from Cto B.
The Price System: Rationing and Allocating Resources
Price Rationing
2010
160247.
C B.
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The adjustment of price is the rationing mechanism in free markets. Pricerationing means that whenever there is a need to ration a goodthat is, when ashortage existsin a free market, the price of the good will rise until quantitysupplied equals quantity demandedthat is, until the market clears.
It is very important to distinguishbetween the priceof a product andtotal expenditurefrom that product.
Total revenue or expenditure in a
market is simply the number ofunits sold multiplied by the price.
Prices and Total Expenditure: A Lesson from the Lobster Industryin 2008-2009 :2008-
2009
E C O N O M I C S I N P R A C T I C E
Lobster Prices Plummet As MaineFishermen Catch Way Too Many
Business Insider
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FIGURE 4.2 Market for a RarePainting
There is some price that will clear any
market, even if supply is strictly
limited.
In an auction for a unique painting,
the price (bid) will rise to eliminateexcess demand until there is only one
bidder willing to purchase the single
available painting.
Some estimate that the Mona Lisa
would sell for $600 million if
auctioned.
The Price System: Rationing and Allocating Resources :
Price Rationing
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600.
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On occasion, both governments and private firms decide touse some mechanism other than the market system to rationan item for which there is excess demand at the current price.
Regardless of the rationale, two things are clear:
1. Attempts to bypass price rationing in the market and to usealternative rationing devices are more difficult and morecostly than they would seem at first glance.
2. Very often such attempts distribute costs and benefitsamong households in unintended ways.
The Price System: Rationing and Allocating Resources
Constraints on the Market and Alternative Rationing Mechanisms
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2012 Pearson Education
price ceiling A maximum pricethat sellers may charge for agood, usually set by government.
FIGURE 4.3 Excess Demand (Shortage)Created by a Price Ceiling
In 1974, a ceiling price of $0.57 cents per gallon
of leaded regular gasoline was imposed. If the
price had been set by the interaction of supply
and demand instead, it would have increased to
approximately $1.50 per gallon.At $0.57 per gallon, the quantity demanded
exceeded the quantity supplied. Because the
price system was not allowed to function, an
alternative rationing system had to be found to
distribute the available supply of gasoline.
The Price System: Rationing and Allocating Resources
Constraints on the Market and Alternative Rationing Mechanisms
Oil, Gasoline, and OPEC
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queuing Waiting in line as a means ofdistributing goods and services: a nonpricerationing mechanism.
favored customers Those who receivespecial treatment from dealers duringsituations of excess demand.
ration coupons Tickets or coupons thatentitle individuals to purchase a certain amount
of a given product per month.
black market A market in which illegal tradingtakes place at market-determined prices.
The Price System: Rationing and Allocating Resources
Constraints on the Market and Alternative Rationing Mechanisms
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FIGURE 4.4 Supply of and Demandfor a Concert at the Staples Center
At the face-value price of $50, there isexcess demand for seats to the concert.
At $50 the quantity demanded is
greater than the quantity supplied,
which is fixed at 20,000 seats.
The diagram shows that the quantity
demanded would equal the quantity
supplied at a price of $300 per ticket.
The Price System: Rationing and Allocating Resources
Constraints on the Market andAlternative Rationing Mechanisms
Rationing Mechanisms forConcert and Sports Tickets
50
20000
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No matter how good the intentions of privateorganizations and governments, it is very difficultto prevent the price system from operating andto stop willingness to pay from asserting itself.Every time an alternative is tried, the pricesystem seems to sneak in the back door. Withfavored customers and black markets, the finaldistribution may be even more unfair than what
would result from simple price rationing.
The Price System: Rationing and Allocating Resources
Constraints on the Market and Alternative Rationing Mechanisms
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Price changes resulting from shifts of demand inoutput markets cause profits to rise or fall. Profitsattract capital; losses lead to disinvestment. Higherwages attract labor and encourage workers to acquireskills. At the core of the system, supply, demand, andprices in input and output markets determine theallocation of resources and the ultimate combinationsof goods and services produced.
The Price System: Rationing and Allocating Resources
Prices and the Allocation of Resources
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price floor A minimum price belowwhich exchange is not permitted.
minimum wage A price floor setfor the price of labor.
The Price System: Rationing and Allocating Resources
Price Floor
A .
A .
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Every summer, New York City puts onfree performances of Shakespeare inthe Park.
The true cost of a ticket is $0 plus the
opportunity cost of the time spent inline.
Students can produce tickets relativelycheaply by waiting in line. They canthen turn around and sell those ticketsto the high-wage Shakespeare lovers.
The Price Mechanism at Work for Shakespeare
E C O N O M I C S I N P R A C T I C E
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FIGURE 4.5 The U.S. Market for Crude Oil, 1989
At a world price of $18, domestic production
is 7.7 million barrels per day and the total
quantity of oil demanded in the United States
is 13.6 million barrels per day.
The difference is total imports (5.9 million
barrels per day).
If the government levies a 33 1/3 percent tax on imports,
the price of a barrel of oil rises to $24.
The quantity demanded falls to 12.2 million barrels per day.
At the same time, the quantity supplied by domestic
producers increases to 9.0 million barrels per day and the
quantity imported falls to 3.2 million barrels per day.
Supply and Demand Analysis: An Oil Import Fee:
7.713.6
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consumer surplus The difference betweenthe maximum amount a person is willing topay for a good and its current market price.
Supply and Demand and Market Efficiency
Consumer Surplus
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2012 Pearson Education
FIGURE 4.6 Market Demand and Consumer Surplus
As illustrated in (a), some consumers (see point A) are willing to pay as much as $5.00 each for hamburgers.
Since the market price is just $2.50, they receive a consumer surplus of $2.50 for each hamburger that they consume.
Others (see point B) are willing to pay something less than $5.00 and receive a slightly smaller surplus.
Since the market price of hamburgers is just $2.50, the area of the shaded triangle in (b) is equal to total consumer surplus.
Supply and Demand and Market Efficiency
Consumer Surplus
()( A) 5.00.
$2.502.50.
(())5.00.
$2.50().
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FIGURE 4.7 Market Supply and Producer Surplus
As illustrated in (a), some producers are willing to produce hamburgers for a price of $0.75 each.
Since they are paid $2.50, they earn a producer surplus equal to $1.75.
Other producers are willing to supply hamburgers at a price of $1.00; they receive a producer surplus
equal to $1.50.
Since the market price of hamburgers is $2.50, the area of the shaded triangle in (b) is equal to total
producer surplus.
Supply and Demand and Market Efficiency
Producer Surplus
()0 75$. 2.501.75.
1.001.50.
$2.50().
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2012 Pearson Education
FIGURE 4.8 Total Producer and Consumer Surplus
Total producer and consumer surplus is greatest where supply and demand curves intersect at equilibrium.
Supply and Demand and Market Efficiency
Competitive Markets Maximize the Sum of Producer and Consumer Surplus
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deadweight loss The net loss of producer and consumersurplus from underproduction or overproduction.
Supply and Demand and Market Efficiency
Competitive Markets Maximize the Sum of Producer and Consumer Surplus
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Figure 4.9(a) shows the consequences of producing 4 million hamburgers per month instead of 7 million
hamburgers per month.
Total producer and consumer surplus is reduced by the area of triangle ABCshaded in yellow.
This is called the deadweight loss from underproduction.
Figure 4.9(b) shows the consequences of producing 10 million hamburgers per month instead of 7 million
hamburgers per month.
As production increases from 7 million to 10 million hamburgers, the full cost of production rises above
consumers willingness to pay, resulting in a deadweight loss equal to the area of triangle ABC.
FIGURE 4.9 Deadweight Loss
Supply and Demand and Market Efficiency
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Economics
2012 Pearson Education
When supply and demand interact freely, competitive marketsproduce what people want at least cost, that is, they are efficient.
There are a number of naturally occurring sources of marketfailure. Monopoly power gives firms the incentive to underproduceand overprice, taxes and subsidies may distort consumer choices,external costs such as pollution and congestion may lead to over-or underproduction of some goods, and artificial price floors andprice ceilings may have the same effects.
Supply and Demand and Market Efficiency
Potential Causes of Deadweight Loss from Under- and Overproduction
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IIntroduction
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2012 Pearson Education
We have now examined the basic forces of supply and demandand discussed the market/price system. These fundamentalconcepts will serve as building blocks for what comes next.
Whether you are studying microeconomics or macroeconomics,you will be studying the functions of markets and the behavior ofmarket participants in more detail in the following chapters.
Looking Ahead
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IIntroduction
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black market
consumer surplus
deadweight loss
favored customers
minimum wage
price ceiling
price floor
price rationing
producer surplus
queuing
ration coupons
R E V I E W T E R M S A N D C O N C E P T S