CHAPTER 6 PUTTING DEMAND AND SUPPLY

TOGETHER

Prices and Decision Making 6.1 

I. Advantages of Prices    A. Prices are neutral because they do not         favor the buyer or the seller.          Prices are the result of competition

Prices answer the three basic      economic questions: What, How,      and For Whom 

     B. Prices are flexible, allowing for the       “shocks” of unforeseen events and changes        in the market    C. Prices have no administration costs    D. Prices are familiar and easily understood

II. Allocations Without Prices     A. Political connections or some other          allocation

 

 B. Rationing, leads to the question of          fairness     *  Rationing leads to high         administrative cost      *  Rationing leads to fewer incentives          to work and produce         

III. Prices as a System A.  Prices comprise a system that helps buyers       and sellers allocate resources between       markets, linking all markets in the       economyB.  High prices = producers to produce more and buyers to buy less

C. Low prices = producers to produce less and buyers to buy more

I. The Price Adjustment Process - Putting Supply and Demand together         A. Together, demand and supply make a complete picture of the market B. Price adjustments help a competitive market reach market equilibrium, with fairly equal supply and demand

       C. Surpluses occur when supply exceeds demand    D. Shortages occur when demand exceeds supplyE. The equilibrium price is the price at which supply meets demand

II. Explaining and Predicting PricesA.  A change in price is normally the result of a      change in supply, a change in demand, or      bothB.  Even small changes in an inelastic supply      can create big changes in priceC.  Elastic supply and demand help keep prices      from changing dramatically 

III. The Competitive Price Theory A.  The theory of competitive pricing represents a set of ideal conditions and outcomes; it serves as a model to       measure market performanceB.  In theory, a competitive market allocates           resources efficiently

C. To be competitive, sellers are forced to lower      prices, which makes them find ways to keep 

their costs downD.  Competition among buyers keeps prices from      falling too far

What are the broad social and economic goals?

I. Distorting Market Outcomes A. Achieving equity and security usually      requires policies that distort market outcomes.

B. One way to achieve these goals is to set         “socially desirable” prices, which interferes         with the pricing system (rent control, minimum wage)

Prices are not allowed to adjust to their equilibrium levels

C. Price ceiling = maximum legal price that can be

      charged for a product      * Setting price ceilings affects the allocation of         resources 

D. Price floors are set to ensure that prices do     not drop too low*Minimum wage is an example of a price floor

 

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Effects of Price Floors and Price Ceilings:

In some cases the government intervenes in a market to prevent the laws of supply and demand from determining price.

•For example, to help support dairy farmers, the government might establish a price floor, a minimum allowable price for milk. Because the price is kept artificially high, farmers will increase the supply they are willing to produce, even though demand is not increasing•This will lead to a SURPLUS

Effects of Price Floors and Price Ceilings:

Another example of a price floor is the establishment of minimum wage

•When minimum wage goes up, the demand for labor goes down, leading to a surplus of labor, and an increase in unemployment

In other markets, the government might establish a price ceiling, the highest price that can be charged for a particular good or service

•A good example of a price ceiling is rent-controlled apartments. When rents are kept artificially low, many landlords will decide that it is not worthwhile to rent out apartments. As a result, the supply of apartments will decline, leading to a shortage•In general, price ceilings lead to shortages

II. Agricultural Price Supports to stabilize     agricultural prices     A. Loan Supports … makes use of target price     1. Government loan support was offered in          the 1930s       2. The CCC loan program led to food           surpluses      3. Government issued non-recourse loans 

B. Deficiency Payments; check sent to      producers that make up the difference 

between the actual market price and the target priceThe CCC switched to deficiency payments,    which prevented the government from    holding surplus food and had farmers sell     their crops on the open market.

C. Reforming Price Supports – goal to make     agricultural output responsive to market 

forces 1. 1996, Congress passed FAIR—Federal         Agricultural Improvement and Reform Act 2. Cash payments replaced price supports and         deficiency payments  3. The payments ended up costing as much

III. When Markets Talk      A.   Markets “talk” when prices move up or            down dramatically      B.   Buyers and sellers respond to changes in             the market through their decisions