price theory in action

7/24/2019 Price Theory in Action

1/16

5- 1

PRICE THEORY IN

ACTION

Slides by

Alex Stojanovic

Chapter 5

ECONOMICSTENTH

EDITION

LIPSEY &

CHRYSTAL


2/16

5- 2 Learning Outcomes

Changes in price really do lead to changes in

quantity demanded Market prices do adjust in response to shifts in

demand and supply conditions

Elasticity of demand can be measured directly so

long as other influences can be held constant

Intervention in markets by governments to fi

prices has important consequences! not all of

"hich can be considered desirable Intervention in agricultural markets has been

costly for consumers and for foreign producers


3/16

5- 3 Changes in demand for newspaper

#$p

%!&'(!$)(

Price Average daily sales Percent change

*re+,ep-.() *ost+,ep-.() Price Sales

The Times

Gardian

)#p

/#p

/#p

/%$!/

)0%!$((

%!&(0!/0/

*re+,ep-.() *ost+,ep-.()

!aily Telegraph

"ndependent #$p

/#p

/#p

/#p

-1#$1%

&1'$#

-#$3'

-1$'3

%$%

-33$3

%$%

%$%

)'0!1)0 %!&(0!/0/

&!&)'!)'# &!$&'!)%0

/$&!'$#

)0%!$((


4/16

5- #

2

E

,

p%

p&

p$

q)q&q$q%$

3uantity

!ise(ili)rim *antity

*ri

ce


5/16

5- 5

Market equilibrium is at point E"ith pricep0and quantity q0.

4or prices belo" P0the quantity echanged "ill be determined by the supply

curve-

4or eample! q2"ill be echanged at pricep1! in spite of the ecess demand

of q1-q2.

4or prices abovep0the quantity echanged "ill be determined by the

demand curve-

4or eample! q2"ill be echanged at pricep2in spite of the ecess supply ofq)+q2.

5hus the dark blue and dark yello" portions of the Sand Dcurves sho" the

actual quantities echanged at each price-

In other "ords! in disequilibrium! quantity echanged is determined by the

lesser of quantity demanded and quantity supplied-

!ise(ili)rim *antity


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5- +

2

E

,

p%

p&

p$

q&q$q%$

3uantity

,lac-maret pricing

Maimum price permitted

Ecess

2emand


7/16

5- .

Equilibrium price is atp0-

6o" let a price ceiling be set atp1.

5he quantity demanded "ill rise to q1and the quantity

supplied "ill fall to q2-

3uantity actually echanged "ill be q2- Ecess demand is q1-q2-

7lack marketers could buy q2at the controlled price of

p1paying the amount sho"n by the light blue area p1q2-

5hey could sell at the pricep2earning profits sho"n bythe dark blue area bet"eenp1 andp2.

,lac-maret pricing


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5- /

Inelastic

2emand

E

2i

p$

q& q$ q%$3uantity

0nplanned lctations in tpt

Elastic 2emand

2e

Elasticd

emand

Inelasticdemand

*r

ice

8nplanned changes

in output


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5- '

8nplanned fluctuations in output lead to much sharper fluctuations in price

if the demand curve is inelastic than if it is elastic-

*roducers epect the market price to bep0 and they plan to produce q0-

5he t"o curves Diand De, are alternative demand curves- If actual production al"ays equalled planned production! the equilibrium

price and quantity "ould bep0and q0"ith either demand curve-

8nplanned fluctuations in output! ho"ever! cause quantity to vary year by

year bet"een q19a bad harvest: and q2! 9a good harvest:-

;hen demand is inelastic 9sho"n by the yello" curve:! prices "ill sho"large fluctuations-

;hen demand is elastic 9sho"n by the blue curve:! prices "ill sho" much

smaller fluctuations-

9In both cases elasticity is measured around point E)

0nplanned lctations in tpt


10/16

5- 1%

2

E

< &

p&

q% q# q)$

3uantity

"ncome Sta)iliation

,

2e

*rice

p/

p%

p#

p)

q&q/


11/16

5- 11

Income stabili=ation is achieved "hen the government purchases or sells

just enough to allo" price to fluctuate in inverse proportion to output-

D is the demand curve- S is the curve sho"ing planned supply-

Equilibrium is at E.

>o"ever! actual production fluctuates bet"een q2and q3.

5hese unplanned fluctuations in output cause the free+market price to

fluctuate bet"eenp2andp3-

? curve of unit elasticity over its "hole range is dra"n through Eandlabelled =1-

5o stabili=e income! any given output must be sold at a price determined

by this curve-

5he government buys or sells an amount equal to the hori=ontal distance

bet"een the =1curve and the demand curve-

"ncome Sta)iliation


12/16

5- 12

4or eample! "hen production is q3market price must be held at

p5if income is to be unchanged-

7ut at market pricep5the public "ishes to purchase only q5- ,o the government must buy up the remaining production! q3 - q5.

It adds this amount to its stocks-

4armers. total sales are q3at priceps.

,ince the broken yello" curve is a rectangular hyperbola!income!p5q3!is equal to incomep1 q1.

;hen production is equal to q2price must be allo"ed to rise only

top4-

97y construction the areap4q

2is equal to the areap

1q

1-:

7ut at pricep4the public "ill "ish to buy q4so that the

government must sell q4 -q2out of its stocks-

"ncome Sta)iliation


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5- 13

inish yor coffee4 were off to the msem ;orld commodity prices! such as coffee! change in response

to the balance of supply and demand factors- 5he increase in museum visits follo"ing the abolition of

admission charge sho"s that demand curve really do havenegative slope-

6eeping p with The Timesand the Tnnel

2emand and supply theory is a potent tool for analysingmany real+"orld situations as the effects of the Channel5unnel and price+cutting among 7ritish ne"spapers-

Government "ntervention in 7arets Effective price ceilings lead to ecess demand! black

markets!and non+price methods of allocating the scarcesupplies among "ould+be purchasers-

@ent controls are a form of price ceiling- 5heir majorconsequence is a shortage of rental accommodation thatgets "orse because of a slo" but ineorable decline in thequantity of rental accommodation-

C8APT9: 5; P:"C9 T89:< "= ACT"=


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5- 1#

5he *roblems of ?griculture

On the free market many agricultural prices are

subject to "ide fluctuations as a result of "eather+

induced! year+to+year fluctuations in supply operating

on inelastic demand curves! and cyclical fluctuations

in demand operating on inelastic supply curves-

Aovernments can stabilise agricultural incomes by

reducing price fluctuations-

5hey achieve this by holding stocks! "hich they add

to through purchases in times of surplus and sell from

in times of shortage-

C8APT9: 5; P:"C9 T89:< "= ACT"=


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5- 15

5he long+term problems of agriculture arise from

productivity gro"th on the supply side combined "ith lo"

income elasticity on he demand side-

5his means that! unless many resources are being

transferred out of agricultural fairly rapidly! quantitysupplied tends to increase faster than quantity demanded

year after year-

,tabilisation schemes that hold prices above their free+

market levels on average! over short+term and cyclicals"ings! frustrate the long+term adjustment process and

lead to over+gro"ing surpluses + as the E8.s Common

?gricultural *olicy Bthe C?*-

C8APT9: 5; P:"C9 T89:< "= ACT"=


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5- 1+

Some General >essons a)ot the price System;

Costs may be shifted! but they can not be avoidedD

free+market prices and profits encourage economical useof resourcesD

government intervention affects resource allocationD and

intervention requires alternative allocative mechanisms-

C8APT9: 5; P:"C9 T89:< "= ACT"=

price theory in action

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