Chapter 6, Section 2 – How Prices are Determined

1. Chapter 6, Section 2 – How Prices are Determined • The Adjustment Process • Market Equilibrium / Equilibrium Price • Surplus • Shortage

2. 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?

3. Econ Model for SUPPLY and DEMAND

4. 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

5. Econ Model for SUPPLY and DEMAND

6. Price Adjustment – Surplus Sometimes Supply is GREATER than Demand This is called a SURPLUS There is extra product that consumers are not buying At what price(s) does a surplus exist? Why might a surplus exist? Example?

7. Econ Model for SUPPLY and DEMAND

8. Price Adjustment – Shortage Sometimes Demand is GREATER than Supply This is called a SHORTAGE There is not enough of a product that consumers want to buy At what price(s) does a shortage exist? Why might a shortage exist? Example?

9. Econ Model for SUPPLY and DEMAND

10. Review of Supply and Demand Graphs

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

12. At P1, which is greater: supply or demand?

13. At P1, which is greater: supply or demand?

14. A Touch of Realism Market Equilibrium rarely exists in Market Systems Buyers and Sellers come close on price with respect to some products – gas, clothes, pizza More 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

15. 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 Controls Rent Control (ceiling) Minimum Wage (floor)

16. 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....