Demand and Supply Applications
The Price System:
Rationing and Allocating Resources
The market system, performs two important and closely related functions:
Resource allocation: the market system determines the allocation of resources among produces and the final mix of outputs.
The Price System:
Rationing and Allocating Resources
The market system, performs two important and closely related functions:
Price rationing: the market system distributes goods and services on the basis of willingness and ability to pay.
Price Rationing
A decrease in supply creates a shortage at the original price.
The lower supply is rationed to those who are willing and able to pay the higher price.
Price Rationing
There is some price that will clear any market.
The price of a rare painting will eliminate excess demand until there is only one bidder willing to buy the single available painting.
Constraints on the Market
A price ceiling is a maximum price that sellers may charge for a good, usually set by government.
In 1974, the government set a price ceiling to distribute the available supply of gasoline.
At an imposed price of 57 cents per gallon, the result was excess demand.
Alternative Rationing Mechanisms
Queuing is a nonprice rationing system that uses waiting in line as a means of distributing goods and services.
Alternative Rationing Mechanisms
Favored customers are those who receive special treatment from dealers during situations when there is excess demand.
Ration coupons are tickets or coupons that entitle individuals to purchase a certain amount of a given product per month.
Alternative Rationing Mechanisms
Attempts to restrict prices often result in the evolution of a black market.
A black market is a market in which illegal trading takes place at market-determined prices.
Alternative Rationing Mechanisms
The problem with rationing systems is that excess demand is created but not eliminated.
No matter how good the intentions of private organizations and governments, it is very difficult to prevent the price system from operating and to stop the willingness to pay from asserting itself.
Prices and the Allocation of Resources
Price changes resulting from shifts of demand cause profits to rise or fall.
Profits attract capital; losses lead to disinvestment.
Higher wages attract labor and encourage workers to acquire skills.
At the core of the system, supply, demand, and prices in input and output markets determine the allocation of resources and the ultimate combinations of things produced.
Price Floors
A price floor is a minimum price below which exchange is not permitted.
The most common example of a price floor is the minimum wage, which is a floor set under the price of labor.
The result of setting a price floor will be excess supply, or higher quantity supplied than quantity demanded.
Supply and Demand Analysis:
An Oil Import Fee
At a world price of $18, imports are million barrels per day.
The tax on imports causes an increase in domestic production, and quantity imported falls.
Supply and Demand
and Market Efficiency
Supply and demand curves can be used to illustrate the idea of market efficiency, an important aspect of “normative economics.”
Consumer Surplus
Consumer surplus is the difference between the maximum amount a person is willing to pay for a good and its current market price.
Consumer Surplus
Some consumers are willing to pay as much as $5 each for hamburgers.
Since the price is only $, they receive a consumer surplus of $.
Consumer Surplus
Others are willing to pay something less than $ but more than $.
Consumer surplus is the area below the demand curve and above the price level.
Producer Surplus
Producer surplus is the difference between the maximum amount a producer is willing to accept to supply a good and its current market price.
Producer Surplus
Some producers are willing to accept as little as 75 cents each for hamburgers.
Since the price is $, they receive a producer surplus of $ per hamburger.
Producer Surplus
Others producers are willing to receive something less than $ but higher than 75 cents.
Producer surplus is the area above the supply curve and below the price level.
Markets Maximize the Sum of Producer and Consumer Surplus
Total producer and consumer surplus is highest where supply and demand curves intersect at equilibrium.
Consumers receive benefits in excess of what they pay and producers receive compensation in excess of costs.
Markets Maximize the Sum of Producer and Consumer Surplus
If the market produces too little, say 4 million instead of 7 million hamburgers per month, total producer and consumer surplus is reduced. This reduction (triangle ABC) is called a deadweight loss.
Potential Causes of Deadweight Loss From Under- and Overproduction
Deadweight losses can occur from under- and overproduction.
If the market produces 10 million instead of 7 million hamburgers per month, the cost of production rises above the willingness of consumers to pay, resulting in a deadweight loss.
Review Terms and Concepts
black market
consumer surplus
deadweight loss
favored customers
minimum wage
price ceiling
price floor
price rationing
producer surplus
queuing
ration coupons
By 2003, domestic production had fallen to million barrels per day and imports were up to million per day.
