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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
___________________
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