Ss and Equilibrium Analysis

8/11/2019 Ss and Equilibrium Analysis

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EQUILBRIUM, PPC AND GOVTINTERVENTION(PRICE FLOOR, PRICE

CEILING)SUMEETHA M


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Market Equilibrium

The operation of the marketdepends on the interactionbetween buyers and sellers.

An equilibrium is the condition thatexists when quantity supplied andquantity demanded are equal.

At equilibrium, there is no tendencyfor the market price to change.


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Market Equilibrium

Only in equilibriumis quantity supplied

equal to quantitydemanded.

At any price levelother than P 0, the

wishes of buyersand sellers do notcoincide.


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Market Disequilibria

Excess demand , orshortage, is the conditionthat exists when quantity

demanded exceeds quantitysupplied at the currentprice.

When quantity demandedexceeds quantity supplied, price

tends to rise until equilibrium isrestored.


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Market Disequilibria

Excess supply , or surplus, isthe condition that existswhen quantity suppliedexceeds quantity demandedat the current price.

When quantity supplied exceedsquantity demanded, price tends tofall until equilibrium is restored.


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Increases in Demand and Supply

Higher demand leads to higherequilibrium price and higherequilibrium quantity.

Higher supply leads to lowerequilibrium price and higherequilibrium quantity.


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Decreases in Demand and Supply

Lower demand leads tolower price and lowerquantity exchanged.

Lower supply leads tohigher price and lowerquantity exchanged.


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Relative Magnitudes of Change

The relative magnitudes of change in supply and demand determine theoutcome of market equilibrium.


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The relative magnitudes of change in supply and demand determine theoutcome of market equilibrium.


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When supply and demand both increase, quantity will increase, butprice may go up or down.


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SUPPLY, DEMAND, ANDGOVERNMENT POLICIES

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Government Policies That Alter thePrivate Market Outcome

Price controls Price ceiling : a legal maximum on the price

of a good or service Example: rent control Price floor : a legal minimum on the price of

a good or service Example: minimum wage Taxes

The govt can make buyers or sellers pay a specificamount on each unit bought/sold.

We will use the supply/demand model to seehow each policy affects the market outcome

(the price buyers pay, the price sellers receive, and

eqm quantity).


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Shortages and Rationing With a shortage, sellers must ration the goods among

buyers. Some rationing mechanisms: (1) Long lines

(2) Discrimination according to sellers biases

These mechanisms are often unfair, and inefficient: thegoods do not necessarily go to the buyers who valuethem most highly.

In contrast, when prices are not controlled,the rationing mechanism is efficient (the goodsgo to the buyers that value them most highly)and impersonal (and thus fair).


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EXAMPLE :The Market for Unskilled Labor

Eqm w/oprice controls

W

LD

SWagepaid to

unskilledworkers

$4

500

Quantity ofunskilled workers


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How Price Floors Affect Market Outcomes

W

LD

S

$4

500

Pricefloor$3

A price floorbelow theeqm price isnot binding has no effecton the marketoutcome.


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How Price Floors Affect Market Outcomes

W

LD

S

$4

Pricefloor$5

The eqm wage ($4) isbelow the floor andthereforeillegal.The flooris a binding constraint on the wage,causes asurplus ( i.e., unemployment). 400 550

labor

surplus


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Min wage laws

do not affecthighly skilledworkers.

They do affectteen workers.Studies:A 10% increasein the min wageraises teenunemploymentby 1-3%.

The Minimum Wage

W

LD

S

$4

Min.wage$5

400 550

unemp-

loyment


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See this example

Price controls

40

50

60

70

80

90

100

110

120

130

140

50 60 70 80 90 100 110 120 130 Q

P S

0

The market for

hotel rooms

D

Determineeffects of:

A. $90 priceceiling

B. $90 pricefloor

C. $120 pricefloor

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A C T I V E L E A R N I N G 1

A. $90 price ceiling

40

50

60

70

80

90

100

110

120

130

140

50 60 70 80 90 100 110 120 130 Q

P S

0

The market for

hotel rooms

D

The price fallsto $90.

Buyers

demand120 rooms,sellers supply90, leaving ashortage.

shortage = 30

Price ceiling

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A C T I V E L E A R N I N G 1

B. $90 price floor

40

50

60

70

80

90

100

110

120

130

140

50 60 70 80 90 100 110 120 130 Q

P S

0

The market for

hotel rooms

D

Eqm price isabove the floor,so floor is not

binding.P = $100,Q = 100 rooms. Price floor

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B. $90 price floor

40

50

60

70

80

90

100

110

120

130

140

50 60 70 80 90 100 110 120 130 Q

P S

0

The market for

hotel rooms

D

Eqm price isabove the floor,so floor is not

binding.P = $100,Q = 100 rooms. Price floor

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Wh G C l P i


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Why Governments Control Prices

The market price moves to the level at which the quantitysupplied equals the quantity demanded. But this equilibriumprice does not necessarily please all buyers or all sellers.

Therefore, the government intervenes to regulate prices by

imposing price controls, which are legal restrictions on howhigh or low a market price may go. Price ceiling is the maximum price sellers are allowed to charge

for a good or service.

Price floor is the minimum price buyers are required to pay fora good or service.

Why Governments Control Prices

BA 210 Lesson I.6 Price andQuantity Controls

P i C ili


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Price ceilings are typically imposed during crises because these

events often lead to sudden price increases that hurt manypeople but produce big gains for a lucky few.

Price Ceilings


P i C ili g


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1.6 0 1.8 2.0 2.2 2.4

$1,400

1,200

1,000

800

600

Quantity of apartments (millions)

Monthly rent

(per apartment)

D

S

E

B A

Housing shortage

of 400,000apartmentscaused by

price ceiling

Priceceiling

The Effects of a Price Ceiling


Price Ceilings


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How Price Ceilings Cause Inefficiency


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Price ceilings often lead to inefficiency in the form ofinefficient allocation to consumers: some people who arewilling to pay the highest prices dont get it, and those onlywilling to pay less do get it.

If Abe is willing to pay $1,300 for an apartment butdoes not get it, and Burt is willing to pay only$1,100 and does get it, there is $200 lost surplus,in addition to deadweight loss.

Price ceilings typically lead to inefficiency in the form of wastedresources: potential expend money, effort and time to be able

to buy at the low ceiling prices. If Abe is willing to pay $1,300 for an apartment and Burt is

willing to pay only $1,100 and does get it, then Abe iswilling to pay up to $200 more than Burt in money, effortand time to be able to buy at the low ceiling prices.

How Price Ceilings Cause Inefficiency


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Evaluating Price Controls Recall one of the Ten Principles from Chapter 1:

Markets are usually a good wayto organize economic activity.

Prices are the signals that guide the allocation of

societys resources. This allocation is altered whenpolicymakers restrict prices.

Price controls often intended to help the poor,but often hurt more than help.

How Price Floors Cause Inefficiency


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The persistent surplus that results from a price floor creates

missed opportunities inefficiencies that resemble thosecreated by the shortage that results from a price ceiling.These include:

Deadweight loss from inefficiently low quantity Inefficient allocation of sales among sellers Wasted resources Inefficiently high quality

How Price Floors Cause Inefficiency

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Ss and Equilibrium Analysis