Chapter 4: Demand and Supply Applications

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Chapter 4 Demand and Supply Applications
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The Outline

• Price rationing
• Government policies and alternative rationing
  mechanisms
• 1. Price ceiling
• 2. Price floor

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I. The Price SystemRationing and Allocating
Resources

• The market system, performs two important and
  closely related functions
• Resource allocation the market system
  determines the allocation of resources among
  producers and the final mix of outputs.

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The Price SystemRationing 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.

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Price Rationing (Example 1)

• 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.

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Price Rationing (Example 2)

• 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.

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Prices and the Allocation of Resources

• Price changes resulting from shifts of demand or
  supply 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.

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II. Government Policy 1. Price Ceiling

• 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.

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Alternative Rationing Mechanisms

• Queuing is a nonprice rationing system that uses
  waiting in line as a means of distributing goods
  and services.

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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.

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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.

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Alternative Rationing Mechanisms

• The problem with (price ceiling) 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.

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II. Government Policy2. 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.

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How the Minimum Wage Affects the Labor Market