lecture on demand and supply applications

7/29/2019 Lecture on Demand and Supply Applications

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Lecture 4

Demand and Supply Applications

The Price System: Rationing and Allocating Resources

Price RationingConstraints on the Market and Alternative Rationing Mechanisms

Prices and the Allocation of ResourcesPrice Floors

Supply and Demand Analysis: An Oil Import Fee

Supply and Demand and Market Efficiency

Consumer SurplusProducer SurplusCompetitive Markets Maximize the Sum of Producer and Consumer SurplusPotential Causes of DeadweightLoss from Under- and Overproduction


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THE PRICE SYSTEM: RATIONING

AND ALLOCATING RESOURCES

price rationing The process by which

the market system allocates goods andservices to consumers when quantitydemanded exceeds quantity supplied.


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FIGURE 4.1 The Market for Lobsters

PRICE RATIONING


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The adjustment of price is the rationing mechanism in free markets.

Price rationing means that whenever there is a need to ration a good

that is, when a shortage existsin a free market, the price of the good

will rise until quantity supplied equals quantity demandedthat is, until

the market clears.


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FIGURE 4.2 Market for a Rare Painting


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CONSTRAINTS ON THE MARKET ANDALTERNATIVE RATIONING MECHANISMS

On occasion, both governments and private firms decideto use some mechanism other than the market system toration an item for which there is excess demand at thecurrent price.

Regardless of the rationale, two things are clear:

1. Attempts to bypass price rationing in the market and touse alternative rationing devices are much more difficultand costly than they would seem at first glance.

2. Very often, such attempts distribute costs and benefitsamong households in unintended ways.


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Oil, Gasoline, and OPEC

price ceiling A maximum price that sellers maycharge for a good, usually set by government.

FIGURE 4.3 Excess Demand

(Shortage) Created

by a Price Ceiling


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queuing Waiting in line as a means ofdistributing goods and services: a

nonprice rationing mechanism.

favored customers Those whoreceive special treatment from dealers

during situations of excess demand.


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Even when trading coupons is declared illegal, it is virtually impossible to stop black

markets from developing. In a black market, illegal trading takes place at market-

determined prices.

ration coupons Tickets or couponsthat entitle individuals to purchase acertain amount of a given product per

month.

black market A market in which illegaltrading takes place at market-determined prices.

C S S O G


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NCAA March Madness: College Basketballs

National Championship

FIGURE 4.4 Supply of and Demand for a

Pair of Final Four Tickets in

2003

THE PRICE SYSTEM RATIONING


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PRICES AND THE ALLOCATION OF RESOURCES

Price changes resulting from shifts of demand in output markets 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.

Thinking of the market system as a mechanism forallocating scarce goods and services among competingdemanders is very revealing, but the market determinesmuch more than just the distribution of final outputs. Italso determines what gets produced and how resourcesare allocated among competing uses.

THE PRICE SYSTEM RATIONING


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PRICE FLOORS

price floor A minimum price belowwhich exchange is not permitted.

minimum wage A price floor set underthe price of labor.

SUPPLY AND DEMAND ANALYSIS


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SUPPLY AND DEMAND ANALYSIS:

AN OIL IMPORT FEE

The basic logic of supply anddemand is a powerful tool ofanalysis.

FIGURE 4.5 The U.S. Market for Crude

Oil, 1989

SUPPLYANDDEMANDAND


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SUPPLY AND DEMAND AND

MARKET EFFICIENCY

CONSUMER SURPLUS

consumer surplus The differencebetween the maximum amount a

person is willing to pay for a good andits current market price.

SUPPLYANDDEMANDAND


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MARKET EFFICIENCY

FIGURE 4.6 Market Demand and Consumer Surplus

SUPPLYANDDEMANDAND


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MARKET EFFICIENCY

PRODUCER SURPLUS

producer surplus The differencebetween the current market price and

the full cost of production for the firm.

SUPPLYANDDEMANDAND


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MARKET EFFICIENCY

FIGURE 4.7 Market Supply and Producer Surplus

SUPPLYANDDEMANDAND


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MARKET EFFICIENCY

COMPETITIVE MARKETS MAXIMIZE THE SUM OF

PRODUCER AND CONSUMER SURPLUS

FIGURE 4.8 Total Producer and Consumer Surplus

SUPPLYANDDEMANDAND


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MARKET EFFICIENCY

deadweight loss The net loss of

producer and consumer surplus fromunderproduction or overproduction.

FIGURE 4.9 Deadweight Loss

SUPPLYANDDEMANDAND


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MARKET EFFICIENCY

POTENTIAL CAUSES OF DEADWEIGHT LOSSFROM UNDER- AND OVERPRODUCTION

When supply and demand interact freely,

competitive markets produce what people wantat least cost, that is, they are efficient.


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black market

consumer surplus

deadweight lossfavored customers

minimum wage

price ceiling

price floor

producer surplus

price rationingqueuing

ration coupons

REVIEW TERMS AND CONCEPTS

lecture on demand and supply applications

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