CHAPTER 6

PRICE: Supply and Demand

Together

Moving to Equilibrium

Supply and demand work together to determine price. For example, they work together to determine the price of corn at an auction.

A surplus occurs when the quantity supplied of a good is greater than the quantity demanded. Surpluses occur only at prices above the equilibrium price.

• Prices fall when a surplus occurs, because suppliers hope to sell their inventory, or the excess stock of goods that they have on hand.

Supply and Demand at Work at an Auction

Only at a price of $4 is the quantity demanded equal to the quantity supplied.

When:Quantity supplied (Qs) > Quantity demanded (Qd) = SurplusQd > Qs = ShortageQd = Qs = Equilibrium

A shortage occurs when the quantity demanded of a good is greater than the quantity supplied. Shortages occur only at prices below equilibrium price. A shortage is the opposite of a surplus.

• Prices rise when there is a shortage. Buyers will offer to pay a higher price to get sellers to sell to them rather than to other buyers.

A market is considered to be in equilibrium when the quantity of a good that buyers are willing and able to buy is equal to the quantity that sellers are willing and able to produce and offer for sale. When a market reaches equilibrium, quantity demanded equals quantity supplied.

• The equilibrium quantity is the amount of a good that is bought and sold in a market that is in equilibrium.

• The equilibrium price is the price at which a good is bought and sold in a market that is in equilibrium.

What Causes Equilibrium Prices to Change?

Either supply or demand must change in order for the equilibrium price to change.

• Demand can cause changes to the equilibrium price. If there is greater demand for a particular good, buyers are willing to pay a higher price to obtain that good.

• Supply can also cause changes to the equilibrium price. If the supply for a particular good exceeds the demand—a surplus exists—the price will decrease until it reaches an equilibrium price.

Moving to Equilibrium

Changes in Supply and in Demand at the Same Time

So far, we have looked at situations where either supply or demand has changed. Often, both supply and demand are constantly changing. The change in equilibrium price will be determined by which changes more, supply or demand. If demand increases more than supply, the equilibrium price goes up.

Does It Matter if Price Is at Its Equilibrium Level?

When price is at its equilibrium level, there are no shortages or surpluses of any goods or services. All buyers and sellers are happy with the market.

Price Is a Signal

Price serves as a signal that directs the allocation of resources toward producing the product with the highest demand.

What Are Price Controls?

Sometimes the government prevents markets from reaching an equilibrium price. It may do so by setting a price ceiling or a price floor.

A price ceiling is a price that is set lower than the equilibrium price. Buyers and sellers cannot legally buy and sell a good for more than this price. A government may set a price ceiling if it wants to make a good cheaper for consumers to buy.

• The government can also set a price floor, which is a price that is set above the equilibrium price. Buyers and sellers cannot legally buy and sell a good for less than this price. A government may set a price floor to assist a certain group of producers.

Price Controls and the Amount of Exchange

Price ceilings and price floors have the unintended result of reducing the amount of trade in the economy.

A price ceiling creates a shortage and reduces the quantity of a good bought and sold.Example: Rent Control

A price floor creates a surplus and reduces the quantity of the good bought and sold.Example: Minimum Wage

Price ceiling Price floor

Price Controls

Supply and Demand in Everyday Life

Why the Long Lines for Concert Tickets?

When some people are unable to purchase a good that they are willing and able to purchase, it means that quantity demanded exceeds quantity supplied. The result is a shortage in the market.

The Difference in Prices for Candy Bars, Bread, and Houses

In general, the price of many consumer goods is consistent throughout the United States. You can expect to pay approximately the same for a candy bar, or a loaf of bread, in any state.

Real estate prices demonstrate the impact of supply and demand.

• A house in San Francisco, California, will sell for approximately three to four times the price of a similar house in Louisville, Kentucky.

• Why don’t these two houses move toward an equilibrium price?

• Because of supply and demand. The houses come with the land on which they are built, and suppliers cannot pick up the land and move it to an area where there is higher demand.

When the supply of a good cannot be moved in response to a difference in price between cities, as in our real estate example, prices for this good are likely to remain different in different cities.

Supply and Demand at the Movies

Have you noticed that ticket prices to see a movie on Friday night are different than ticket prices for Sunday afternoon? A theater has a fixed number of seats. In response to higher demand on Friday night, it charges a higher price for those tickets.

Supply and Demand on a Freeway

Most of the time, traffic is able to move freely on the freeway. However, during rush hour, the demand for freeway space increases. This results in a shortage of space and in slower traffic.

One solution to freeway congestion is to build more freeways.

• Building more freeway space will increase the supply, helping to meet demand.

Another is to convince people to carpool.

• Carpooling will reduce the demand, helping to reduce or eliminate the shortage.

Yet another solution to freeway congestion is to charge a toll for freeway use.

Supply and Demand on the Gridiron

Supply and demand even plays a part in high school athletics. There are a limited number of spots on some teams, and several people may compete for each spot. Athletes will have to train harder and impress the coaches to secure a spot when demand exceeds supply.

Supply and Demand on the College Campus

Some colleges require higher GPAs or higher standardized test scores to gain admission. A college that is in high demand will have higher entrance requirements.

Necessary Conditions for a High Income: High Demand, Low Supply

To earn a high wage, a person must perform a job that is in high demand and that not many other people can do. If few know how to do the job, then supply will be low. Low supply and high demand will result in relatively higher wages.

Practice Graphs

1. Event: The price of snow skis goes up.

The equilibrium price of ski boots goes _______ and the equilibrium quantity of ski boots goes _____________.

S D

Quantity

Ski Boots

Pri

ce

Practice Graphs

1. Event: The price of snow skis goes up.

The equilibrium price of ski boots goes DOWN and the equilibrium quantity of ski boots goes DOWN.

S D

Quantity

Ski Boots

Pri

ceReason: Demand shifts because of the price of related goods.

Practice Graphs

2. Event: The Atkins low-carb diet sweeps the nation.

The equilibrium price of hamburger goes _______ and the equilibrium quantity of hamburger goes _____________.

S D

Quantity

Hamburger

Pri

ce

Practice Graphs

2. Event: The Atkins low-carb diet sweeps the nation.

The equilibrium price of hamburger goes UP and the equilibrium quantity of hamburger goes UP.

S D

Quantity

Hamburger

Pri

ceReason: Demand shifts because of preferences / trends.