ECON help

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PART I Introduction to Economics

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4

Demand and Supply Applications

CHAPTER OUTLINE

The Price System: Rationing and Allocating Resources

Price Rationing

Constraints on the Market and Alternative Rationing Mechanisms

Prices and the Allocation of Resources

Price Floors

Supply and Demand Analysis: An Oil Import Fee

Supply and Demand and Market Efficiency

Consumer Surplus

Producer Surplus

Competitive Markets Maximize the Sum of Producer and Consumer Surplus

Potential Causes of Deadweight Loss from Under- and Overproduction

Looking Ahead

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PART I Introduction to Economics

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price rationing The process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied.

The Price System: Rationing and Allocating Resources

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PART I Introduction to Economics

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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 exists—in a free market, the price of the good will rise until quantity supplied equals quantity demanded—that is, until the market clears.

It is very important to distinguish between the price of a product and total expenditure from that product.

Total revenue or expenditure in a market is simply the number of units sold multiplied by the price.

Prices and Total Expenditure: A Lesson from the Lobster Industry
in 2008-2009

E C O N O M I C S I N P R A C T I C E

Lobster Prices Plummet As Maine Fishermen Catch Way Too Many

Business Insider

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PART I Introduction to Economics

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On occasion, both governments and private firms decide to use some mechanism other than the market system to ration an item for which there is excess demand at the current price.

Regardless of the rationale, two things are clear:

• Attempts to bypass price rationing in the market and to use alternative rationing devices are more difficult and more costly than they would seem at first glance.

2. Very often such attempts distribute costs and benefits among households in unintended ways.

The Price System: Rationing and Allocating Resources

Constraints on the Market and Alternative Rationing Mechanisms

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PART I Introduction to Economics

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queuing Waiting in line as a means of distributing goods and services: a nonprice rationing mechanism.

favored customers Those who receive special treatment from dealers during situations of excess demand.

ration coupons Tickets or coupons that entitle individuals to purchase a certain amount of a given product per month.

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

The Price System: Rationing and Allocating Resources

Constraints on the Market and Alternative Rationing Mechanisms

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PART I Introduction to Economics

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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 willingness to pay from asserting itself. Every time an alternative is tried, the price system seems to sneak in the back door. With favored customers and black markets, the final distribution may be even more unfair than what would result from simple price rationing.

The Price System: Rationing and Allocating Resources

Constraints on the Market and Alternative Rationing Mechanisms

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PART I Introduction to Economics

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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 goods and services produced.

The Price System: Rationing and Allocating Resources

Prices and the Allocation of Resources

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PART I Introduction to Economics

© 2012 Pearson Education, Inc. Publishing as Prentice Hall

price floor A minimum price below which exchange is not permitted.

minimum wage A price floor set for the price of labor.

The Price System: Rationing and Allocating Resources

Price Floor

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PART I Introduction to Economics

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Every summer, New York City puts on
free performances of Shakespeare in
the Park.

The true cost of a ticket is $0 plus the
opportunity cost of the time spent in
line.

Students can produce tickets relatively
cheaply by waiting in line. They can
then turn around and sell those tickets
to the high-wage Shakespeare lovers.

The Price Mechanism at Work for Shakespeare

E C O N O M I C S I N P R A C T I C E

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PART I Introduction to Economics

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consumer surplus The difference between the maximum amount a person is willing to pay for a good and its current market price.

Supply and Demand and Market Efficiency

Consumer Surplus

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PART I Introduction to Economics

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producer surplus The difference between the current market price and the full cost of production for the firm.

Supply and Demand and Market Efficiency

Producer Surplus

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PART I Introduction to Economics

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deadweight loss The net loss of producer and consumer surplus from underproduction or overproduction.

Supply and Demand and Market Efficiency

Competitive Markets Maximize the Sum of Producer and Consumer Surplus

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PART I Introduction to Economics

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When supply and demand interact freely, competitive markets produce what people want at least cost, that is, they are efficient.

There are a number of naturally occurring sources of market failure. Monopoly power gives firms the incentive to underproduce and overprice, taxes and subsidies may distort consumer choices, external costs such as pollution and congestion may lead to over- or underproduction of some goods, and artificial price floors and price ceilings may have the same effects.

Supply and Demand and Market Efficiency

Potential Causes of Deadweight Loss from Under- and Overproduction

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PART I Introduction to Economics

© 2012 Pearson Education, Inc. Publishing as Prentice Hall

black market

consumer surplus

deadweight loss

favored customers

minimum wage

price ceiling

price floor

price rationing

producer surplus

queuing

ration coupons

R E V I E W T E R M S A N D C O N C E P T S