PART I INTRODUCTION TO ECONOMICS

Demand and
4
Supply
Applications

Prepared by:
Fernando & Yvonn
Quijano
© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Macroeconomics 9e by Case, Fair and Oster
 PART I INTRODUCTION TO ECONOMICS

Demand and
4
Supply CHAPTER
OUTLINE
The Price System: Rationing and
Applications Allocating Resources
Price Rationing
CHAPTER 4 Demand and Supply Applications

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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 The Price System: Rationing and Allocating Resources
Price rationing: The process by which the price system allocates
goods and services to consumers when there is a shortage (The
process by which the market system allocates goods and services to
consumers when quantity demanded exceeds quantity supplied).

Suppose in 2008 that 15,000

CHAPTER 4 Demand and Supply Applications

square miles of lobstering

waters off the coast of Maine are
closed. The supply curve shifts
to the left. Before the waters are
closed, the lobster market is in
equilibrium at the price of $11.50
and a quantity of 81 million
pounds. The decreased supply
of lobster leads to higher prices,
and a new equilibrium is
reached at $16.10 and 60 million
pounds.

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 The Price System: Rationing and Allocating Resources

Price Rationing: The Market for a Rare Panting

There is some price that will

clear any market, even if
supply is strictly limited. In an
auction for a unique painting,
CHAPTER 4 Demand and Supply Applications

the price (bid) will rise to

eliminate excess demand until
there is only one bidder willing
to purchase the single
available painting.

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

rationing means that whenever there is a shortage exists, the price of the
good will rise until equilibrium is reached.

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 The Price System: Rationing and Allocating Resources

On occasion, both governments and private firms decide to use

some mechanism other than the market system to ration an
good in shortage.
CHAPTER 4 Demand and Supply Applications

Regardless of the rationale, two things are clear:

1. Attempts to bypass price rationing in the market and use

alternative rationing devices are more costly than they seem.

2. Often, such attempts distribute costs and benefits among

households in unintended ways.

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 The Price System: Rationing and Allocating Resources
Price Ceiling: When a maximum legal price is charged for a good.

Oil, Gasoline, and OPEC In 1974, a ceiling price of $0.57 cents

per gallon of gasoline was imposed.
The equilibrium price was $1.50 per
CHAPTER 4 Demand and Supply Applications

gallon.

At $0.57 per gallon, there was a

shortage in the market.

Because the price system was not

allowed to function, a governmental
rationing system was used to
distributed the available supply of
gasoline.

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 The Price System: Rationing and Allocating Resources

Alternative Rationing Mechanisms

Queuing: Waiting in line as a means of distributing goods
and services
CHAPTER 4 Demand and Supply Applications

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

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 The Price System: Rationing and Allocating Resources

Concert by a Popular Musician

The face value of a ticket to the Justin

Timberlake concert on September 16,
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2007, at the Staples Center in Los

Angeles was $50. The Staples Center
holds 20,000. The supply curve is
vertical at 20,000.

At $50, the quantity supplied is below

the quantity demanded. The diagram
shows that the equilibrium price was
$300.

On E-Bay, some tickets were sold at

$16,000 each.

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 The Price System: Rationing and Allocating Resources

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.
CHAPTER 4 Demand and Supply Applications

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 that which would
result from simple price rationing.

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 The Price System: Rationing and Allocating Resources

Price changes resulting from shifts of demand in output markets

cause profits to rise or fall.

Profits attract capital and enable firms to pay higher wages. Higher
CHAPTER 4 Demand and Supply Applications

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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 The Price System: Rationing and Allocating Resources

The Price Mechanism at

Work for Shakespeare
CHAPTER 4 Demand and Supply Applications

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.
Some high school/college students pick up tickets by waiting in line. They
then turn around and sell tickets to more affluent Shakespeare lovers.

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 The Price System: Rationing and Allocating Resources

Price Floor: When a minimum legal price is charged for a good.

The Minimum Wage: When the government sets the

market wage above the equilibrium wage.
CHAPTER 4 Demand and Supply Applications

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 Supply and Demand Analysis: An Oil Import Fee
The U.S. Market for Crude Oil, 1989
CHAPTER 4 Demand and Supply Applications

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 Supply and Demand and Market Efficiency

Consumer Surplus: The difference between the

maximum amount a person is willing to pay for a
good and its current market price.
CHAPTER 4 Demand and Supply Applications

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 Supply and Demand and Market Efficiency
CHAPTER 4 Demand and Supply Applications

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 Supply and Demand and Market Efficiency

Producer Surplus: The difference between the

market price and the cost of production for the firm.
CHAPTER 4 Demand and Supply Applications

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 Supply and Demand and Market Efficiency
CHAPTER 4 Demand and Supply Applications

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 Supply and Demand and Market Efficiency

Competitive Markets maximize the sum of PS and CS

CHAPTER 4 Demand and Supply Applications

Total producer and consumer surplus is greatest where supply and demand curves
intersect at equilibrium.

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 Supply and Demand and Market Efficiency

Dead-weight Loss: The net loss of producer and

consumer surplus from underproduction or
overproduction.
CHAPTER 4 Demand and Supply Applications

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 Supply and Demand and Market Efficiency
CHAPTER 4 Demand and Supply Applications

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 Supply and Demand and Market Efficiency

Potential Causes of Deadweight Loss From Under- and

Overproduction

When supply and demand interact freely, competitive markets produce

what people want at least cost, that is, they are efficient.
CHAPTER 4 Demand and Supply Applications

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

• Price floors and price ceilings may have the same effects.

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