1 Bringing the curves together 1. Create a combined demand and supply schedule (see at right). IMPORTANT: Make sure you create an equilibrium price by making one of the price levels have the exact same quantity demanded (D) and quantity supplied (S). D $ Quantity Demanded Price Step 1 S Quantity Supplied 2. Now create ONE graph but plot both sets of points - first make the demand curve and label it D; then make the supply curve and label it S. 3. Now label the equilibrium price and draw dotted lines (vertically and horizontally) to show the price point at which quantity demanded and quantity supplied are equal. Steps 2 and 3
2 ESTABLISHING PRICES One of the most appealing features of a competitive market economy is that everyone who participates has a hand in determining prices. This is why economists consider prices to be neutral and impartial. The process of establishing prices... is remarkable because buyers and sellers have exactly the opposite hopes and desires. Buyers want to find good buys at low prices. Sellers hope for high prices and large profits. Neither can get exactly what they want, so some adjustment is necessary to reach a compromise. Because transactions in a market economy are voluntary, the compromise must be to the benefit of both parties, or the compromise would not occur in the first place. - Textbook, p We call this compromise the price adjustment process.
3 ECONOMIC MODEL A set of assumptions that can be listed in a table, illustrated with a graph, or even stated algebraically - to help analyze behavior and predict outcomes. A supply schedule and a supply curve graph are both examples of an economic model.
4 MARKET EQUILIBRIUM Equilibrium Price Equilibrium Quantity A situation in which prices are fairly stable and the quantity of goods and services supplied is equal to the quantity demanded. The equilibrium price is the price that clears the market by leaving neither a surplus or a shortage at the end of the trading period. What if we are at a different price and quantity than the equilibrium price and quantity? Those situations are described on the next slide.
5 SURPLUS A situation in which quantity supplied is greater than the quantity demanded at a given price. Surplus = unsold products on store shelves or in warehouses. A surplus tends to make the price go down. SHORTAGE A situation in which quantity demanded is greater than the quantity supplied at a given price. Shortage = the product is sold out and may be on back order. A shortage tends to: 1) make the price go up; 2) motivate suppliers to increase supply.
6 OPEN TEXTBOOK TO PAGE 145: Dynamics of the Price Adjustment Process Look at the four step process described in FIGURE 6.2 Make one more supply AND demand schedule. Use that data to create THREE graphs to replicate steps A, B and D on p A: Choose a price at which there is a SURPLUS and label the surplus on the new graph you draw (label the exact quantity of surplus, as in example A on p. 145) B: Choose a price at which there is a SHORTAGE and label the shortage (the exact quantity of shortage, as in example B on p. 145) C: Label the equilibrium price and quantity. Call me over with any questions, or to check it when you are done. Just think: You re almost done drawing these things! (unless you become an economist, that is).
7 PRICES IN A MARKET ECONOMY In the final analysis, the market economy is one that runs itself. There is no need for a bureaucracy, planning commission, or other agency to set prices because the market tends to find its own equilibrium. In addition, the three basic economic questions of WHAT, HOW, and FOR WHOM to produce are decided by the participants - the buyers and sellers - in the market. - p. 148
8 PRICE CEILING A maximum legal price that can be charged for a product. Rent controls are an example of a price ceiling. Price ceilings are usually set for social goals of equity and security so that people can afford necessities such as food or shelter. One downside of price ceilings is that they may encourage a growing black market to supply the goods or services in shortage.
9 PRICE FLOOR The lowest legal price that can be paid for a good or service. Minimum wage is an example of a price floor (in this case, for labor). It sets the lowest price that employers can pay workers for their labor, per hour. If the price floor is above the equilibrium price, it can result in a surplus (such as a surplus of workers = higher unemployment rate). On the other hand, it can provide workers with a more realistic working wage, which may reduce society s costs.