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Principles of Microeconomics, Case/Fair/Oster PRINCIPLES OF MICROECONOMICS E L E V E N T H E D I T I O N CASE x FAIR x OSTER PEARSON Prepared by: Fernando Quijano w/Shelly Tefft © 2014 Pearson Education, Inc. 2of 44 The Price System: Rationing and Allocating Resources Demand and Supply Applications 4 C H A P T E R O U T L I N E The Price System: Rationing and Allocating Resources Price Rationing Constraints on the Market and Alternative price rationing The process by which the market system allocates goods and Rationing Mechanisms services to consumers when quantity demanded exceeds quantity supplied. 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 © 2014 Pearson Education, Inc. 3of 44 © 2014 Pearson Education, Inc. 4of 44 Price Rationing Refer to the graph below. At what price level is price rationing f FIGURE 4.1 The Market especially necessary? for Wheat a. At $3.25. Fires in Russia in the b. At $2.50. summer of 2010 c. At $1.75. caused a shift in the world‘s supply of wheat d. None of the above. Price rationing is never desirable. to the left, causing the price to increase from $160 per millions of metric tons to $247. The equilibrium moved from C to B. © 2014 Pearson Education, Inc. 5of 44 © 2014 Pearson Education, Inc. 6of 44 Refer to the graph below. At what price level is price rationing Refer to the figure. Start at point C. What is the impact of the shift in supply especially necessary? on the demand side of the market? a. At $3.25. a. After the shift in supply, there is a decrease in quantity demanded. b. At $2.50. b. After the shift in supply, there is a decrease in demand. c. At $1.75. c. After the shift in supply, there is an increase in demand. d. None of the above. Price rationing is never desirable. d. After the shift in supply, there is an increase in quantity demanded. © 2014 Pearson Education, Inc. 7of 44 © 2014 Pearson Education, Inc. 8of 44 Refer to the figure. Start at point C. What is the impact of the shift in supply f FIGURE 4.2 Market for a Rare Painting on the demand side of the market? There is some price that will clear any a. After the shift in supply, there is a decrease in quantity demanded. market, even if supply is strictly b. After the shift in supply, there is a decrease in demand. limited. c. After the shift in supply, there is an increase in demand. In an auction for a unique painting, the d. After the shift in supply, there is an increase in quantity demanded. price (bid) will rise to eliminate excess demand until there is only one bidder willing to purchase the single available painting. Some estimate that the Mona Lisa would sell for $600 million if auctioned. 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. © 2014 Pearson Education, Inc. 9of 44 © 2014 Pearson Education, Inc. 10 of 44 Refer to the figure below. The price of the good in question in this graph is Refer to the figure below. The price of the good in question in this graph is primarily determined by: primarily determined by: a. Demand. a. Demand. b. Supply. b. Supply. c. Consumer surplus. c. Consumer surplus. d. None of the above. The price is indeterminate. d. None of the above. The price is indeterminate. © 2014 Pearson Education, Inc. 11 of 44 © 2014 Pearson Education, Inc. 12 of 44 E C O N O M I C S I N P R A C T I C E Constraints on the Market and Alternative Rationing Mechanisms Why Is My Hotel Room So Expensive? A Tale of Hurricane Sandy On occasion, both governments and private firms decide to use some Under normal circumstances, we would expect that most markets are more or mechanism other than the market system to ration an item for which there is less in equilibrium. To predict which prices rose post Hurricane Sandy, all we excess demand at the current price. Policies designed to stop price rationing need to do is look at those businesses facing large shifts in either their demand are justified in a number of ways, most often in the name of fairness. or supply curves after the storm. With many people forced out of their homes, hotel rooms became scarce. The Regardless of the rationale, two things are clear: hotel industry saw a large outward shift of the demand curve in its market. Unable to quickly increase output levels, higher prices and price gouging were 1. Attempts to bypass price rationing in the market and to use alternative now possible. rationing devices are more difficult and more costly than they would seem at first glance. Complaints of price gouging were not only lodged against hotel businesses. You should be able to see how economics can help us predict what kinds of 2. Very often such attempts distribute costs and benefits among households in businesses are likely to be charged with the offense. unintended ways. THINKING PRACTICALLY 1. Why might we see a greater demand for festivals in poor countries than in rich ones? How might this be affected by choices available? © 2014 Pearson Education, Inc. 13 of 44 © 2014 Pearson Education, Inc. 14 of 44 Oil, Gasoline, and OPEC f FIGURE 4.3 Excess Demand (Shortage) Created by a Price Ceiling price ceiling A maximum price that sellers may charge for a good, usually set In 1974, a ceiling price of $0.57 by government. cents per gallon of leaded regular gasoline was imposed. If the price had been set by the interaction of supply and queuing Waiting in line as a means of distributing goods and services: a demand instead, nonprice rationing mechanism. it would have increased to approximately $1.50 per gallon. At $0.57 per gallon, the favored customers Those who receive special treatment from dealers during quantity demanded exceeded situations of excess demand. the quantity supplied. Because the price system was not allowed to function, an ration coupons Tickets or coupons that entitle individuals to purchase a alternative rationing system certain amount of a given product per month. had to be found to distribute the available supply of gasoline. black market A market in which illegal trading takes place at market- determined prices. © 2014 Pearson Education, Inc. 15 of 44 © 2014 Pearson Education, Inc. 16 of 44 Refer to the figure. Assume that the price Refer to the figure. Assume that the price of $1.75 is a government imposed price. of $1.75 is a government imposed price. Only one of the statements below is Only one of the statements below is entirely correct. Which one? entirely correct. Which one? a. At a price of $1.75, there is a surplus a. At a price of $1.75, there is a surplus of soybeans, which is the result of an of soybeans, which is the result of an imposed price floor. imposed price floor. b. At a price of $1.75, there is a b. At a price of $1.75, there is a shortage of soybeans, which is the shortage of soybeans, which is the result of an imposed price floor of result of an imposed price floor of $1.75. $1.75. c. This graph shows a surplus of c. This graph shows a surplus of soybeans, which is the result of an soybeans, which is the result of an imposed price ceiling of $1.75. imposed price ceiling of $1.75. d. This graph shows a shortage of d. This graph shows a shortage of soybeans, which is the result of an soybeans, which is the result of an imposed price ceiling of $1.75. imposed price ceiling of $1.75. © 2014 Pearson Education, Inc. 17 of 44 © 2014 Pearson Education, Inc. 18 of 44 Rationing Mechanisms for Concert and Sports Tickets f FIGURE 4.4 Supply of and Demand for a Concert at the Staples Center At the face-value price of $50, there is excess demand for seats to the No matter how good the intentions of private organizations and governments, concert. it is very difficult to prevent the price system from operating and to stop At $50 the quantity demanded is people’s willingness to pay from asserting itself. greater than the quantity supplied, Every time an alternative is tried, the price system seems to sneak in the which is fixed at 20,000 seats. back door. With favored customers and black markets, the final distribution The diagram shows that the may be even more unfair than what would result from simple price rationing. quantity demanded would equal the quantity supplied at a price of $300 per ticket. © 2014 Pearson Education, Inc. 19 of 44 © 2014 Pearson Education, Inc. 20 of 44 Prices and the Allocation of Resources Price Floor Price changes resulting from shifts of demand in output markets cause profits to rise or fall. Profits attract capital; losses lead to disinvestment. price floor A minimum price below which exchange is not permitted.
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