PART I Introduction to Economics © 2012 Pearson Education, Inc. Publishing as Prentice Hall Prepared by: Fernando Quijano & Shelly Tefft CASE FAIR OSTER P R I N C I P L E S O F MACROECONOMICS T E N T H E D I T I O N * of 26 PART I Introduction to Economics © 2012 Pearson Education, Inc. Publishing as Prentice Hall * of 26 PART I Introduction to Economics © 2012 Pearson Education, Inc. Publishing as Prentice Hall 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 * of 26 PART I Introduction to Economics © 2012 Pearson Education, Inc. Publishing as Prentice Hall 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 * of 26 PART I Introduction to Economics © 2012 Pearson Education, Inc. Publishing as Prentice Hall 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 * of 26 PART I Introduction to Economics © 2012 Pearson Education, Inc. Publishing as Prentice Hall 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 * of 26 PART I Introduction to Economics © 2012 Pearson Education, Inc. Publishing as Prentice Hall queuing Waiting in line as a means of distributing goods and services: a nonprice.

1. PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
Prepared by: Fernando Quijano & Shelly Tefft
CASE FAIR OSTER
P R I N C I P L E S O F
MACROECONOMICS
T E N T H E D I T I O N
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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

2. 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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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

3. 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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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.

4. 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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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.

5. The Price System: Rationing and Allocating Resources
Prices and the Allocation of Resources
* of 26
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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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.

6. 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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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
* of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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

7. * of 26
PART I Introduction to Economics
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
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
* of 26
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

8. 1) In the short run, it is necessary to non-price ration a good
whenever ________ exists.
A) excess demand
B) excess supply
C) a surplus
D) market equilibrium
2) Among the methods of nonprice rationing are
A) coupons.
B) favored customers.
C) waiting in line.
D) all of the above
3) The price system
A) automatically distributes scarce goods.
B) is inefficient.
C) requires government help to allocate goods.
D) is the only way to allocate goods.
4) Attempts to bypass price rationing in the market
A) are efficient.
B) are easily administered.
C) are costly.
D) always fail.
5) An example of an ineffective price ceiling would be the
government setting the price of wheat at ________ per bushel
when the market price is at $5.00 per bushel.
A) $2.25
B) $3.00
C) $4.75
D) $6.00

9. 6) If the equilibrium price of gasoline is $4.00 per gallon and
the government will not allow oil companies to charge more
than $3.00 per gallon of gasoline, which of the following will
happen?
A) Demand must eventually decrease so that the market will
come into equilibrium at a price of $3.00. B) Supply must
eventually increase so that the market will come into
equilibrium at a price of $3.00.
C) A nonprice rationing system such as ration coupons must be
used to ration the available supply of gasoline.
D) The market will be in equilibrium at a price of $3.00.
7) An example of a price ceiling would be the government
setting the price of sugar
A) above the equilibrium market price.
B) at the equilibrium market price.
C) below the equilibrium market price.
D) none of the above
8) If the market price of coffee is $3.00 per pound but the
government will not allow coffee growers to charge more than
$2.00 per pound of coffee, which of the following will happen?
A) Demand must eventually decrease so that the market will
come into equilibrium at a price of $2.50. B) There will be a
shortage of coffee.
C) Supply must eventually increase so that the market will come
into equilibrium at a price of $2.50.
D) The market will be in equilibrium at a price of $2.00
9) It is necessary to ration a good whenever ________ exists.
A) excess demand
B) excess supply
C) a surplus

10. D) market equilibrium
10) The adjustment of ________ is the rationing mechanism in
market economies.
A) quantity
B) price
C) supply
D) demand Answer: B Diff: 2 Topic: The Price System:
Rationing and Allocating Resources Skill: Conceptual AACSB:
Reflective Thinking
11) A price ceiling is
A) a minimum price set by government that sellers must charge
for a good.
B) a maximum price set by government that sellers may charge
for a good.
C) the difference between the initial equilibrium price and the
equilibrium price after a decrease in supply.
D) the minimum price that consumers are willing to pay for a
good.
12) A price floor is
A) a minimum price set by government that sellers must charge
for a good.
B) a maximum price set by government that sellers may charge
for a good.
C) the difference between the initial equilibrium price and the
equilibrium price after a decrease in supply.
D) the minimum price that consumers are willing to pay for a
good
13) A maximum price, set by the government, that sellers may
charge for a good is known as
A) a price floor.
B) a price rationing mechanism.
C) a price ceiling.

11. D) a subsidy
14) If the price floor is set below the equilibrium price,
A) quantity demanded will be less than quantity supplied.
B) there will be a surplus.
C) there will be a shortage.
D) the floor will be ineffective.
15) If the price ceiling is set above the equilibrium price,
A) quantity demanded will equal quantity supplied.
B) there will be a surplus.
C) there will be a shortage.
D) demand will be less than supply
16) If the price floor is set above the equilibrium price,
A) quantity demanded will equal quantity supplied.
B) there will be a surplus.
C) there will be a shortage.
D) the floor will be ineffective.
17) The government imposes a maximum price on apartments
that is ABOVE the equilibrium price. You accurately predict
that
A) the law will have no economic impact.
B) the law will create a surplus of apartments.
C) renters will find that landlords start offering to furnish the
apartments.
D) landlords are less likely to do routine maintenance work in
the apartments
18) The type of non-price rationing that most closely
approaches the market outcome is
A) coupon rationing with coupons that can be resold.
B) coupon rationing with coupons that cannot be resold.

12. C) first-come, first-served basis or queuing.
D) favored customer rationing.
19) The government imposes a price ceiling on gasoline that is
below the market price. You are asked to suggest a rationing
scheme that will minimize the misallocation of resources. You
suggest
A) using rationing coupons that can be resold.
B) using rationing coupons that cannot be resold.
C) using rationing on a first-come, first-served basis.
D) using rationing only on weekdays
20) The government imposes a price ceiling on sugar that is
above the market price. You are asked to suggest a rationing
scheme that will minimize the misallocation of resources. You
suggest
A) using rationing coupons that cannot be resold.
B) using rationing on a first-come, first-served basis.
C) using rationing coupons that can be resold.
D) that no rationing system will be necessary
21) People scalping tickets for a rock concert can sell their
tickets for at least a normal profit
A) any time the rock group is popular.
B) when the price set by the concert hall is less than the market
equilibrium price.
C) when prices are too high.
D) only when there is excess supply.

13. TRUE /FALSE
_________22) Goods are allocated in a market system by price
rationing. Answer: TRUE Diff: 2 Topic: The Price System:
Rationing and Allocating Resources Skill: Conceptual AACSB:
Reflective Thinking
_______ 23) Non price rationing will happen whenever there is
excess supply in a market.
_______24) When supply is fixed, price is supply determined.
____ ___25) With price rationing those who are both able and
willing to pay for a product get it.
_______26) Queuing or waiting in line is an alternative
rationing mechanism to price rationing
_______27) A shortage is when there is an excess supply in a
market
_______28) In a ʺblack marketʺ goods are traded at market
determined prices
_______ 29) Favored customers receive special treatment from
dealers during periods of excess demand
_______ 30) Ration coupons are tickets or coupons that give
someone a right to purchase a certain amount of a product each
time period such as a month. Answer: TRUE Diff: 2 Topic: The
Price System