3. Outline (Cont.)Outline (Cont.)
II. Changes in Equilibrium
A. Change in Demand
B. Change in Supply
C. Change in Both Demand and Supply
III. Disequilibrium
A. Price Floors
B. Price Ceilings
4. ShortageShortage
• Let’s say that Loony’s uptown decides to
sell their CDs for $3 each.
• More than likely there will be a lot more
people wanting to buy CDs than Loony’s
has to sell.
• Why? Because at such a low price, the
quantity demanded is quite high. But
Loony’s does not want to sell that many at
such a low price.
5. ShortageShortage
• This situation is called a shortage
• Shortage - when Qd > Qs at current market
price.
– Amount of Shortage = Qd - Qs
• Note - it is not correct to say Demand
exceeds Supply, but rather quantity
demanded exceeds quantity supplied.
6. ShortageShortage
Result of Shortage:
• If you are the manager of Loony’s and you
find that you are selling out of CDs at $3,
what do you want to do?
– Raise the price
• Buyers can’t get all they want. Therefore,
competition among buyers drive prices up.
• P will increase
14. SurplusSurplus
• Let’s say that as the manager, you raised the
prices of CDs to $20.
• At $20 you would love to sell a lot of CDs,
but not a lot of people are willing to pay
$20 for a CD.
• So the CDs keep piling up as they come in
from your supplier, but they don’t seem to
be going out the door in sales.
15. SurplusSurplus
• This situation is called a surplus
• Surplus - when Qs > Qd at current market
price.
• Amount of surplus = Qs - Qd
• Note - not correct to say Supply exceeds
Demand, but rather that quantity supplied
exceeds quantity demanded.
16. Results of SurplusResults of Surplus
Result of Surplus:
• As manager you have to decide what do
with all these CDs that are piling up and not
selling. What do you do?
– Have a sale!
17. Results of SurplusResults of Surplus
• Firms have more than they can sell.
Therefore, firms lower price to sell the
product.
• As price decreases, Qd increases and Qs
decreases
• P will decrease
25. Equilibrium in the MarketEquilibrium in the Market
• Note that if the price is below P* then there
will be a shortage causing price to rise
• If the price is above P* then there will be a
surplus causing price to fall
• It’s as if P* is a magnet that keeps drawing
price to it (and consequently quantity to Q*)
• This magnet is sometimes called “The
Invisible Hand”
26. Equilibrium in the MarketEquilibrium in the Market
• Equilibrium - where quantity demanded
equals quantity supplied.
• Equilibrium Price (P*) - price where
equilibrium occurs.
28. Equilibrium in the MarketEquilibrium in the Market
What Occurs at Equilibrium
• Demand Side - those who get the good are
those willing and able to pay the P*.
• Supply Side - only those firms which are
able to produce at or below the cost of P*
will remain in business.
29. Changes in EquilibriumChanges in Equilibrium
• Remember that Supply and Demand are
drawn under the ceteris paribus assumption.
• Any factors which cause Supply and/or
Demand to change will affect equilibrium
price and quantity.
30. Change in DemandChange in Demand
• Demand will change for any of the factors
discussed previously.
• For instance, let’s say the demand for CDs
increased due to an increase in income
38. Change in SupplyChange in Supply
• Supply will change for any of the factors
discussed previously.
• For instance, let’s say that the government
lowers taxes on CDs
46. Changes in Demand and SupplyChanges in Demand and Supply
To determine the impact of both supply and
demand changing:
• First examine what happens to equilibrium
price and quantity when just demand shifts.
• Second, examine what happens to
equilibrium price and quantity when just
supply changes
• Finally, add the two effects together.
47. Changes in Demand and SupplyChanges in Demand and Supply
General Results:
• When supply and demand move in the same
direction
• Equilibrium price is ambiguous
• When supply and demand move in opposite
directions
• Equilibrium quantity is ambiguous
68. Increase in Supply and DemandIncrease in Supply and Demand
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69. Increase in Supply and DemandIncrease in Supply and Demand
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70. Increase in Supply and DemandIncrease in Supply and Demand
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71. Increase in Supply and DemandIncrease in Supply and Demand
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72. The Role of PricesThe Role of Prices
• Convey information
– When “Tickle Me Elmo”s went up in price
form about $30 to $300 this past Christmas, it
told us something about the popularity of the
doll
• Rationiong device
– The price is what determines who can have the
good
73. Rationing DevicesRationing Devices
• What are other rationing devices?
– First Come-First Served
– Alphabetical
– The government could decide who needs it the
most
– Height
– Gender
– etc.
74. Disequilibrium BehaviorDisequilibrium Behavior
• Is it possible for the price and quantity to
NOT be in equilibrium?
• Yes - While the invisible hand may move
price towards equilibrium, there are two
types of forces that keep the price away
from equilibrium
• We will call these “The Invisible Foot” and
“The Invisible Handshake” (thanks for David Colander
for these names!)
75. The Invisible FootThe Invisible Foot
• This is government interference with prices
in the market.
• The government does this quite often. For
instance you mau notice that at UDF they
advertise that they sell milk and beer at
“state minimum prices” meaning that the
state will not allow prices on milk and beer
to be below a set amount.
77. Price CeilingsPrice Ceilings
• Price Ceiling - sets a maximum price that is
allowed by law.
• Result of Price Ceiling:
– Stay at a permanent shortage situation
• Note that a price ceiling can be any price
the government chooses. It is, however only
effective if it is below the equilibrium price
78. Price CeilingPrice Ceiling
• Example of Price Ceiling
• Rent controlled apartments
• In New York City, San Francisco, Boston,
and other cities the city or state determines
the maximum amount that can be charged
for rent on many apartments.
• A maximum price is a price ceiling
85. Winners and LosersWinners and Losers
Who gains and loses with price ceilings:
• 1. Benefit - those who get rent controlled
apartments
• 2. Loses - those who can’t find apartments
due to the shortage.
• 3. Loses - landlords who must accept lower
rent.
86. Price FloorsPrice Floors
• Price Floor - sets a minimum price that is
allowed by law.
• Result of Price Floor
• Stay at a permanent surplus situation
• Note that a price floor can be set at any
price, but is only effective if it is above the
equilibrium price
87. Price FloorsPrice Floors
• Example of Price Floor
• Minimum Wage Legislation
• The minimum wage is a lowest price the
government will allow firms to pay for
labor.
• A minimum price is a price floor
88. Price FloorsPrice Floors
• When we look at the labor market it is
similar to other supply and demand
diagrams except for the labels.
• L - quantity of workers
• w - wages (the price we pay workers)
• It is also different because the suppliers of
labor are households, not firms and the
demanders of labor are firms, not
households
89. Winners and LosersWinners and Losers
Who gains and loses with price floors:
• 1. Benefit - those who get higher wages
• 2. Loses - those who can’t find jobs at the
higher wage
• 3. Loses - firms who must pay higher
wages.
96. Invisible HandshakeInvisible Handshake
• The Invisible Handshake is social pressure
that often prevents price from reaching
equilibrium
• For instance, let’s think about what
happened recently when Bruce Springsteen
played Music Hall downtown.
• Tickets sold out in hours and there many
people who wanted to get tickets than were
able to buy them from Ticketmaster
97. Invisible HandshakeInvisible Handshake
• What does that say about the price of the
tickets?
• Were the tickets priced below or above
equilibrium price?
– Below, since there was a shortage
• So why weren’t prices at the equilibrium
price?
– Bruce didn’t want alienate fans
– It is not considered “right” to charge so much
98. Invisible HandshakeInvisible Handshake
• Another example of the Invisible
Handshake is with transplant organs
• There are not enough organs for all the
people who need them
• This means the price of an organ is below
the equilibrium
• Why don’t hospitals and doctors raise the
price to equilibrium?
99. Rationing DevicesRationing Devices
• When a market it out of equilibrium, price
is not always working as a rationing device.
Think about what might be the rationing
device for our examples
– Tickets to the concert
– Rent controlled apartments
– Transplant Organs
