Demand and Supply Applications: Fernando & Yvonn Quijano

Chapter
4
Demand and Supply
Applications
Prepared by:
Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
Demand and Supply
Applications 4
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
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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
ETP A HC
Potential Causes of Deadweight

Loss from Under- and Overproduction
Looking Ahead
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 23
THE PRICE SYSTEM: RATIONING
AND ALLOCATING RESOURCES
price rationing The process by which

the market system allocates goods and
services to consumers when quantity
demanded exceeds quantity supplied.
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ETP A HC
PRICE RATIONING
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ETP A HC
FIGURE 4.1 The Market for Lobsters
When supply is fixed or

something for sale is unique, its
price is demand determined.
Price is what the highest bidder is
willing to pay. In 2004, the highest
bidder was willing to pay $104.1
million for Picasso’s Boy with a
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Pipe.
The adjustment of price is the rationing mechanism in free markets. Price rationing means
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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.
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ETP A HC
FIGURE 4.2 Market for a Rare Painting
CONSTRAINTS ON THE MARKET AND ALTERNATIVE

RATIONING MECHANISMS
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.
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Regardless of the rationale, two things are clear:
1. Attempts to bypass price rationing in the market and to

use alternative rationing devices are much more difficult
and costly than they would seem at first glance.
2. Very often, such attempts distribute costs and benefits
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among households in unintended ways.
Oil, Gasoline, and OPEC
price ceiling A maximum price that sellers may
charge for a good, usually set by government.
FIGURE 4.3 Excess Demand

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(Shortage) Created by
a Price Ceiling
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queuing Waiting in line as a means of

distributing goods and services: a
nonprice rationing mechanism.
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favored customers Those who

receive special treatment from dealers
during situations of excess demand.
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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

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trading takes place at market-

determined prices.
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Even when trading coupons is declared illegal, it is virtually impossible to stop black
markets from developing. In a black market, illegal trading takes place at market-
determined prices.
NCAA March Madness: College Basketball’s

National Championship
FIGURE 4.4 Supply of and Demand for a Pair

of Final Four Tickets in 2003
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ETP A HC
There are many ways to deal

with the excess demand to
premiere sporting events such as
the NCAA finals, but it is hard to
keep tickets from those who are
willing to pay high prices.
Syracuse played Kansas in the
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NCAA championship game in

2003.
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
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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 that which would result from simple price rationing.
PRICES AND THE ALLOCATION OF RESOURCES
Thinking of the market system as a mechanism for

allocating scarce goods and services among competing
demanders is very revealing, but the market determines
much more than just the distribution of final outputs. It
also determines what gets produced and how resources
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are allocated among competing uses.
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
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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.
PRICE FLOORS
price floor A minimum price below

which exchange is not permitted.
minimum wage A price floor set under

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the price of labor.

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SUPPLY AND DEMAND ANALYSIS:
AN OIL IMPORT FEE
The basic logic of supply and

demand is a powerful tool of
analysis.
FIGURE 4.5 The U.S. Market for Crude

Oil, 1989
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ETP A HC
SUPPLY AND DEMAND AND
MARKET EFFICIENCY
CONSUMER SURPLUS
consumer surplus The difference

between the maximum amount a
person is willing to pay for a good and
its current market price.
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ETP A HC
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MARKET EFFICIENCY
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FIGURE 4.6 Market Demand and Consumer Surplus
MARKET EFFICIENCY
PRODUCER SURPLUS
producer surplus The difference

between the current market price and
the full cost of production for the firm.
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ETP A HC
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MARKET EFFICIENCY
FIGURE 4.7 Market Supply and Producer Surplus

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MARKET EFFICIENCY
COMPETITIVE MARKETS MAXIMIZE THE SUM OF

PRODUCER AND CONSUMER SURPLUS
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ETP A HC
FIGURE 4.8 Total Producer and Consumer Surplus
MARKET EFFICIENCY
deadweight loss The net loss of

producer and consumer surplus from
underproduction or overproduction.
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FIGURE 4.9 Deadweight Loss

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.
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REVIEW TERMS AND CONCEPTS
black market price floor

consumer surplus producer surplus
deadweight loss price rationing
favored customers queuing
minimum wage ration coupons
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price ceiling
ETP A HC

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Chapter

Fernando & Yvonn Quijano

The Price System: Rationing and

Supply and Demand Analysis:

Potential Causes of Deadweight

price rationing The process by which

FIGURE 4.1 The Market for Lobsters

When supply is fixed or

FIGURE 4.2 Market for a Rare Painting

CONSTRAINTS ON THE MARKET AND ALTERNATIVE

On occasion, both governments and private firms decide to

Regardless of the rationale, two things are clear:

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

among households in unintended ways.

FIGURE 4.3 Excess Demand

queuing Waiting in line as a means of

favored customers Those who

ration coupons Tickets or coupons

black market A market in which illegal

trading takes place at market-

NCAA March Madness: College Basketball’s

FIGURE 4.4 Supply of and Demand for a Pair

There are many ways to deal

NCAA championship game in

No matter how good the intentions of private organizations and governments, it is

PRICES AND THE ALLOCATION OF RESOURCES

Thinking of the market system as a mechanism for

are allocated among competing uses.

price floor A minimum price below

minimum wage A price floor set under

the price of labor.

The basic logic of supply and

FIGURE 4.5 The U.S. Market for Crude

consumer surplus The difference

FIGURE 4.6 Market Demand and Consumer Surplus

producer surplus The difference

FIGURE 4.7 Market Supply and Producer Surplus

COMPETITIVE MARKETS MAXIMIZE THE SUM OF

FIGURE 4.8 Total Producer and Consumer Surplus

deadweight loss The net loss of

FIGURE 4.9 Deadweight Loss

POTENTIAL CAUSES OF DEADWEIGHT LOSS

When supply and demand interact freely,

black market price floor

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