Chapter 6

Equilibrium Prices

Prices act as Signals

Signal both producers and consumers

High prices signal to produce more and consume less

Prices act to Ration (allocate scarce resources)

Advantages of Price System

Neutral (fair)

Flexible

Familiar

No administration cost

Disadvantages of Non-price Rationing

Unfair (people cheat)

Inflexible

High administration cost

Reduce incentives to produce and work

Market prices are determined by the interaction of supply and demand

Equilibrium is reached when quantity supplied equal quantity demanded

Equilibrium Quantity is where the demand and supply curves intersect

Equilibrium Price is where the demand and supply curves intersect

FREE MARKETS SEEK EQUILIBRIUM

A temporary shortage is created when the price falls below the equilibrium price

Quantity Demanded is greater than Quantity Supplied

A temporary surplus is created when the price is above the equilibrium price

Quantity Supplied is greater than Quantity Demanded

A surplus results in increased inventories

In free markets, a shortage will lead to an increase in price and a movement along both curves until equilibrium is reached

In free markets, a surplus will lead to a decrease in price and a movement along both curves until equilibrium is reached

Changes in Equilibrium Price

Shifts in either the demand or supply curve will affect the Equilibrium Price.

The top charts summarize the effects of increases and decreases in demand upon Equilibrium Prices.

The bottom two charts summarize the effects of an increase or decrease in supply upon Equilibrium Prices

Free markets seek equilibrium by adjusting price and quantity

Government intervention in markets distorts the market and makes equilibrium difficult to achieve.

Price floors result in a permanent surplus.

Examples: minimum wage and agricultural subsidies.

Price ceilings result in a permanent shortage.

Example: rent control laws.

For practice on graphing equilibrium pricing Click Here