Demand and Supply Applications: © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair

CHAPTER 4
Demand and Supply

Applications
Prepared by: Fernando Quijano

and Yvonn Quijano
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair
The Price System:
Rationing and Allocating Resources
• The market system, performs

C H A P T E R 4:Demand and Supply Applications
two important and closely

related functions:
1. Resource allocation: the
market system determines the
allocation of resources among
produces and the final mix of
outputs.
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 2 of 24
The Price System:
Rationing and Allocating Resources
• The market system, performs

two important and closely

related functions:
2. Price rationing: the market
system distributes goods and
services on the basis of
willingness and ability to pay.
Price Rationing
• A decrease in supply
creates a shortage at
the original price.

• The lower supply is
rationed to those who
are willing and able to
pay the higher price.
Price Rationing
• There is some price

that will clear any
market.
• The price of a rare
painting will eliminate
excess demand until
there is only one bidder
willing to buy the single
available painting.
Constraints on the Market
• A price ceiling is a
maximum price that sellers
may charge for a good,

usually set by government.
• In 1974, the government set
a price ceiling to distribute
the available supply of
gasoline.
• At an imposed price of 57
cents per gallon, the result
was excess demand.
Alternative Rationing Mechanisms
• Queuing is a nonprice
rationing system that uses

waiting in line as a means of
distributing goods and
services.
• Favored customers are those

who receive special treatment
from dealers during situations

when there is excess demand.
• Ration coupons are tickets or
coupons that entitle individuals
to purchase a certain amount
of a given product per month.
• Attempts to restrict
prices often result in
the evolution of a
black market.
• A black market is a
market in which illegal
trading takes place at
market-determined
prices.
• The problem with rationing systems

is that excess demand is created but
not eliminated.
• 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 the willingness
to pay from asserting itself.
Prices and the Allocation of Resources
• Price changes resulting from shifts of demand

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 things produced.
Price Floors
• A price floor is a minimum price

below which exchange is not
permitted.
• The most common example of a price
floor is the minimum wage, which is a
floor set under the price of labor.
• The result of setting a price floor will

be excess supply, or higher quantity
supplied than quantity demanded.
Supply and Demand Analysis:
An Oil Import Fee
• At a world price of $18, imports • The tax on imports causes an

are 5.9 million barrels per day. increase in domestic production,
and quantity imported falls.
Supply and Demand
and Market Efficiency
• Supply and demand curves

can be used to illustrate the

idea of market efficiency, an
important aspect of “normative
economics.”
Consumer Surplus
• Consumer surplus is
the difference between

the maximum amount a
person is willing to pay
for a good and its current
market price.
Consumer Surplus
• Some consumers are

willing to pay as much
as $5 each for
hamburgers.
• Since the price is only
$2.50, they receive a
consumer surplus of
$2.50.
Consumer Surplus
• Others are willing to

pay something less
than $5.00 but more

than $2.50.
• Consumer surplus is
the area below the
demand curve and
above the price level.
Producer Surplus
• Producer surplus is the

difference between the

maximum amount a
producer is willing to
accept to supply a good
and its current market
price.
Producer Surplus
• Some producers are

willing to accept as
little as 75 cents each

for hamburgers.
• Since the price is
$2.50, they receive a
producer surplus of
$1.75 per hamburger.
Producer Surplus
• Others producers are

willing to receive
something less than

$5.00 but higher than
75 cents.
• Producer surplus is
the area above the
supply curve and
below the price level.
Markets Maximize the Sum of
Producer and Consumer Surplus
• Total producer and

consumer surplus is
highest where supply and

demand curves intersect
at equilibrium.
• Consumers receive
benefits in excess of what
they pay and producers
receive compensation in
excess of costs.
Markets Maximize the Sum of
Producer and Consumer Surplus
• If the market produces

too little, say 4 million
instead of 7 million
hamburgers per month,
total producer and
consumer surplus is
reduced. This reduction
(triangle ABC) is called
a deadweight loss.
Potential Causes of Deadweight Loss
From Under- and Overproduction
• Deadweight losses can

occur from under- and
overproduction.
• If the market produces 10
million instead of 7 million
hamburgers per month,
the cost of production rises
above the willingness of
consumers to pay,
resulting in a deadweight
loss.
Review Terms and Concepts
black market price floor
consumer surplus price rationing

deadweight loss producer surplus
favored customers queuing
minimum wage ration coupons
price ceiling

Demand and Supply Applications: © 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair

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CHAPTER 4

Demand and Supply

Prepared by: Fernando Quijano

• The market system, performs

two important and closely

• The market system, performs

two important and closely

the original price.

• There is some price

may charge for a good,

rationing system that uses

• Favored customers are those

from dealers during situations

• The problem with rationing systems

• No matter how good the intentions of

• Price changes resulting from shifts of demand

• Profits attract capital; losses lead to disinvestment.

• Higher wages attract labor and encourage workers

• At the core of the system, supply, demand, and

• A price floor is a minimum price

• The result of setting a price floor will

• At a world price of $18, imports • The tax on imports causes an

• Supply and demand curves

can be used to illustrate the

the difference between

• Some consumers are

• Others are willing to

than $5.00 but more

• Producer surplus is the

difference between the

• Some producers are

little as 75 cents each

• Others producers are

something less than

• Total producer and

highest where supply and

• If the market produces

• Deadweight losses can

black market price floor

consumer surplus price rationing

deadweight loss producer surplus

favored customers queuing

minimum wage ration coupons

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