Demand and Supply Applications

CHAPTER 4
DEMAND AND SUPPLY

APPLICATIONS
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
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 2 of
Loss from Under- and Overproduction
23
Looking Ahead
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
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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PRICE RATIONING
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FIGURE 4.1 The Market for Lobsters
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.
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
among households in unintended ways. 5 of
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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

(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.
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

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 23
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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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
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 and10 of
encourage workers to acquire skills. At the core of the system, supply, demand, and 23
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

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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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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MARKET EFFICIENCY
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FIGURE 4.6 Market Demand and Consumer Surplus 23
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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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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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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THANK YOU
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CHAPTER 4

DEMAND AND SUPPLY

The Price System: Rationing and

Supply and Demand Analysis:

price rationing The process by which

CONSTRAINTS ON THE MARKET AND

On occasion, both governments and private firms decide

Regardless of the rationale, two things are clear:

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

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

NCAA March Madness: College Basketball’s

FIGURE 4.4 Supply of and Demand for a

PRICES AND THE ALLOCATION OF RESOURCES

Thinking of the market system as a mechanism for

price floor A minimum price below

minimum wage A price floor set under

The basic logic of supply and

FIGURE 4.5 The U.S. Market for Crude

consumer surplus The difference

producer surplus The difference

FIGURE 4.7 Market Supply and Producer Surplus

COMPETITIVE MARKETS MAXIMIZE THE SUM OF

deadweight loss The net loss of

POTENTIAL CAUSES OF DEADWEIGHT LOSS

When supply and demand interact freely,

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