Review!

1. What are the two main points of the Law

of Demand?
2. What are the two main points of the Law
of Supply?
3. What is Profit?
4. What is Elasticity of Demand?
5. What is Elasticity of Supply?
Law of Demand: As price goes up, demand
goes down. As price goes down, demand
goes up.
Law of Supply: As price goes up, supply
goes up. As price goes down, supply goes
down.
Profit: The difference between the cost to
produce a good and what it is sold for.
Elasticity of Demand: How sensitive demand
is to a change in price.
Elasticity of Supply: How sensitive supply is
to a change in price.
 Demand Curve
$3.50

$3.00
Price per Quantity of
Slice of Slices
$2.50 Pizza Demanded
$2.00
$.50 300
Slices of
Pizza $1.00 250
$1.50 Demanded
$1.50 200
$1.00 $2.00 150
$0.50
$2.50 100
$3.00 50
$0.00
50 100 150 200 250 300
 Supply Curve
$3.50

Price per Quantity of

$3.00
Slice of Slices
$2.50 Pizza Supplied
$.50 300
$2.00
Slices of
Pizza
$1.00 250
$1.50
$1.50 200
$1.00 $2.00 150
$0.50
$2.50 100
$3.00 50
$0.00
100 150 200 250 300 350
So, What happens if we combine
the two?
$3.00

$2.50

$2.00
Slices of
Pizza
Supplied
$1.50
Slices of
Pizza
Demanded
$1.00

$0.50

$0.00
100 150 200 250 300
 Equilibrium Price

When the Laws of Supply and

Demand Collide
 Equilibrium
• Def. The point at which quantity
demanded and quantity supplied come
together.
 Equilibrium
$3.00

Price Quantity Quantity of

$2.50 per of Slices Slices
Slice of Supplied Demanded
$2.00 Pizza
Slices of
Pizza $.50 100 300
Supplied
$1.50
Slices of $1.00 150 250
Pizza

$1.00
Demanded $1.50 200 200
$2.00 250 150
$0.50
$2.50 300 100
$0.00
100 150 200 250 300
 Disequilibrium
• If the market price or quantity supplied is
anywhere but at equilibrium price, the
market is in a state called Disequilibrium.

• Interactions between buyers and sellers

will always push the market back towards
equilibrium…
UNLESS THE GOVERNMENT INTERFERES
 Government Interference
• In some cases, the government steps in to
control prices. These interventions appear
as price ceilings and price floors.
 Price Ceiling
• Def. A maximum price that can be legally
charged for a good.

• Ex. Rent Control: a situation where the

government sets a maximum amount that
can be charged for rent in an area.
 Price Floor
• Def. A minimum price, set by the
government, that must be paid for a good
or service
• Ex. Minimum Wage; sets a minimum price
that an employer can pay a worker for an
hour of labor.
• Ex. Luxury or “Sin” Taxes; Items like
alcohol, cigarettes, and gasoline have
extra taxes, creating a price floor.
 Problems with Price Floors and
Ceilings
• Price ceilings and floors prevent markets
from reaching equilibrium. They prevent
suppliers from producing as much as price
dictates or prevent consumers from buying
as much as they wish
• Ex. Rent control prevents landlords from
getting full value for their property.
• Ex. Cigarette taxes prevent people from
buying cigarettes, hopefully reducing the
number of smokers.
 Changes in Equilibrium
• The point where supply and demand meet
can change for 3 reasons:
 1. Change in Supply
• Excess Supply leads to a surplus (when
supply is greater than demand). This leads
to a decrease in price and an increase in
demand.
– Ex. After Christmas, stores have clearance
sales to get rid of surplus merchandise
• A decrease in supply leads to an increase
in price. This leads to a decrease in
demand.
 2. Changes in Demand
• If there is a shortage, when demand is
greater than supply, price rises, which
increases supply and decreases demand.
– Ex. Tickle Me Elmo dolls sold out at the
stores, so on Ebay price of the dolls
skyrocketed
• When demand falls, suppliers cut prices
and find a new equilibrium
 3. Change in Price
• As prices change, supply and demand will
both change.
So why are prices so important?
• Prices are vital in a free market economy.
• They help move land, labor and capital
into the hands of producers and finished
goods into the hands of buyers.
• Price is a language both consumers and
producers can use to determine value.
 Advantages of Prices
1. Prices as an Incentive
Prices communicate to buyers and sellers
whether goods or services are scarce or
easily available. They encourage or
discourage production.
2. Prices as Signals
Prices act like a traffic light. A high price (green
light) tell producers to make more, while a
low price (red light) tell producers to make
less.
 Advantages of Price (cont.)
3. Flexibility of Prices
Prices are generally more flexible than
production levels and can be easily increased or
decreased to reach equilibrium.
4. Price System is “Free”
A distribution system based on prices costs
nothing to administer, unlike in command
economies.
How does scarcity of an item affect
its price?
• If there is a scarcity of an item, then the
price will be high.
• Ex. Gasoline
 How does a boycott affect the
price?
• If an item is being boycotted, then the
price often will go down.

• Ex. If everyone stopped buying gas, the

price of gas would drop.
 How does the War in Afghanistan
affect the price of certain items?
• Price of many items have increased.
– Ex. Gas, security
• If the war continues, we can expect the
price of many items to increase
– Ex. Foods, metal