Econ 4

Front 1

• The market is a price rationing device→

Back 1

o the market system (aka price system) provides an automatic mechanism for distributing scarce goods and services
o it allocates goods and services to consumers when the quantity demanded exceeds the quantity supplied
o price system also determines both the allocation of resources among producers and the final mix of outputs

Front 2

• Price rationing

Back 2

o The process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied

Front 3

• Equilibrium

Back 3

o Happens when supply equals demand
o When quantity demanded equals quantity supplied
o Happens when supply and demand curves intersect

Front 4

• Price rationing example

Back 4

o Prices dictate decisions
o Ex: a fire in Russia destroys all Russia wheat, thus decreasing supply of wheat
• Quantity demand exceeds quantity supplied
o Price of wheat rises b/c of excess demand
o Consumers start to buy substitutes instead (buy rye bread instead)
o Suppliers in the US see that the price is rising and they try to supply more (b/c higher prices means they will make more money)
• Suppliers are unknowingly making up for the wheat lost in the Russian fire
• The price dictates their decision to supply more, and they unknowingly are making up for the wheat shortage
o The lower total supply of wheat is then rationed to those who are willing and able to pay a higher price

Front 5

• Price rationing mechanism

Back 5

o The adjustment of price is the rationing mechanism in free markets
o Prices determine how goods are distributed (whoever is willing to pay the price gets the good)
o Price rationing means that whenever there is a need to ration a good (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 is cleared

Front 6

• Demand determined

Back 6

if a product is in strictly scarce supply, its price is determined solely by the amount that the highest bidder is willing to pay

Front 7

• There is some price that will clear any market

Back 7

o The price of a good when the quantity supplied equals the quantity demanded

Front 8

• Govmts and firms decide to use some mechanism other than the natural market system to ration an item for which there is excess demand at the current price. How are policies designed to stop price rationing justified?

Back 8

o It is not fair to charge too much for things like insurance (not fair for the lower income families)
o Price gouging is bad
o Income is unfairly distributed
o Some items are necessities and everybody should be able to buy them at a “reasonable” price
o HOWEVER
• Attempts to bypass price rationing in the market and use alternative rationing devices are more difficult and costly than they would seem
• Such attempts often distribute costs and benefits among households in unintended ways

Front 9

• Price ceiling

Back 9

o Maximum price that sellers may charge for a good, usually set by govmt

Front 10

• Gas example of govmt manipulation of price system

Back 10

o In 1970’s OPEC imposed an embargo on oil to the US
o Supply of gas drastically fell
o If the market system were allowed to operate without govmt intervention, prices would have increased until quantity supplied equaled quantity demanded- then the low supply would have been naturally rationed to those who could afford it (aka the wealthy)
o But govmt made it illegal for prices to rise past $0.54 (imposed a price ceiling)
• Price ceiling was supposed to keep gas affordable for everybody
o Price ceiling perpetuatd the shortage, because quantity demanded continued to exceed quantity supplied
o Govmt had to impose an alternative rationing system because the price ceiling forbade the price rationing system to function
o Govmt started queuing people for gas
• People waited in line as a means of distributing goods
• A non price rationing mechanism

Front 11

• Queuing

Back 11

o A non price rationing mechanism
o Making people wait in line for things that are scarce

Front 12

• Favored customers

Back 12

o Non price rationing device
o Those who receive special treatment from dealers during situations of excess demand
o Ex: gas station owners decided not to sell gas to general public, but instead reserve it for their friends

Front 13

• Ration coupons

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o Non price rationing device
o Tickets or coupons that entitle individuals to purchase a certain amount of a given product per month
o Ex: it was suggested for people to get ration coupons for gas during the gas shortage- that way everybody gets a fair share of gas

Front 14

• Black market

Back 14

o A market in which illegal trading takes place at market determined prices

Front 15

• Price floor

Back 15

o Minimum price below which exchange is not permitted
o If a price floor is set above the equilibrium price, the result will be excess supply; quantity supply will exceed quantity demanded
o Minimum wage is an example of a price floor
• Critics argue that since minimum wage is above equilibrium, the result will be wasteful employment (aka TOP THIS, paying us 7.25 an hour to do nothing)

Front 16

• Pros and cons of inducing a tax on imported oil

Back 16

o PROS
• Import tax would reduce overall consumption (would make oil more expensive)
• Would provide an incentive for increased domestic production
• Would make US less dependent on foreign oil
• b/c of higher price, quantity demanded will drop
• quantity supplied by domestic producers will increase
• b/c of increase of domestic supplied and decrease in quantity demanded, foreign imports will decrease

Front 17

• Consumer surplus

Back 17

o the difference between the maximum amount a person is willing to pay for a good and its current market price
o when somebody pays less than they are willing to pay they enjoy a consumer surplus

Front 18

• Producer surplus

Back 18

o The difference between the current market price and the full cost of production for the firm
o When somebody sells something for more than the production price they enjoy a producer surplus

Front 19

• Competitive markets and producer/consumer surplus

Back 19

o Competitive markets maximize the sum of producer surplus and consumer surplus

Front 20

• Deadweight loss

Back 20

o The total loss of producer and consumer surplus from underproduction or overproduction

Front 21

• Market system/price system serves two functions

Back 21

o Determines allocation of resources among producers
o Determines final mix of outputs
o Distributes goods/services to consumers on the willingness and ability to pay
o Price system serves as a price rationing device

Front 22

• Three ways govmt tries to ration an item w/o using the price rationing device

Back 22

o Queuing, favored customers, ration coupons
o Most common rationale for such govmt policies is fairness