PRINCIPLE OF ECONOMIC
6 EDITION
KARL CASE, RAY FAIR
PRENTICE HALL BUSINESS PUBLISHING
COPY RIGHT 2002
The Price System
•
The market system, also called the price
system, performs two important and closely related functions :
•
Price Rationing
•
Resource Allocation
Price Rationing
•
Price rationing
is the process by which the market system allocates goods and services to
consumers when quantity demanded exceeds quantity supplied.
Price Rationing
•
A decrease in supply creates a shortage
at P0. Quantity demanded is
greater than quantity supplied. Price
will begin to rise.
•
The lower total 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.
Alternative Rationing Mechanisms
•
A price ceiling is a
maximum price that sellers may charge for a good, usually set by government.
•
Queuing
is a nonprice rationing system that uses waiting in line as a means of
distributing goods and services.
Alternative Rationing Mechanisms
•
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.
•
The problem with these alternatives is
that excess demand is created but not eliminated.
Alternative Rationing Mechanisms
•
In 1974, the government used an
alternative rationing system to distribute the available supply of gasoline.
•
At an imposed price of 57 cents per
gallon, the result was excess demand.
•
A black market is a market
in which illegal trading takes place at market-determined prices.
Alternative Rationing Mechanisms
•
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.
•
With favored customers and black
markets, the final distribution may be even more unfair than that which would
result from simple price rationing.
Prices and the Allocation of Resources
•
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.
•
With favored customers and black
markets, the final distribution may be even more unfair than that which would
result from simple price rationing.
Elasticity
• Elasticity is a general
concept that can be used to quantify the response in one variable when another
variable changes.
•
Price elasticity of demand measures
how responsive consumers are to changes in the price of a product.
Price Elasticity of
Demand
- Measures the responsiveness of demand to changes in price
- It is the ratio of the percentage change in quantity demanded to the percentage change in price
-
Its value is always negative, but stated
in absolute terms.
• The value of the line of the slope and the value of elasticity are not the same.Interpreting the Value of ElasticityHere is how to interpret two different values of elasticity:• When e = 0.2, a 10% increase in price leads to a 2% decrease in quantity demanded.• When e = 2.0, a 10% increase in price leads to a 20% decrease in quantity demanded.Elasticity Changes along a Straight-Line Demand Curve• Price elasticity of demand decreases as we move downward along a linear demand curve.• Demand is elastic on the upper part of the demand curve and inelastic on the lower part.• Along the elastic range, elasticity values are greater than one.• Along the inelastic range, elasticity values are less than one.Elasticity and Total Revenue• Wrelated. Price increases generate higher revenues.• When demand is elastic, price and total revenues are indirectly related. Price increases generate lower revenues.• hen demand is inelastic, price and total revenues are directlyDeterminants of Demand Elasticity• Availability of substitutes -- demand is more elastic when there are more substitutes for the product.• Importance of the item in the budget -- demand is more elastic when the item is a more significant portion of the consumer’s budget.• Time frame -- demand becomes more elastic over time.
Other Important
Elasticities
•
Cross-price elasticity
of demand:
A measure of the response of the quantity of one good demanded to a
change in the price of another good.
•
Income elasticity of demand
– measures the responsiveness of demand to changes in income.
•
Elasticity of labor
supply:
A measure of the response of labor supplied to a change in the price of
labor.
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