The Price System, Demand and Supply, and Elasticity ….ppt

ch4 The Price System, Demand and Supply, and Elasticity Chapter 4 The Price System:Rationing and Allocating Resources The market system, also called the price system, performs two important and closely related functions: Resource allocation: the market system determines the allocation of resources among produces and the final mix of outputs. Price rationing: the market system, an automatic mechanism, distributes scarce goods and services to consumers when quantity demanded exceeds the quantity supplied on the basis of willingness and ability to pay. Price Rationing The price system eliminates a shortage as shown in the figure on the left. 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 Suppose in 2003 that 15.000 square miles of lobstering waters off the coast of Maine are closed. The supply curve shifts to the left. Before the waters are closed, the lobster market is in equilibrium at the price of $3.27 and a quantity of 81 million pounds. The decreased supply of lobster leads to higher prices, and a new equilibrium is reached at $4.50 and 60 million pounds (point B) so the shortage is automatically eliminated by price mechanism. Price Rationing The adjustment of price is the rationing mechanism in free market. Price rationing means that whenever there is need to ration a good-that is, when a shortage exist- in a free market, the price of the good will rice until quantity supplied equals quantity demanded- that is, until the market clears. Price Rationing There is some price that will clear any market. Consider the market for a famous painting such as Van Gogh’s. At a low price, there would be an enormous excess demand for such as important painting. The price of a rare painting will eliminate excess demand until there is only one bidder willing to buy the single available painting. If the product is in strictly scarce supply, as a single