141_Chapter_4_Lecture - 4 Demand and Supply Applications

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4 Demand and Supply Applications OUTLINE OF TEXT MATERIAL I. Introduction This chapter continues studying supply, demand, and the price system. II. The Price System: Rationing and Allocating Resources A. The price system performs two important and closely related functions. 1. It allocates goods and services when there is a shortage (price rationing). 2. It determines the allocation of resources among producers and hence the final mix of outputs. B. Price Rationing 1. Price rationing eliminates shortages and surpluses in free markets. 2. When there is a shortage or surplus the price will adjust in the direction of equilibrium. C. Constraints on the Market and Alternative Rationing Mechanisms 1. Governments and private firms sometimes decide to ration a particular product using some nonprice mechanism. 2. The rationale given for this is usually “fairness” which includes: a. price-gouging is “bad”; b. income is distributed “unfairly”; and c. some items are “necessities” and everyone should be able to buy them at a “reasonable” price. 3. A price ceiling is the maximum price that can be legally charged for a product. 33
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Principles of Macroeconomics a. The “fairness” rationale is that this will keep the product from being so expensive that the poor can’t afford it. b. This does not resolve the problem of excess demand, but rather means that other mechanisms will have to be used to ration. Examples are queuing (waiting in line), favored customers, or ration coupons. c.
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141_Chapter_4_Lecture - 4 Demand and Supply Applications

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