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CHAPTER 4 - SUPPLY AND DEMAND: APPLICATIONS AND EXTENSIONS (Note: Skip pages 83-84 and page 93-102) ECONOMICS OF PRICE CONTROLS: REPEALING THE LAWS OF S AND D (p. 85) When prices are unregulated, market forces (S and D) will exert strong and relentless pressure to move the price toward equilibrium, resulting in the "market clearing" outcome: Q d = Q s . When Q d = Q s , the market is in balance or equilibrium, meaning that there are NO SHORTAGES and NO SURPLUSES. Market equilibrium is efficient and socially desirable because it eliminates shortages and surpluses, which are considered to be economically inefficient and undesirable. Think of the stock market, which is considered to be close to the economic ideal of an "efficient market", a market that continually clears. Prices are set in an "auction" type setting, by buyers and sellers. When there is "buying pressure" in the stock market, what happens to prices? What about when there is "selling pressure"? Stock market prices continually adjust during trading, and the fluctuating prices bring about continual market equilibrium. Stock prices adjust to "clear the market." When have you ever heard of a "shortage" or "surplus" of GM stock? Never, because the market price continually adjusts up and down to eliminate any shortages or surpluses of GM. For example, assume that there was a temporary surplus of GM stock on the market (more sellers than buyers at a given price), what would happen to the price of GM? What if there was a temporary shortage (more buyers than sellers at a given price) - what would happen to the price? The stock market may be more efficient than some markets, since prices change by the minute in the stock market and there are many markets where prices don't change daily. For example, think of the labor market, prices (wages) may be fixed for years at a time in a union contract. Even if markets don't have continual market clearing like a stock market, the market forces are still in effect, and are moving the prices towards equilibrium. Even if it takes years to reach equilibrium, or even if a market never actually reaches equilibrium, we still want to understand the direction that the market is moving towards. Market forces (when prices are unregulated) are always pushing the market towards equilibrium, markets are always "gravitating" towards the equilibrium outcome. There are some cases when prices are NOT allowed to freely fluctuate according to market forces, but
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This note was uploaded on 01/23/2012 for the course FIN 551 taught by Professor Staff during the Spring '11 term at University of Michigan.

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