ECONOMICS TOPIC 3 LESSON 7

ECONOMICS TOPIC 3 LESSON 7

Equilibrium and Price Controls

Standards

ESSENTIAL QUESTION

How do we affect the economy?

Achieving Equilibrium

You are benefiting from the free market system at work. Businesses are making enough profit to produce and sell the goods you want at a price you are willing to pay.

Open Ended

Analyze Political Cartoons How would you describe the relationship between supply and demand shown here?

Balancing Supply and Demand

The point at which demand and supply come together is called the equilibrium. Equilibrium is the point of balance at which the quantity demanded equals the quantity supplied. At equilibrium, the market for a good is stable.

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Benefits to Buyers and Sellers

In any market, supply and demand will be equal at only one price and one quantity. At this equilibrium price, buyers will purchase exactly as much of a good as firms are willing to sell.

Multiple Choice

Identify Central Ideas How many equilibrium points can exist at the same time on a combined supply and demand graph? Explain.

• One; the supply and demand curves intersect at one point.

• Two; each supply and demand curve contains one equilibrium point.

• Three; the supply curve intersects the x-axis at one point, and the demand curve intersects the x-axis and the y-axis at one point each.

• An infinite number; every point on the supply and demand curves is an equilibrium point.

Effects of Disequilibrium

If the market price or quantity supplied is anywhere but at the equilibrium, the market is in a state of disequilibrium. Disequilibrium occurs when quantity supplied is not equal to quantity demanded in a market.

Shortage

The problem of shortage—also known as excess demand—exists when the quantity demanded in a market is more than the quantity supplied. When the actual price in a market is below the equilibrium price, you have a shortage, because the low price encourages buyers and discourages sellers.

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Moving From Shortage to Equilibrium

As long as there is a shortage and the quantity demanded exceeds the quantity supplied, suppliers will keep raising the price. When the price has risen enough to close the gap, suppliers will have found the highest price that the market will bear. They will continue to sell at that price until some factor changes either the demand or the supply curve, creating new pressures to raise or lower prices and, eventually, a new equilibrium.

Surplus

If the price is too high, the market will face the problem of surplus, also known as excess supply. A surplus exists when quantity supplied exceeds quantity demanded and the actual price of a good is higher than the equilibrium price. 

Open Ended

At a certain price, quantity supplied exceeds quantity demanded, creating a surplus. Analyze Graphs How might the pizzeria solve the problem of excess supply?

Moving From Surplus to Equilibrium

Whenever the market is in disequilibrium and prices are flexible, market forces will push the market toward the equilibrium. Sellers do not like to waste their resources on a surplus, particularly on goods that cannot be stored for long, like pizza. And when there is a shortage, profit-seeking sellers realize that they can raise prices to earn more profits. For these reasons, market prices move toward the equilibrium level.

Multiple Choice

Identify Main Ideas Under what conditions might a baker have to throw out many muffins at the end of the day?

• a surplus, when quantity demanded is lower than quantity supplied

• a surplus, when quantity supplied is lower than quantity demanded

• a shortage, when quantity demanded is lower than quantity supplied

• a shortage, when quantity supplied is lower than quantity demanded

Price Ceilings

Markets tend toward equilibrium, but in some cases the government intervenes to control prices. The government can impose a price ceiling, or a maximum price that can be legally charged for a good or service. The price ceiling is set below the equilibrium price.

Effects of Government Rent Control

 rent control, or price ceilings placed on apartment rents, to prevent inflation during a housing crisis. Later, other cities imposed rent control to help the poor cut their housing costs and enable them to live in neighborhoods that they could not otherwise afford. Let’s examine how rent control affects the quantity and quality of housing available to consumers.

Open Ended

In these graphs, a price ceiling of $600 for rent-controlled apartments is below the equilibrium price. Analyze Graphs Why does rent control lead to a shortage of desirable apartments?

Cost of Rent Control

since the rent controls limit landlords’ profits, landlords may try to increase their income by cutting costs. Why should a landlord give a building a fresh coat of paint and a new garden if he or she can’t earn the money back through higher rent? Besides, if there’s a waiting list to get an apartment, the landlord has no incentive to work hard and attract renters. As a result, many rent-controlled apartment buildings become run-down, and renters may have to wait months to have routine problems fixed.

Consequences of Ending Rent Control

Instead of spending time and money searching for apartments and then having to accept an apartment in a poorly maintained building, many renters would be able to find a wider selection of apartments. Landlords would also have a greater incentive to properly maintain their buildings and invest in new construction.

Multiple Choice

Apply Concepts How does a price ceiling affect the quantity demanded and the quantity supplied?

• It leads to a decrease in quantity demanded and a decrease in quantity supplied.

• It leads to a decrease in quantity demanded and an increase in quantity supplied.

• It leads to an increase in quantity demanded and a decrease in quantity supplied.

• It leads to an increase in quantity demanded and an increase in quantity supplied.

Price Floors

A price floor is a minimum price, set by government, that must be paid for a good or service. Governments set price floors to ensure that certain sellers receive at least a minimum reward for their efforts. Sellers can include workers, who sell their labor.

The Minimum Wage

One well-known price floor is the minimum wage, which sets a minimum price employers can pay for one hour of labor. (The federal government sets a minimum wage, but states can make theirs higher.) A full-time worker paid the federal minimum wage will earn less than government says is necessary to support a couple with one child. Still, the minimum wage does ensure a lower limit for workers’ earnings.

Open Ended

A minimum wage law can set the price of labor above the equilibrium price. Analyze Graphs In this graph, what happens to the supply of labor with a minimum wage of $7.25 per hour?

Agricultural Price Supports

Agricultural price supports are another example of price floors used for farm products. Like the minimum wage, price supports have supporters and opponents.

Open Ended

The U.S. government has supported milk prices by setting a price floor and buying the excess supply that results. Analyze Information What does the government do with the milk that it buys from farmers?

Multiple Choice

Predict Consequences How does a minimum wage above the equilibrium rate affect the labor market?

• It leads to a higher equilibrium wage for labor.

• It leads to a lower equilibrium wage for labor.

• It leads to a decreased supply of labor

• It leads to an excess supply of labor.

Open Ended

How do we affect the economy?