Principles of Economics Chapter 4 Flashcards
Demand and Supply Applications
price rationing
The process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied.
The adjustment of price is the
rationing mechanism in free markets. Price rationing means that whenever there is a need to ration a good—that is, when a shortage exists—in a free market, the price of the good will rise until quantity supplied equals quantity demanded—that is, until the market clears.
price ceiling
A maximum price that sellers may charge for a good, usually set by government.
queuing
Waiting in line as a means of distributing goods and services: a nonprice rationing mechanism.
favored customers
Those who receive special treatment from dealers during
situations of excess demand.
ration coupons
Tickets or coupons that entitle individuals to purchase a certain amount of a given product per month.
black market
a market in which illegal trading takes place at market-determined prices.
Constraints on the Market and Alternative Rationing Mechanisms
On occasion, both governments and private firms decide to use some mechanism other than the market system to ration an item for which there is excess demand at the current price. Policies designed to stop price rationing are justified in a number of ways, most often in the name of fairness.
Regardless of the rationale, two things are clear:
1. Attempts to bypass price rationing in the market and to use alternative rationing devices are more difficult and more costly than they would seem at first glance.
2. Very often such attempts distribute costs and benefits among households in unintended ways.
Prices and the Allocation of Resources
Price changes resulting from shifts of demand in output markets cause profits to rise or fall. Profits attract capital; losses lead to disinvestment. Higher wages attract labor and encourage workers to acquire skills. At the core of the system, supply, demand, and prices in input and output markets determine the allocation of resources and the ultimate combinations of goods and services produced.
price floor
A minimum price below which exchange is not permitted.
minimum wage
A price floor set for the price of labor.
consumer surplus
The difference between the maximum amount a person is
willing to pay for a good and its current market price.
producer surplus
The difference between the current market price and the cost of production for the firm.
deadweight loss
The total loss of producer and consumer surplus from underproduction or overproduction.
Potential Causes of Deadweight Loss from Under- and Overproduction
When supply and demand interact freely, competitive markets produce what people want at the least cost, that is, they are efficient.
There are a number of naturally occurring sources of market failure. Monopoly power gives firms the incentive to underproduce and overprice, taxes and subsidies may distort consumer choices, external costs such as pollution and congestion may lead to over- or underproduction of some goods, and artificial price floors and price ceilings may have the same effects.
