1. Demand and Supply Shortages and Surpluses

2. The Price System: Rationing and Allocating Resources Price Rationing price rationing The process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied The Market for Lobsters Suppose in 2008 that 15,000 square miles of cod fisheries of Scotland are closed. The supply curve shifts to the left. Before the waters are closed, the cod market is in equilibrium at the price of £11.50 and a quantity of 81 tonnes. The decreased supply of cod leads to higher prices, and a new equilibrium is reached at £16.10 and 60 tonnes (point B). Priceperton(£) Tonnes of cod per year

3. The Price System: Rationing and Allocating Resources Price Rationing Market for a Monet Painting There is some price that will clear any market, even if supply is strictly limited. In an auction for a unique Monet painting, the price (bid) will rise to eliminate excess demand until there is only one bidder willing to purchase the single available painting. Some estimate that the Monet’s Water Lilies would sell for £100 million if auctioned. The adjustment of price is the rationing mechanism in free markets. Price rationing means that whenever there is a need to ration a good and a shortage exists in a free market, the price of the good will rise until quantity supplied equals quantity demanded and the market clears. £

4. The Price System: Rationing and Allocating Resources Price Rationing Constraints on the Market and Alternative Rationing Mechanisms The Government may decide to use some mechanism other than the market system to ration an item for which there is excess demand at the current price. Regardless of the rationale, two things are clear: 1. Attempts to bypass price rationing in the market and to use alternative rationing devices are very difficult and costly. 2. Very often, such attempts distribute costs and benefits among households in unintended ways.

5. The Price System: Rationing and Allocating Resources Constraints on the Market and Alternative Rationing Mechanisms price ceiling A maximum price that sellers may charge for a good, usually set by government. Excess Demand (Shortage) Created by a Price Ceiling In 1974, a ceiling price of 0.57 cents per gallon of leaded petrol was imposed in the US. If the price had been set by the interaction of supply and demand instead, it would have increased to approximately $1.50 per gallon. At $0.57 per gallon, the quantity demanded exceeded the quantity supplied. Because the price system was not allowed to function, an alternative rationing system had to be found to distribute the available supply of gasoline. Oil, Gasoline, and OPEC

6. The Price System: Rationing and Allocating Resources Alternative Rationing Methods queuing Waiting in line as a means of distributing goods and services: a non-price rationing mechanism used for pop concerts, for example. favoured customers Those who receive special treatment from dealers during situations of excess demand. Example: Glyndebourne Opera tickets, or Champions League football games. ration coupons Tickets or coupons that entitle individuals to purchase a certain amount of a given product per month. Example: UK 1945-56 food coupons black market A market in which illegal trading takes place at market-determined prices. Example: illegal drugs.

7. The Price System: Rationing and Allocating Resources Constraints on the Market and Alternative Rationing Mechanisms Supply of and Demand for a World Cup final ticket The face value of a ticket to the World Cup Final in 2014 in Brazil was £50. The stadium holds 50,000. The supply curve is vertical at 50,000. At £50, the quantity supplied is below the quantity demanded. The diagram shows that the quantity demanded and the quantity supplied would be equal at £300. The Web shows that one ticket would be worth £16,000 if a free market exists. World Cup tickets £

8. The Price System: Rationing and Allocating Resources Constraints on the Market and Alternative Rationing Mechanisms Eternal Economic Truth: it is very difficult to prevent the price mechanism from operating. Every time an alternative is tried, the price system seems to apply its invisible hand of market forces. With favoured customers and black markets, the final distribution may be even more unfair. Corruption may also be rife – with FIFA members selling allocations on the black market.

9. The Price System: Rationing and Allocating Resources 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 labour 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 things produced.

10. The Price System: Rationing and Allocating Resources Price Floors price floor A minimum price below which exchange is not permitted. minimum wage A price floor set for the price of labour.

11. Supply and Demand Analysis: An Oil Import Duty The U.S. Market for Crude Oil, 1989 At a world price of $18, domestic production is 7.7 million barrels per day and the total quantity of oil demanded in the United States is 13.6 million barrels per day. The difference is total imports (5.9 million barrels per day). If the government levies a 33 1/3 percent tax on imports, the price of a barrel of oil rises to $24. The quantity demanded falls to 12.2 million barrels per day. At the same time, the quantity supplied by domestic producers increases to 9.0 million barrels per day and the quantity imported falls to 3.2 million barrels per day.

12. Key Terms • black market • favoured customers • market clearing price • price ceiling • price floor • price rationing • queuing • ration coupons