Introduction to Microeconomics: Chapter 4

Also known as the market system. Has two important functions: 1. Serves as a price rationing device for allocating goods and services to consumers when quantity demanded exceeds quantity supplied. 2. It ultimately determines both the allocation of resources among producers and the final mix of outputs.

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. Whenever there is a need to ration a good - that is, whenever there is a shortage - the price of the good will rise until quantity supplied equals quantity demanded.

When a product is in strictly scarce supply and its price is determined solely by the amount that the highest bidder is willing to pay. Ex: a famous single painting

For some goods and services, the government might decide to use another method other than the market system to ration items for which there is an excess demand because 1. Price gouging (charging very high prices) is bad 2. Income is unfairly distributed 3. Some items are necessities and everyone should be able to buy them at "reasonable" prices.

A maximum price that sellers may charge for a good, usually set by the government. Intended to keep a good affordable, can perpetuate a shortage. Often imposed because price rationing seems unfair, results in alternative non-price rationing mechanisms that are inefficient and may be equally unfair (queuing, favored customers, and ration coupons).

Waiting in line as a means of distributing goods and services: the most common non-price rationing mechanism. Here, the people most willing to pay for a good still get it, but rather than pay with money, they are paying with their time.

Those who receive special treatment from dealers during situations of excess demand (owners giving goods and services to their friends). Another non-price rationing mechanism.

Tickets or coupons that entitle individuals to purchase a certain amount of a given product per month. Intended to provide every individual with the same amount of a good, regardless of income. With no prohibition on trading them, the result is almost identical to price rationing because those who are willing and able buy other people's coupons.

A market in which illegal trading takes place at market-determined prices.

A minimum price below which exchange is not permitted. If it is set above the equilibrium price, the result will be excess supply; quantity supplied will be greater than quantity demanded.

A price floor set for the price of labor. Employers (who demand labor) are not permitted under federal law to pay wages less than $7.25. This wage is above the equilibrium price, so the quantity of labor demanded is less than the quantity of labor supplied, creating a surplus.

The difference between the maximum amount a consumer is willing to pay for a good and its current market price. Ex: If a person is willing to pay $5 for a hamburger, but the price of the hamburger is $3, his consumer surplus is $2. Equal to the area of the triangle under the demand curve and above the market price.

The difference between the current market price and the cost of production for the firm. Ex: If it costs a firm $3 to make a hamburger, but they can sell it for $5, their producer surplus is $2. Equal to the area of the triangle above the surplus curve and below the market price.

The total loss of producer and consumer surplus from underproduction or overproduction. Underproduction: something halts production at a quantity below equilibrium: less consumers are willing to buy at this higher price and less producers are willing to supply at this lower price. Overproduction: at a quantity above equilibrium, consumers are willing to pay less than the cost of production. The cost of resources needed to produce the good exceeds the benefit to consumers.