Market Equilibrium and Price Controls

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Markets seek equilibrium, and the demand for goods and services will come to an equilibrium with supply of goods and services. When markets are not in equilibrium, surpluses and shortages, as well as underground markets, can exist. Sometimes, the government may want to intervene in markets to try to help reduce economic hardships.

What is the difference between a price floor and price ceiling? According to the laws of demand and supply and how market equilibrium, efficiency, and equity are reached, do attempts to repeal those laws and market results with price floors and price ceilings justify legislative bodies to implement price controls?

Review the mechanics of supply and demand. Disequilibrium between supply and demand will occur if price is above (surpluses) or below (shortages). Why does a price floor lead to surpluses? Why does a price ceiling lead to shortages? Review consumer and producer surplus. A price floor will lead to a transfer of consumer surplus to producer surplus; a price ceiling will lead to a transfer of producer surplus to consumer surplus; both price regulations lead to deadweight losses, which is a loss of surplus to society. Why?

Below is the lecture for assignment:

Market Equilibrium

How does society bring together those who want to consume and those who want to sell? How are scarce resources and products allocated within an economy? Who or what determines at what price consumers will be willing and able to pay for a product? Who or what determines at what price producers and suppliers will be willing and able to supply a product?

Markets bring together the consumers and producers and suppliers of goods and services, and it is in markets where the exchange process occurs. For brevity sake, producers will be used to represent suppliers too. In order to more fully understand how this exchange process takes place and how the consumer and producer determine price and quantity, we are going to discuss specifically first the DEMAND process, and then the SUPPLY process.

Change in Quantity Demanded vs. Change in Demand

Quantity demanded is a function of, or depends upon, price. There are certain variables which affect or change demand from one level to a lower or higher level. Price of related goods, population, preferences, expectations, taxes, substitutes, complements, number of buyers, and income are some of the main variables that will affect demand. Because there is a negative, or inverse relationship, between quantity (dependent variable) and price (independent variable), the slope of the demand curve will most often be negatively downward sloped.

Due to that notion, as you move down the demand curve from left to right, as price falls, or at lower prices, quantity demanded rises; going up the demand curve from right to left, as price rises, or at higher prices, quantity demanded is less. That is the Law of Demand. When all you are doing is comparing one price and quantity to another price and quantity, that is “movement along the demand curve;” if one of those variables changes, that is going to lead to a new demand curve, and that is referred to “a change in demand.”

Change in Quantity Supplied vs. Change in Supply

Quantity supplied is a function of price. There are certain variables which affect or change supply from one level to a lower or higher level. Price of other goods, nature, taxes, technology, capacity, number of producers, and expectations are some of the main variables that will affect supply. Because there is a positive, or direct relationship, between quantity (dependent variable) and price (independent variable), the slope of the supply curve will most often be positively downward sloped.

Like the demand curve, moving up or down the supply curve implies “movement along the supply curve” in which at higher prices, quantity supplied is higher (direct relationship); at lower prices, quantity supplied is lower. That is the Law of Supply. If any one of the variables for supply changes, then a new supply curve will ensue, and that is referred to “a change in supply.”

In summary, markets exist to allow an exchange between a consumer and a producer. Consumers will be willing and able to purchase a good based upon the sensitivity between quantity and price. Because there is a negative relationship between quantity and price, at higher prices, quantity demanded will be less, while at lower prices, quantity demanded will be higher.

That is the Law of Demand, and when one of the variables (price of related goods, population, preferences, expectations, taxes, substitutes, complements, number of buyers, and income) changes in the market, a new demand curve will ensue, and it can shift either left or right of the original demand curve (leftward always indicates less, while rightward shift indicates more).Similarly, quantity supplied will be contingent upon price, and producers will be willing and able to supply based upon quantity and price.

There is a positive relationship between quantity and price, so quantities supplied will coincide with higher or lower prices, which is the Law of Supply. A shift in supply (new supply curve) will occur when one or more of the variables (price of other goods, nature, taxes, technology, capacity, number of producers, and expectations) changes (leftward shift is less, and rightward shift is more).When the demand and supply curves are presented together, the market equilibrium price and quantity are found.

Market Disequilibrium

How does the market ultimately clear and allocate scarce resources? Markets inherently seek equilibrium. Due to scarcity, finite resources, and unlimited consumer wants and needs, markets bring together consumers and producers to an equilibrium point where both parties agree on price and quantity.

The Circular Flow Diagram of Economic Activity exemplifies this process of consumers and firms coming together to make possible markets and the exchange process: Households, which are the individuals within an economy or market, provide the factor resources (factors of production) to firms to produce the goods and services households need and want; compensation or rewards for those resources to households come in the form of income, wages, interest, or rent, from which the consumption and purchase of the goods and services transpires.

Leakages to the circular flow manifest when taxes are imposed, imports from foreign markets, and savings; injections to the circular flow occur with exports to foreign markets, consumption, and investment. None of the leakages or injections are necessarily good or bad, since we must consider the specific variables involved for unique economic situations when they occur. However, market disruptions can occur with the imposition of price floors, price ceilings, taxes, and producer subsidies.

Price Floor

Surpluses exist in the market if quantity supplied is greater than quantity demanded. A price artificially set above the equilibrium point where demand and supply cross is called a price floor. The laws of demand and supply are applied to determine the price floor’s effects. Because at higher prices quantity demanded is less (Law of demand), and because at higher prices quantity supplied is more (Law of Supply), surpluses ensue in markets. More simply stated, quantity demanded is less than quantity supplied. One common example used for price floors is minimum wages.

When a minimum wage is mandated in markets, the price of labor will not be allowed to fall below that specific floor (or minimum price) to come back down to equilibrium. Unemployment actually can result. Thus, at that higher price, the negatively-sloped demand curve is affected first when moving from that price on the vertical axis (Y axis or price axis) horizontally across to determine quantity, indicating a discrepancy between quantity demanded and quantity supplied.

Price Ceiling

Shortages exist in the market if quantity demanded is greater than quantity supplied .A price artificially set below the equilibrium point where demand and supply cross is called a price ceiling. Here, too, the laws of demand and supply determine the price ceiling’s effects. Because at lower prices quantity demanded is greater, and because at lower prices quantity supplied is less, shortages ensue. Quantity demanded is greater than quantity supplied.

If, for example, a price ceiling were imposed on gasoline, consumers would be more willing and able to consume higher quantities at that lower price. However, for the producer, his marginal costs would rise if he were to try to keep up with the increase in quantity demanded; the producer would be left with no choice but to cut back on production to lower his marginal costs, as marginal revenues cannot increase due to the price ceiling. Shortages.

Tax

What happens when money is confiscated from households and allocated to the government? Taxes remove private property from consumers. Taxes are also imposed on firms. Taxes are needed to run a government, but anything greater than what is “needed” can lead to deadweight losses and disequilibrium.

When we refer back to the variables affecting demand and supply, we see that taxes are common to both. If taxes are increased, for example, that will have a contracting effect on markets in which the demand curve (aggregate demand) shifts leftward and the supply curve (aggregate supply) shifts leftward. When both curves shift leftward, for example, quantity output (X axis or horizontal axis) is reduced, and price is indeterminate (depends whether demand rises or falls more than supply).

Subsidy

Lastly, a subsidy leads to disequilibrium. Most commonly, producer subsidies are imposed on markets. When a producer subsidy is imposed, the higher quantity desired, usually by the government issuing the subsidy, leads to a shift in supply and a new supply curve. Falling on a lower point on the demand curve, quantity demanded is higher, quantity supplied is higher, and the difference between the market equilibrium price and the “promised” price, or subsidy price, is what the producer will sell for economic profits. The discrepancy between the producer subsidy price and the actual selling price will be deadweight losses (or welfare losses) to society. Overproduction and inefficiencies ensue from there.

Thus, markets seek equilibrium. The Circular Flow of Economic Activity reveals the efficient processes between the consumer and producer. Breaks in the process will cause disruptions, inefficiencies, and equity problems within the economic system.Price floors artificially lead to surpluses, price ceilings lead to shortages, taxes can affect demand and supply, and producer subsidies can lead to overproduction and inefficiencies. Efficiency and equity are most clearly found when markets reach natural equilibrium.

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Last Updated on August 22, 2019 by Essay Pro