How are price determined in a competitive market.

The Adjustment Process - Price determination.

Economic Model — Description of how the economy behaves and is expected to perform in the future.


A set of assumptions (Table, Graphs, formulas) that analyze behavior and predict outcomes.
Economists use it to make predictions. Business use it to set and initial price on products.
Used to estimate the future of markets, products, etc.


Market Equilibrium — price stability - Where demand equals supply. The quantities are in equilibrium.

Negotiating price. Seller wants and high price than the buyer wants to pay.

They negotiate a price in the middle. Market equilibrium has been set.
Surplus — quantity supplied is greater than quantity demanded - at a given price.
Shortage — quantity supplied is less than quantity demanded - at a given price
Equilibrium Price — quantity supplied equals quantity demanded; price that clears the market.
Loss Leader — item sold below cost to attract customers.

People are sensitive to prices and change their buying habits.

How do surpluses and shortages help the market find the equilibrium price.

How do retail merchants move product that is overstocked? What has this got to do with Equilibrium Price

Why do American farmers consistently produce surplus crops? Government policy. Who pays? Is this Good?

Prices as a system.

The economy is made up of many markets: financial, food, housing, recreation, etc.
Price change affects the allocation of resources between markets.

Rebate — refund (partial) for buying an item.

Change in product

Governments sometimes control Prices. What happens when prices are fixed?

Price Ceilings — maximum legal price that can be charged.

Creates a shortage. Rent controls in New York. Seinfeld.
Price Floors — lowest legal price that can be charged.

Minimum Wage — lowest legal wage that can be paid to most workers

A surplus is created. Why is paper filled with minimum wage jobs.

Predicting Prices & Changes in Supply

Demand Elasticity — The elasticity of the demand curve affect the size of the price change.
Changes in Demand

The more elastic the demand curve — the smaller the price change,
The less elastic the demand curve — the larger the price change

Agricultural Price Supports
The Commodity Credit Corporation was set up to stabilize agricultural prices.
This was accomplished by Loan Support & Deficiency Payments to establish floor prices

Target Price — the agricultural floor price set by the government to stabilize farm incomes.
Loan Supports — Non Recourse Loan — agricultural loan that carry neither a penalty nor further obligation to repay if not paid back

- the government kept the crop. In effect became a guaranteed payment in advance.
Deficiency Payments — A Cash payment for the difference between market price and the target price of an agricultural crop.


What are the 2 possible effects of having a fixed price rather than the equilibrium price in the market?

Shortages, surpluses

Describe why When Markets Talk. Markets are impersonal?

How do markets speak collectively for buyers and sellers.

Why does the knowledge of Demand Elasticity predict the size of a price change.

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January 29 1998