TAILIEUCHUNG - Ten Principles of Economics - Part 13

Ten Principles of Economics - Part 13. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 6 SUPPLY DEMAND AND GOVERNMENT POLICIES 125 a A Price Floor That Is Not Binding Cones quantity A Market with a Price Floor. In panel a the government imposes a price floor of 2. Because this is below the equilibrium price of 3 the price floor has no effect. The market price adjusts to balance supply and demand. At the equilibrium quantity supplied and quantity demanded both equal 100 cones. In panel b the government imposes a price floor of 4 which is above the equilibrium price of 3. Therefore the market price equals 4. Because 120 cones are supplied at this price and only 80 are demanded there is a surplus of 40 cones. 4 3 0 Equilibrium price Price of Ice-Cream Cone b A Price Floor That Is Binding demanded supplied Cones Figure 6-4 When the government imposes a price floor on the ice-cream market two outcomes are possible. If the government imposes a price floor of 2 per cone when the equilibrium price is 3 we obtain the outcome in panel a of Figure 6-4. In this case because the equilibrium price is above the floor the price floor is not binding. Market forces naturally move the economy to the equilibrium and the price floor has no effect. Panel b of Figure 6-4 shows what happens when the government imposes a price floor of 4 per cone. In this case because the equilibrium price of 3 is below the floor the price floor is a binding constraint on the market. The forces of supply and demand tend to move the price toward the equilibrium price but when the market price hits the floor it can fall no further. The market price equals the price floor. At this floor the quantity of ice cream supplied 120 cones exceeds the quantity demanded 80 cones . Some people who want to sell ice cream at the going price are unable to. Thus a binding price floor causes a surplus. Just as price ceilings and shortages can lead to undesirable rationing mechanisms so can price floors and surpluses. In the case of a price floor some sellers are unable to sell all they want at the .

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