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Price Adjustment Bicycle shops and other busi-
Equilibrium Price
nesses often price certain goods below cost to
attract customers. What can occur if the price for If the new price is $20 on Day 3, the result will
a given product is too low? be the surplus of six CDs shown in Panel C of
Figure 6.2. This surplus will cause the price to drop,
but probably not below $10, which already proved to
A surplus is a situation in which the quantity sup-
be too low. If the price drops to $15, as shown in
plied is greater than the quantity demanded at a
Panel D in Figure 6.2, the market will have found its
given price. The 10 unit surplus at the end of Day 1
equilibrium price. The equilibrium price is the price
is shown in column four of Panel A in Figure 6.1 as
that “clears the market” by leaving neither a surplus
the difference between the quantity supplied and the
nor a shortage at the end of the trading period.
quantity demanded at the $25 price. It is also shown
While our economic model of the market can-
graphically in Panel A of Figure 6.2 as the horizontal
not show exactly how long it will take to reach
distance between the supply and demand curves.
equilibrium, equilibrium will be reached because
This surplus shows up as unsold products on
of the pressure that temporary surpluses and
suppliers™ shelves, and it begins to take up space in
shortages put on prices. Whenever the price is set
the suppliers™ warehouses. Sellers now know that
too high, the surplus will tend to force it down.
$25 is too high, and they know that they have to
Whenever the price is set too low, the shortage
lower their price if they want to attract more buy-
ers and dispose of the surplus.
Therefore, the price tends to go down as a result
of the surplus. The model cannot tell us how far
the price will go down, but we can reasonably
The Internet and Prices
assume that the price will go down only a little if
When you buy a $100 sweater at a stylish
the surplus is small, and much more if the surplus
boutique, most of the money you pay goes
is larger.
to the distribution channels. The Internet
lessens the need for most go-betweens, thus it
Shortage eliminates most distribution costs and increases
the possible savings for both the consumer and
Suppliers are more cautious on Day 2, and so
the manufacturer.
they anticipate a much lower price of $10. At that
price, the quantity they are willing to supply changes

144 UNIT 2 MICROECONOMICS
ECONOMICS
Figure 6.2
AT A GLANCE
AT A GLANCE


Dynamics of the Price Adjustment Process
A At a price of $25, a surplus of B At a price of $10, a shortage of
ten causes the price to drop. seven causes the price to rise.
$30 D $30 D
Surplus = 10 S
S
25 25

20 20
Price




Price
15 15

10 10
D
D
Shortage = 7
5 5
S S

0 0
1 3 6 9 10 11 13 15 1 3 6 9 10 11 13 15
Quantity Quantity



D Alternating surpluses and
C At a price of $20, a surplus of six shortages cause equilibrium
to be reached.
causes the price to drop again.
$30 D $30 D
S S
25 25 Equilibrium price
Surplus = 6
20 20
Price




Price




15 15

10 10
D D
5 5 Equilibrium quantity
S
S

0 0
1 3 6 9 10 11 13 15 1 3 6 9 10 11 13 15
Quantity Quantity



Using Graphs In a competitive market, prices are drawn toward equilibrium as a result of the
constant pressures from temporary surpluses and shortages. Panel A shows that a price of $25 will
create a surplus. A surplus is also created on Day 3, as shown in Panel C. Why did a surplus occur
on Day 1?


CHAPTER 6: PRICES AND DECISION MAKING 145
will tend to force it up. As a result, the market result of a change in supply, a change in demand, or
tends to seek its own equilibrium. changes in both. Elasticity of demand is also impor-
When the equilibrium price of $15 is reached, it tant when predicting prices.
will tend to remain there because the quantity sup-
plied is exactly equal to the quantity demanded. Changes in Supply
Something could come along to disturb the equi-
Consider the case of agriculture, which often
librium, but then new shortages or new surpluses,
experiences wide swings in prices from one year to
or both, would appear to push the price to its new
the next. A farmer may keep up with all the latest
equilibrium level.
developments and have the best advice experts can
offer, but the farmer never can be sure what price
to expect for the crop. A soybean farmer may put
Explaining and Predicting Prices in 500 acres of beans, expecting a price of $9 a
bushel. The farmer knows, however, that the actual
Economists use their market models to
price may end up being anywhere from $5 to $20.
explain how the world around us works and
to predict how certain events such as changes in Weather is one of the main reasons for the varia-
prices might occur. A change in price is normally the tion in agricultural prices. If it rains too much after



ECONOMICS
Figure 6.3
AT A GLANCE
AT A GLANCE

Factors Affecting Price Changes in Agriculture
A Inelastic Supply and Demand B Same Supply with Elastic Demand
$35
S2 S1
D S
S2 S1
S
e ” Y e ld
terd Yiield

Yield

p” Yield
ld
ld




$20
p ” Yie
e d Yie




ip ate d

per Cro
Price of Soybeans




Price of Soybeans




ti e p h
Wciata
r Cro
cip at




D
15
A n tic
m pe




20
A n ti




”Bum
An
”Bad
ield




”Bu




10
r” Y




9
the




8
a




D
9
We




5
ad




5
”B




D
S2 S1
S2 S1 S
S

0 0
Quantity in Bushels Quantity in Bushels

Using Graphs Diagram A shows that larger price changes occur when both the supply and demand
curves are highly inelastic. When the demand curve is more elastic, as in Diagram B, price
fluctuations are smaller. What happens to the slope of a supply curve when it becomes more
elastic?


146 UNIT 2 MICROECONOMICS
ECONOMICS
the farmer plants the seeds, the seeds may rot or be
Figure 6.4
AT A GLANCE
AT A GLANCE
washed away and the farmer must replant. If it rains
too little, the seeds may not sprout. Even if the
The Price of Gold When
weather is perfect during the growing season, rain
can still prevent the harvest from being gathered.
Supply and Demand Change
The weather, then, often causes a change in supply.
The result, shown in Panel A of Figure 6.3, is that
D1 S1 S2
D S
the supply curve is likely to shift, causing the price
to go up or down. At the beginning of the season,
1980
the farmer may expect supply to look like curve SS. $1200
If a bumper, or record, crop is harvested, however,
supply may look like S1S1. If bad weather strikes, sup-




Price of Gold
mid-1990s
850
ply may look like S2S2. Because both demand and
supply for food is inelastic, a small change in supply
1999
is enough to cause a large change in the price.
400
280
Importance of Elasticity
S1 S2 D1
S D
What would happen to prices if the demand for
soybeans were highly elastic, as in Panel B of 0 Quantity in Ounces
Figure 6.3? The results would be quite different.
Because this demand curve is much more elastic,
Using Graphs A change in supply, a change
the prices would only range from $8 to $10 a
in demand, or a change in both can influence
bushel instead of from $5 to $20 a bushel. prices. What could cause the price of
Economists consider elasticity of demand when- gold to go back up?
ever a change in supply occurs. When a given change
in supply is coupled with an inelastic demand curve,
as in Panel A of Figure 6.3, price changes dramatically.
this demand, shown as DD in the figure, was com-
When the same change in supply is coupled with a
bined with a relatively tight supply, SS, the price of
very elastic demand curve, such as that in Panel B of
gold reached $850 per ounce.
Figure 6.3, the change in price is much smaller.
By the mid-1990s, economic fears declined and
In general, price changes in any given market are
people lost some of their desire for gold. This had
likely to be wider if both supply and demand are
the effect of shifting the demand curve to D1D1.
inelastic. The same price changes are likely to be
Meanwhile, gold producers reacted to the sky-
less volatile if both curves are elastic.
high price in a predictable manner”they reopened
mines that had been closed because of low gold
Changes in Demand prices and resumed production. This had the effect
of increasing the supply of gold to S1S1. The combi-
A change in demand, like a change in supply,
nation of increased supply and reduced demand
can also affect the price of a good or service. All
drove the price of gold down to the $400 level.
of the factors we examined in Chapter 4”changes
In early 1999, more bad news hit the gold mar-
in income, tastes, prices of related products,
ket. The Bank of England announced plans to sell
expectations, and the number of consumers”
about 400 tons of gold, or slightly more than half
affect the market demand for goods and services.
of its official gold stock, causing the supply curve
One example is the demand for gold.
to shift to S2S2 and the price of gold to reach a new
Figure 6.4 shows why gold prices have changed
low of $280 an ounce.
so dramatically over a 20-year period. In 1980, ris-
However the price of gold fluctuates, one thing
ing prices, uncertain economic conditions, and
is certain”everything depends on the demand and
other factors created a high demand for gold. When

CHAPTER 6: PRICES AND DECISION MAKING 147
the supply. Whenever economic conditions or polit-
ical instability threatens, people tend to increase
their demand for gold and drive the price up.
Whenever the supply of gold increases dramati-
cally”as when a major holder of gold like the Bank Student Web Activity Visit the Economics: Principles
of England sells half of its gold holdings”the supply and Practices Web site at epp.glencoe.com and click
on Chapter 6”Student Web Activities for a price
of gold increases, driving the price down.
comparison activity.


The Competitive Price Theory
The theory of competitive pricing represents Fortunately, markets only have to be reasonably
a set of ideal conditions and outcomes. The competitive”rather than perfect”to be useful. The
theory is important because it serves as a model by great advantage of competitive markets is that they
which to measure the performance of other, less allocate resources efficiently. As sellers compete to
competitive market structures. Even so, many mar- meet consumer demands, they are forced to lower
kets come reasonably close to the ideal. the price of their goods, which in turn encourages
The prices of some foods such as milk, flour, them to keep their costs down. At the same time,
bread, and many other items in your community competition among buyers helps prevent prices
will be relatively similar from one store to the next. from falling too far.
When the prices of these items vary, it may be In the final analysis, the market economy is one
because advertisers have convinced some people that “runs itself.” There is no need for a bureau-
that its brand is slightly better than others. Another cracy, planning commission, or other agency to set
reason may be that buyers are not well informed. prices because the market tends to find its own
The price of gasoline, for example, is usually higher equilibrium. In addition, the three basic economic
at stations near an expressway because gas station questions of WHAT, HOW, and FOR WHOM to
owners know that travelers do not know the loca- produce are decided by the participants”the buyers
tion of lower cost stations in an unfamiliar area. and sellers”in the market.




Checking for Understanding of milk, a local newspaper, or a haircut. Visit
at least five stores that sell the product, and
1. Main Idea Explain how a change in demand
note its price at each location. What do the
can affect prices.
individual prices tell you about the equilib-
2. Key Terms Define economic model, market
rium price for the good or service?
equilibrium, surplus, shortage, equilibrium
price.
3. Describe how prices are determined in a
competitive market.
7. Understanding Cause and Effect What signal
4. Explain why economic models are useful. does a high price send to buyers and sellers?
5. Explain how different cases of demand and 8. Making Inferences What do merchants usu-
supply elasticity are related to price changes. ally do to sell items that are overstocked?
What does this tell you about the equilib-
Applying Economic Concepts
rium price for the product?
6. Equilibrium Price Choose one good or serv-
ice”for example, unleaded gasoline, a gallon Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.



148 UNIT 2 MICROECONOMICS
Synthesizing Information
Synthesizing information involves integrating information from two
or more sources. The ability to synthesize, or combine, information
is important because information gained from one source often
sheds new light upon other information.


Learning the Skill Source B
Most Americans are
To synthesize information, follow these steps:
accustomed to borrowing
• Analyze each source separately to understand its and buying on credit.
meaning. At times, especially when
• Determine what information each source adds to buying such expensive con-
sumer durables as automobiles
the subject.
and fine furniture, they consider
• Identifypoints of agreement and disagreement
borrowing to be necessary. Because people have
between the sources. Ask: Can Source A give me
In a sense, people feel forced limited resources,
new information or new ways of thinking about most people have to
to buy items on credit because
Source B? borrow to buy a car.
they believe they need them
• Find relationships between the information in the immediately. They do not want
to wait. Of course, consumers are not really “forced” to buy most
sources.
goods and services on credit. They could decide instead to save
Practicing the Skill the money needed to make their purchases.
Study the sources below, then answer the 1. What is the main subject of each excerpt?
questions that follow.
2. What kind of information does Source A add to this
subject?
Source A
3. What kind of information does Source B add to this
A common decision consumers make is whether to
subject?
borrow money for a new car, or to pay cash for a less
expensive used one. Studies show that more than 80 4. Does Source B support or contradict Source A? Explain.
percent of all new cars sold in any given year in the
5. Summarize what you have learned from both sources.
United States are financed. There are advantages to
owning a new car, but there are also significant costs
consumers should keep in mind when they make this
decision.
The interest a consumer pays on a new car loan is a
Find two sources of information on a topic dealing
significant part of its cost. Insuring a new car costs more
with the price of goods. Write a short report
than insuring a used car because new cars are more likely to
answering these questions: What are the main
be stolen or vandalized. In addition, there is a higher sales
ideas in the sources? How does each source add to
tax to pay for a more costly new car.
your understanding of the topic? Do the sources
support or contradict each other?
Practice and assess key social studies skills with the
Glencoe Skillbuilder Interactive Workbook, Level 2.
Social Goals vs. Market Efficiency
Main Idea Key Terms
To achieve one or more of its social goals, price ceiling, minimum wage, price floor, target price,
government sometimes sets prices. nonrecourse loan, deficiency payment

Objectives
Reading Strategy
After studying this section, you will be able to:
Graphic Organizer As you read the section,
1. Describe the consequence of having a fixed price
complete a cause-and-effect chart similar to
in a market.
the one below by explaining how price ceilings
2. Explain how loan supports and deficiency pay-
affect quantity supplied.
ments work.
3. Understand what is meant when “markets talk.”
Effect on quantity
Applying Economic Concepts
Price ceilings
supplied
Price Floor Chances are that you have worked for the
minimum wage at some time in your life. Read to see
why this is an example of a price floor.




I
n Chapter 2 we examined seven broad eco-
Cover Stor y nomic and social goals that most people seem
to share. We also observed that these goals,
Congress Sews while commendable, were sometimes in conflict
a Safety Net with one another. These goals were also partially
responsible for the increased role that government
for Farmers plays in our economy.
The goals most compatible with a market econ-
ajor
Three years after a m
tion™s omy are freedom, efficiency, full employment, price
farm bill ended the na
agri-
decades-old program of stability, and economic growth. Attempts to achieve
orts,
cultural price supp the other two goals”equity and security”usually
beef-
Congress is considering
Various farmer aid require policies like the “safety net for farmers” in the
proposals considered farm-
ing up safety nets to aid cover story that distort market outcomes. In other
op
t by dramatically low cr
s around the country hi words, we may have to give up a little efficiency and
er
and falling incomes.
ices, shrinking exports, freedom in order to achieve equity and security.
pr an
lutions”ranging from
But the proposed so Whether this is good or bad often depends on
to
program to a return
panded crop-insurance a person™s perspective. After all, the person who
ex tend
ts”are both costly and
commodity price suppor receives a subsidy is more likely to support it
and
riented Republicans
to divide market-o than is the taxpayer who pays for it. In general,
bsidies.
Democrats who favor su an-
ies take time. So, as fin however, it is usually wise to evaluate each situa-
Moreover, such remed ason,
begin a new planting se tion on its own merits, as the benefits of a pro-
cially strapped farmers ncy
passing another emerge gram may well exceed the costs. What is
Congress could end up llion
e the more than $5 bi common to all of these situations, however, is
aid package this year lik
t October. . . .
approved for farmers las that the outcomes can be achieved only at the
99
e Monitor, March 12, 19 cost of interfering with the market.
”The Christian Scienc


150
ECONOMICS
Figure 6.5
AT A GLANCE
AT A GLANCE

Distorting Market Outcomes with Price Ceilings and Price Floors
A Price Ceiling B Price Floor
$8.00
D S D S
$1500 Surplus
Price of Apartments




Price Floor




Price of Labor
1200 5.15
In housing
markets, a rent
In labor
Equilibrium Price Equilibrium Price
control is a
900 4.00 markets, the
price ceiling.
minimum wage is
a price floor.
Price Ceiling
600
2.00
Shortage
S D S D


0 1.6 2.0 2.4 0 10 12 14
Quantity (in millions) Quantity (in millions)

Using Graphs Price ceilings and price floors prevent markets from reaching equilibrium, allowing
the resulting shortages and surpluses to become permanent. Why does government sometimes
impose price ceilings and floors on the market?




Distorting Market Outcomes would be supplied and rented at that rate. If
authorities think $900 is too high, and if they
One of the common ways of achieving want to achieve the social goals of equity and
social goals involves setting prices at security for people who cannot afford these rents,
“socially desirable” levels. When this happens, they can establish, arbitrarily, a price ceiling at
prices are not allowed to adjust to their equilibrium $600 a month.
levels, and the price system cannot transmit accu- No doubt consumers would love the lower price
rate information to other buyers and sellers in the and might demand 2.4 million apartments.
market. Landlords, on the other hand, would try to convert
some apartments to other uses, such as condos and
office buildings that offer higher returns.
Price Ceilings Therefore, the supply might only reach 1.6 million
apartments at $600 per month, leaving a permanent
Some cities, especially New York City, have a
shortage of 800,000 apartments.
long history of using rent controls to make hous-
Are consumers better off? Perhaps not. More
ing more affordable. This is an example of a price
than likely, the better apartments will be con-
ceiling, a maximum legal price that can be charged
verted to condos or offices”leaving the poorer
for a product.
ones to be rented. In addition, 800,000 people are
The case of a price ceiling is shown in Panel A
now unhappy because they cannot get an apart-
of Figure 6.5. Without the ceiling, the market
ment, although they are willing and able to pay
establishes monthly rents at $900, which is an
for one. Prices no longer allocate apartments.
equilibrium price because 2 million apartments

CHAPTER 6: PRICES AND DECISION MAKING 151
Instead, landlords resort to long waiting lists or Price Floors
other nonprice criteria such as excluding children Other prices often are considered too low and so
and pets to discourage applicants. steps are taken to keep them higher. The minimum
Rent controls freeze a landlord™s total revenue and wage, the lowest legal wage that can be paid to
threaten his or her profits. As a result, the landlord most workers, is a case in point. The minimum
tries to lower costs by providing the absolute mini- wage is actually a price floor, or lowest legal price
mum upkeep, thereby protecting profits. Landlords that can be paid for a good or service.
may have no incentive at all to add additional units Panel B in Figure 6.5 uses a minimum wage of
if they feel rents are too low. Some apartment build- $5.15 per hour as an illustration of a price floor. At
ings may even be torn down to make way for shop- this wage, the supply curve shows that 14 million
ping centers, factories, or high-rise office buildings. people would want to offer their services.
The price ceiling, like any other price, affects According to the demand curve for labor, however,
the allocation of resources”but not in the way only 10 million would be hired”leaving a surplus
intended. The attempt to limit rents makes some of 4 million workers.
people happy, until their buildings begin to dete- The figure also shows that without the mini-
riorate. Others, including landlords and potential mum wage, the actual demand and supply of labor
renters on waiting lists, are unhappy from the would establish an equilibrium price of $4.00 per
beginning. Finally, some scarce resources”those hour. At this wage, 12 million workers would offer
used to build and maintain apartments”are slowly their services and the same number would be
shifted out of the rental market. hired”which means that there would be neither a
shortage nor a surplus in the labor market.
Some economists argue that the minimum
wage actually increases the number of people who
do not have jobs because employers hire fewer
workers. In the case of Figure 6.5, the number of
Sales Clerk people who lose jobs amounts to 2 million”the
difference between the 12 million who would
The primary purpose of a
have worked at the equilibrium price and the
sales clerk is to interest
10 million who actually work at the higher wage
customers in the merchan-
of $5.15 per hour.
dise. How successful a
Is the minimum wage good or bad for the econ-
business is depends in
omy? Certainly the minimum wage is not as effi-
large part on how effi-
cient as a wage set by supply and demand, but not
cient and courteous its
all decisions in our economy are made on the basis
sales force is.
of efficiency. The basic argument in favor of the
The Work
minimum wage is that it raises poor people™s
Sales clerks™ duties include stocking shelves, taking inven- incomes. A federal minimum wage is evidence that
tory, and dealing directly with customers. Clerks must be the small measure of equity provided by the mini-
able to demonstrate the product, record the sales trans- mum wage”with equity being one of our seven
action, and, if necessary, arrange for the product™s safe major economic and social goals”is preferred to
delivery. For those selling complex items such as comput-
the loss of efficiency.
ers or automobiles, knowing special features and what
Finally, some people argue that the minimum
they can do is essential.
wage is irrelevant anyway because it is actually
lower than the lowest wages paid in many areas.
Qualifications
Consider the wages in your area. Do you think that
Ability to work under pressure is helpful. Other required
your employer would pay you less if he or she were
skills include a strong working knowledge of business
allowed to do so? Your response will provide a par-
math for calculating prices and taxes, and the ability to
tial answer to the question.
communicate clearly and tactfully.

152 UNIT 2 MICROECONOMICS
market and used the proceeds to repay the CCC
Price Stabilization
loan, or the farmer kept the proceeds of the loan
and let the CCC take possession of the crop.
Because the loan was a nonrecourse loan”a loan
that carries neither a penalty nor further obliga-
tion to repay if not paid back”the farmer could
get at least the target price for his or her crops.
Panel A in Figure 6.6 illustrates the CCC loan
program using a $4-per-bushel target price for
wheat. In the end, the farmer received $4 a bushel
for each of the 10,000 bushels produced”with
8,000 sold in the market and the remaining 2,000
picked up by the CCC”for a total of $40,000.
Without the loan program, the farmer would have
produced 9,000 bushels and then sold them at $3
each for a total revenue of $27,000.


Deficiency Payments
The CCC loan program created problems
because the U.S. Department of Agriculture soon
owned enormous stockpiles of food. Surplus wheat
was stored in rented warehouses or on open
ground. Surplus milk was made into cheese and
stored in underground caves. Some food was given
to the military, and other food was donated to pub-
Loan Supports The government plays a role in
lic schools for use in “free lunch” programs. Still
helping farmers market their products and sta-
bilizing agricultural prices. What problems did the surpluses persisted, leaving CCC officials to
the program of loan supports create?
consider how they could support farm prices and
still avoid holding large surpluses.
The solution was to have farmers sell their crops
Agricultural Price Supports on the open market for the best price they could get
and then have the CCC make up the difference with
In the 1930s, the federal government estab- a deficiency payment. A deficiency payment is a
lished the Commodity Credit Corporation
(CCC), an agency in the Department of Agriculture,
to help stabilize agricultural prices. The stabilization
took two basic forms”the first involved loan sup-
ports, and the second involved deficiency payments.
Both made use of a target price, which is essentially Gender Pricing Women often pay higher prices for
a price floor for farm products. haircuts, dry cleaning, and clothes than do men.
Massachusetts found that women were charged up
to $2.50 more per dry cleaned item than men. Dry
Loan Supports cleaners claimed that women™s clothing was harder
Under the loan support program, a farmer bor- to press because the equipment was designed for
men™s shirts. Although some states have laws
rowed money from the CCC at the target price
against gender-biased pricing, these laws are hard
and pledged his or her crops as security in return.
to enforce across the many industries.
The farmer used the loan to plant, maintain, and
harvest the crop. The farmer sold the crop in the

CHAPTER 6: PRICES AND DECISION MAKING 153
ECONOMICS
Figure 6.6
AT A GLANCE
AT A GLANCE

Agricultural Price Support Programs
A CCC Loan Program B CCC Deficiency Payments
D
D S
S
$5.00 $5.00
Target
Target Price Price
Price of Wheat




Price of Wheat
4.00 4.00
CCC acquires The farmer is
unsold portion of paid the difference
crop in exchange between the target
3.00
3.00 for loan default. and the market
2.50 price.
2.00

D
D S
S
0 4 8 910 12 16 0 4 8 910 12 16
Quantity in Thousands of Bushels Quantity in Thousands of Bushels

Using Graphs The farmer sells surplus crops to the government under the plan shown in Panel A.
The farmer receives a payment equal to the difference between the target price and the prices the
farmer received for the crops. What was the total payment the farmer received under the
loan program? Under the deficiency payment program?



Reforming Price Supports
check sent to producers that makes up the difference
between the actual market price and the target price. In an effort to make agricultural output respon-
Panel B in Figure 6.6 illustrates the deficiency pay- sive to market forces, Congress passed the Federal
ment approach. Under this program, the farmer Agricultural Improvement and Reform (FAIR) Act
made $25,000 by selling 10,000 bushels at $2.50 each of 1996. Under this law, eligible producers of
on the open market. Because this was $1.50 below grains, cotton, and rice can enter into a seven-year
the target price of $4.00 a bushel, the farmer received program that allows them almost complete flexi-
a deficiency payment of $1.50, times 10,000 bushels, bility to plant any crop on any land. Other prod-
or the $15,000 represented by the shaded area. ucts, such as milk, sugar, fruits, and vegetables, are
not affected.
When the $15,000 deficiency payment was added
Under FAIR, cash payments take the place of
to the $25,000 market sale, the farmer made
price supports and deficiency payments. Because
$40,000”the same as under the loan program. Under
these new payments have turned out to be as large
this program, however, the CCC does not have the
as the ones they replaced, however, the overall
political and economic problem of disposing of the
cost of farm programs has not gone down.
surplus. Farmers liked this program and would have
Instead, in 1998 a drop in worldwide food prices
produced even more crops if they could. Instead,
made things even worse for farmers. This, as we
they had to promise the CCC that they would limit
saw in the cover story, prompted Congress to pass
production. In many cases, aerial photographs were
a $5 billion aid bill for farmers”with possibly
taken to verify that the acreage planted was within
more in the works.
the limits of the agreement with the CCC.

154 UNIT 2 MICROECONOMICS
When the program expires in the year 2002, In this example, individual investors made
farmers will cease to receive all payments. By then, decisions on the likely outcome of the new policy
farmers should have had enough experience with and sold stocks for cash or gold. Together, their
the laws of supply and demand to no longer need actions were enough to influence stock prices and
government help. If farm income is still down to send a signal to the government that investors
when the bill expires, Congress may decide to did not favor the policy. If investors™ feelings were
bring farm support back”thereby choosing the goal divided about the new policy, some would sell
of economic security over efficiency. while others bought stocks. As a result, prices
might not change, and the message would be that,
as yet, the market has not made up its mind.
When Markets Talk
Markets are impersonal mechanisms that
bring buyers and sellers together. Although
markets do not talk in the usual sense of the word,
INFOBYTE
they do communicate in that they speak collec-
tively for all of the buyers and sellers who trade in
the markets. Markets are said to talk when prices
Consumer Confidence A statistic called the
in them move up or down significantly.
Consumer Confidence Index attempts to gauge
Suppose the federal government announced that
consumers™ feelings about the current condition of
it would raise personal income taxes and corporate the economy and their expectations about the
taxes to pay off some of the federal debt. If investors economy™s future direction. The index is weighted
thought this policy would not work or that other 60% in favor of expectations and 40% in favor of
policies might be better, they might decide to sell current conditions. Large movements in this index
some of their stocks and other investments for cash indicate or signal changes in consumer spending
and gold. As the selling takes place, stock prices fall, patterns.
and gold prices rise. In effect, the market would
“talk””voicing its disapproval of the new tax policy.




Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 6. Price Floor Would small businesses be more
organizer activity on page 150, describe why affected by a change in the minimum wage
price ceilings are often set. than large businesses? Explain your answer.
2. Key Terms Define price ceiling, minimum
wage, price floor, target price, nonrecourse
loan, deficiency payment.
7. Understanding Cause and Effect The price
3. Describe two effects of having a fixed price
of fresh fruit over the course of a year may
other than the equilibrium price forced on a
go up or down by as much as 100 percent.
market.
Explain the causes for these changes in
4. Explain how loan supports and deficiency terms of changes in demand, changes in
payments work. supply, and the elasticity of demand for
fresh fruit.
5. Describe how markets speak collectively for
buyers and sellers. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.



CHAPTER 6: PRICES AND DECISION MAKING 155
DECEMBER 21, 1998
Newsclip
Many considerations are involved in an especially specialists tended to locate in metro
areas with low HMO penetration.
individual™s choice of jobs. These include
Why is this happening? Noting that general
not only whether and how much to work,
practitioners are in high demand throughout the
but where to work. As you read this arti-
U.S., Escarce and his fellow researchers theorize
cle, think about what influences affect that many are seeking to avoid HMOs and the
labor demand. What influences affect cost-control pressures they impose on primary
physicians. And new specialists may be relocat-
labor mobility?
ing because HMOs have been particularly suc-
cessful in curbing demand for their services.
The RAND study looked
Doctors: only at larger metro areas. But
the results offer the hopeful

Charting prospect that continued HMO
growth in such areas could
result in more new docs hang-
New ing their shingles up in smaller
cities and rural locations.

Territory ”Reprinted from December 21, 1998 issue
of Business Week, by special permission,
copyright © 1998 by The McGraw-Hill
Companies, Inc.
Health officials have long
bemoaned the fact that new
Many physicians are relocating to rural
doctors tend to choose to prac- areas. A major reason is avoiding cost-
tice in large, relatively affluent control pressures that health-maintenance
communities, with the result organizations place on them.
that many smaller towns and
rural areas are often undersup-
Examining the Newsclip
plied. Now, changes in the health-care market
itself may be starting to cure the “maldistribu- 1. Sequencing Information What trend does
tion” of doctors. the RAND research show regarding doctors™
According to a new RAND study, the growth choices of location?
of health-maintenance organizations is shifting
2. Finding the Main Idea What theory do the
the locales where new docs decide to practice. At researchers offer to support this relocation
the start of the 1990s, reports Jose J. Escarce of trend?
RAND, newly graduated general practitioners
3. Understanding Cause and Effect Do you
tended to locate in large metro areas where
think the theory is the best explanation for
HMOs were well established, while new special-
the trend? What other factors affect where
ists chose metro areas regardless of HMO pres- doctors locate their practices?
ence. By 1994, however, new generalists and

156 UNIT 2 MICROECONOMICS
Section 1 high, a temporary surplus appears until the price
goes down. If the price is too low, a temporary short-
Prices as Signals (pages 137“140) age appears until the price rises. Eventually the mar-
ket reaches the equilibrium price where there is
• Prices serve as signals to both producers and con- neither a shortage nor a surplus.
sumers. In doing so, they help decide the three
• A change in price can be caused by a change in
basic WHAT, HOW, and FOR WHOM questions
supply or a change in demand. The size of the
that all societies face.
price change is affected by the elasticity of both
• High prices are signals for businesses to produce curves. The more elastic the curves, the smaller the
more and for consumers to buy less. Low prices price change; the less elastic the curves, the larger
are signals for businesses to produce less and for the price change.
consumers to buy more.
• The theory of competitive pricing represents a set of
• Prices have the advantages of neutrality, flexibility, ideal conditions and outcomes. The theory serves as a
efficiency, and clarity. model by which to measure the per-
• Other nonprice allocation methods such as rationing formance of other, less competi-
can be used. Under such a system, people receive tive markets. Because of this,
ration coupons, which are similar to tickets or absolutely pure competition
receipts that entitle the holder to purchase a certain is not needed for the theory
amount of a product. of competitive pricing to be
practical.
• Nonprice allocation systems suffer from problems
regarding fairness, high administrative costs, and
diminished incentives to work and produce.
Section 3
• A market economy is made up of many different
Social Goals vs. Market
markets, and different prices prevail in each. A
change in price in one market affects more than
Efficiency (pages 150“155)
the allocation of resources in that market. It also
affects the allocation of resources between markets.
• Governments sometimes fix prices at levels above or
below the equilibrium price to achieve the social
goals of equity and security.
Section 2
• If the fixed price is a price ceiling, as in the case of
The Price System at Work rent controls, a shortage usually appears for as long
as the price remains fixed below the equilibrium
(pages 142“148) price.

• Agricultural price supports were introduced during
Economists often use an economic model to help
the 1930s to support farm incomes. Nonrecourse
analyze behavior and predict outcomes. Models of
loan support programs allowed farmers to borrow
economic markets are often represented with supply
against crops, and then keep the loan and forfeit
and demand curves in order to examine the concept
the crop if market prices were low.
of market equilibrium, a situation in which prices
are relatively stable, and the quantity of output sup-
• Later, deficiency payments were used, supplying the
plied is equal to the quantity demanded. farmer with a check that made up the difference
• between the target price and the actual price
In a competitive market, prices are established by the
received for the product.
forces of supply and demand. If the price is too


CHAPTER 6: PRICES AND DECISION MAKING 157
Section 2 (pages 142“148)
3. Cite an example of an economic model used in this
chapter.
4. Explain the role of shortages and surpluses in
Self-Check Quiz Visit the Economics: Principles
competitive markets.
and Practices Web site at epp.glencoe.com and
click on Chapter 6”Self-Check Quizzes to prepare
5. Describe three causes of a price change in a
for the chapter test.
market.


Section 3 (pages 150“155)
Identifying Key Terms
6. Explain why shortages and surpluses are not
Write the key term that is an effect of the five causes stated
temporary when price controls are used.
below. Some causes may have more than one effect.
7. Identify two programs that have historically been
a. rationing e. equilibrium price
used to stabilize farm incomes.
b. economic model f. loss leader
8. Explain what is meant by the statement that mar-
c. surplus g. price ceiling
kets “talk.”
d. shortage h. price floor
1. Cause: The government tries to keep prices down
by legislating price ceilings. Effect: ______
Thinking Critically
2. Cause: The government wants to allocate scarce
1. Making Generalizations Some people argue that
goods and services without the help of a price
the minimum wage is not a fair price. Use a web
system. Effect: ______
like the one below to help you identify reasons for
3. Cause: A reasonably competitive market is experi-
this argument. Explain why you agree or disagree.
encing alternating, yet consecutively smaller, sur-
pluses and shortages. Effect: ______
Reason #1
4. Cause: People decide that farmers should receive a Minimum wage
higher price for milk and cheese, so a price floor for
Reason #2
these products is established. Effect: ______
5. Cause: A market is at equilibrium, but the product
falls out of style before producers can reduce pro- 2. Making Predictions Suppose that your state
duction. Effect: ______ wanted to make health care more affordable for
everyone. To do this, state legislators put a series
of price controls”price ceilings”in place that cut
Reviewing the Facts the cost of medical services in half. What would
happen to the demand for medical services at the
Section 1 (pages 137“140)
new, lower price? What would happen to the supply
1. Describe four advantages of using price as an allo- of medical services that doctors would be willing to
cating mechanism. provide at the new, lower price? Where do you
think new doctors would prefer to set up practice?
2. List three problems of allocating goods and services
Explain the reasons for your answers.
using nonprice-related methods.



158 UNIT 2 MICROECONOMICS
Applying Economic Concepts Technology Skill
1. Rationing Suppose that a guest speaker visited Using a Spreadsheet Use your personal buying deci-
your class and left 20 ballpoint pens as samples” sions to create a spreadsheet and graph showing how
not knowing that there were 30 students in the a market equilibrium price is reached.
class. Devise a nonprice rationing system that 1. Select a product that costs about $5.00.
would fairly allocate the scarce item to everyone in
2. In cells A1 through C1, enter the words Price,
the class.
Demand, and Supply.
2. Equilibrium Price Many people feel that the min-
3. In cells A2 through A11, enter prices that range
imum wage is too low. If it increased by $1 per
from $1.00 to $10.00.
hour, what would happen to the number of stu-
4. In the next two columns, enter quantities that
dents who would want to work after school? What
might be demanded and supplied at those prices.
would happen to the number of workers that stores
in your community would want to hire? Would the 5. Highlight the three columns on the spreadsheet,
combination of these factors cause a shortage or a then click on “Chart Wizard” or a similar icon, or
surplus of workers in your community? Provide an click on “Insert” and then “Chart.”
explanation for each of your answers.
6. Click on “line graph,” then highlight a 2-line chart
sub-type.
Math Practice 7. Follow the spreadsheet directions to title your graph.
A shoe store is having a sale. The first pair of shoes
sells for $40. The second pair sells for half price, or
$20. The next pair sells for half of that, and so on.
Synthesizing Information Examine the fig-
Make a table, like the one below, that tracks the total ure, then answer the questions that follow.
cost of the shoes as each pair is added.
$30 D
S
25
Number of Pairs Total Cost
20
Price




15
10
D
5S
0 1 3 6 9 1011 13 15
Quantity
1. What is the quantity demanded at a price
of $20? At $15?
2. What is the quantity supplied at a price of
$10? At a price of $20?
Thinking Like an Economist 3. How large is the shortage or surplus at $5?
Explain your answer.
Economists like to use cost-benefit analysis to ana-
4. If the price started out at $5 today, what
lyze the merits of any program. Use this decision-
would likely happen to the price tomor-
making strategy to evaluate the desirability of row? Why?
continuing to support and stabilize farm income.
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

CHAPTER 6: PRICES AND DECISION MAKING 159
Setting Up the Workshop
For this workshop you should work with one
other person. Your task is to write a technical
manual or report that explains how to construct,
instruct, build, rebuild, or just plain create a
product or process. Your audience must be
real”fellow students, your teachers, your family
members, etc. Keep this goal in mind as you do
your work: The reader will learn something
important, functional, and worthwhile after
using your manual.



Criteria for Manuals
Developing a Your finished manual should include all of
the following:
Training Manual • Numbered pages
• Title page
From the classroom of . . . • Statement of purpose
Juan C. Ledesma
• Table of contents that includes at least five
Flanagan High School sections
Pembroke Pines, Florida • At least five sections that explain “how to”
The forces of supply and demand deter- • Scaled pictures or drawings of important
parts, plans, and procedures, placed appro-
mine what is produced and made avail-
priately in the manual
able to the consumer. Many products in
• Chart, or graphic organizer, that reveals
the marketplace would have little value if
some important, usable data (e.g. a survey)
you”the consumer”did not know how to
• Reference list of at least five other
use the product. Thus, as new products
resource materials that could be utilized
and technology are developed, a demand
• Information gained from an interview
is created for manuals that illustrate the with an expert on the topic
correct way to use the product. In this
• Alphabetized index of the important topics
workshop, you will write a “how-to” in the manual
manual or report. The manual will illus- • Checklist for procedures
trate how to accomplish a process or func-
• Troubleshooting guide with at least ten
tion that you™ve chosen to describe. “what if” problems
• Review/rating/recommendation by some-
one who has tried the manual




160 UNIT 2 MICROECONOMICS
Procedures Summary Activity
Present your training manual to your class,
STEP 1 using the following guidelines:
Determine what process you will describe. 1. Explain the rationale for your manual™s
subject.
STEP 2 2. Describe the aspirations you hold for your
product and its user.
Do research in your school library or on the
Internet for information about your process. 3. Describe any technology you used to create
Interview a person locally who is familiar with your manual.
the process. 4. Describe the trials and errors you encoun-
tered in developing your manual.
STEP 3 5. Describe the problems that you might fore-
see that could still be addressed (and even
Make an outline of the process you hope to
solved) if you had the time.
describe. A flowchart, like the example shown
below, is often a good way to get started
“mapping” the steps in a process.

Process to get ready for school
Start End
1 2 3 4 5a
Eat Catch
Wake up Shower Dress
breakfast the bus
5b
Drive to
school



STEP 4
Put your manual together following the
criteria listed at left.




UNIT 2 MICROECONOMICS 161
Advertisers try to persuade
consumers to purchase
their products.



Why are some products
available at competitive
prices? Why are other products
priced higher? In Chapter 7, you
will learn about the various
effects competition and market
structures have on the prices
you pay. To learn more about
competition in a free enterprise
system, view the Chapter 8
video lesson:
Competition and Monopolies




Chapter Overview Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and
click on Chapter 7”Chapter Overviews to preview
chapter information.
Competition and Market
Structures
Main Idea product differentiation, nonprice competition, oli-
Market structures include perfect competition, gopoly, collusion, price-fixing, monopoly, natural
monopolistic competition, oligopoly, and monopoly. monopoly, economies of scale, geographic monop-
oly, technological monopoly, government monoply
Reading Strategy
Graphic Organizer As you read the section, complete Objectives
a graphic organizer similar to the one below by iden-
After studying this section, you will be able to:
tifying five conditions that characterize perfectly
1. Explain the characteristics of perfect competition.
competitive markets.
2. Understand the nature of monopolistic
competition.
Perfect 3. Describe the behavior and characteristics of the
competition
oligopolist.
4. Identify several types of monopolies.

Applying Economic Concepts
Key Terms Product Differentiation Think of a popular brand of
laissez-faire, market structure, perfect competition, shoes or clothing. Read to find out why sellers go to
imperfect competition, monopolistic competition, such lengths to differentiate their products.




W
hen Adam Smith published An Inquiry into
Cover Stor y the Nature and Causes of the Wealth of Nations
in 1776, the average factory was small, and
lers
Discount for Times Bestsel business was competitive. Laissez-faire, the philosophy
War
Sparks On-line Book Price
that government should not interfere with commerce or
trade, dominated Smith™s writing. “Laissez-faire” is a
French term that means “allow them to do.” Under lais-
SEATTLE”A price
war among the three sez-faire, the role of government is confined to protect-
biggest on-line book- ing private property, enforcing contracts, settling
sellers broke out yester- disputes, and protecting businesses against increased
day when Amazon.com competition from foreign goods.
announced 50 percent By the late 1800s, however, competition was
off all New York Times weakening. In some markets mergers and acquisi-
On-line discounts
[best-selling books] and tions had combined many small firms into a few
Ba rn es an dn ob le .c om
matched the discount. very large businesses. As industries developed”
rders.com immediately
and Bo ll
n that the companies wi industry, meaning the supply side of the market, or
deep discounts will mea
The
oks, but the offer could
little or no profit on the bo all producers collectively”the nature of competitive
make
lucrative products as cus-
ulate sales of other more markets changed. Many modern markets, such as
stim
the Web sites. . . .
tomers browse through the one discussed in the cover story, are now domi-
, 1999
y 18 nated by a few very large firms.
”The Boston Globe, Ma


CHAPTER 7: MARKET STRUCTURES 163
Perfect Competition
Market Structures
Perfect competition is characterized by a large
number of well-informed independent buyers
and sellers who exchange identical products. It repre-
sents a theoretically ideal situation that is used to
evaluate other market structures. Five major condi-
tions characterize perfectly competitive markets.


Necessary Conditions
The first condition is that there are a large num-
ber of buyers and sellers. No single buyer or seller is
large enough or powerful enough to affect the price.
The second condition is that buyers and sellers
deal in identical products. With no difference in
quality, there is no need for brand names and no
need to advertise. One seller™s merchandise is just as
good as another™s. The market for table salt shares
some of these features. Because salt is always the
same chemical”sodium chloride”there is no logical
reason to prefer one brand of salt over another.
The third condition is that each buyer and seller
acts independently. This ensures that sellers com-
pete against one another for the consumer™s dollar,
and that consumers compete against one another
to obtain the best price. This competition is one of
the forces that keeps prices low.
Conditions A market is a place where buyers
The fourth condition is that buyers and sellers
and sellers can exchange products. How do
economists classify markets? are reasonably well-informed about products and
prices. Well-informed buyers shop at the stores
that have the lowest prices. Well-informed sellers
match the lowest prices of their competitors to
Today, economists classify markets according
avoid losing customers.
to conditions that prevail in them. They ask ques-
The fifth condition is that buyers and sellers are
tions such as: How many buyers and suppliers are
free to enter into, conduct, or get out of business.
there? How large are they? Does either have any
This freedom makes it difficult for producers in
influence over price? How much competition

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