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This recap covers the September 22 class, the second and final session on Markets and Coordination (Part 1, September 17, is the page before this one in the module). Class reopened at the four-buyer car table, then delivered the fire and the price ceiling, the four words (scarcity, reduction in supply, shortage, surplus), and the topic’s recap. Two TopHat items ran. The last fifteen minutes were open questions: toilet paper in 2020, restaurant waits, Starbucks points, and the Rolex puzzle. Read the four-step diagnostic first. Then use the lecture sections to reconnect each idea to an example from class. Finish with the application checks. The separate transcript has the full explanation, word for word.

What you should be able to do

1. Find the clearing price from individual demand schedules and a fixed stock, and say what happens one row above (surplus) and one row below (shortage).
2. Explain why the final allocation of a fixed stock does not depend on who owns it at the start, under the stated assumptions (people can trade; no transaction costs).
3. Predict the effect of a fall in the stock with a free price and with a price ceiling, and name the ways a shortage gets rationed when the price cannot rise.
4. Classify a situation as scarcity, a reduction in supply, a shortage, or a surplus, and name what causes each.

Core · Finishing markets and coordination

Seven cars, four buyers. Where do they clear?

Market prices are social coordinators: in equilibrium, everybody’s behavior is mutually consistent. Four buyers, A through D, each with a demand schedule, and seven cars. The price will be $7,000. Why not $8,000? Only six cars would be demanded and one would be left over, which economists call a surplus. Why not $6,000? People would want eight cars and there are only seven, a shortage. The price tells everybody how to adjust their behavior to be consistent with the preferences of everybody else.

Give person A all seven cars. What happens?

Assume no transaction costs and give A all seven cars. A’s first car is worth $10,000 to him and his second $8,000, and his fifth, sixth, and seventh are each worth less than $1,000. B values a first car at $9,000. So B can offer $9,000 for a car and A will say yes, because the cost to A of holding that car is what somebody else would pay for it. People keep trading until they reach equilibrium, which is another way of saying no gains from trade are left. At $7,000, A ends up with two cars, B one, C two, D two, and all seven are allocated to where they are valued most. You would get the same result if B, C, or D had started with all seven. And the market demand for oil, milk, or apartments is found the same way as for these cars: add up the individual demands at each price.

TopHat check: which price clears the seven cars, and why?

The item: seven identical cars are available and the buyers’ demands are combined at each price. Which price establishes market clearing, and why? $7,000: at any other price the four people keep bargaining until the price leaves neither a shortage nor a surplus.

That gives you a test for the news. When someone says there is a shortage of something, they usually mean there is not enough to go around to satisfy everyone’s wants. That is scarcity, and it is always true: there is never enough gasoline, food, or apartments to satisfy everybody. If they mean that the amount people want to buy exceeds the amount available, ask at once: why isn’t the price rising? Hear “a surplus” and ask why the price isn’t falling. Shortages and surpluses are caused by prices not adjusting, so the question becomes what is stopping the price (after the exam, the course looks at policies that do that).

The price does what a benevolent dictator would do

Even with only seven cars and no way to make more, the price is useful: it rations the seven cars to those who value them most. A benevolent dictator whose goal was to make people as well off as they understand it (not as he understands it) would hand out the cars exactly the way the market does. In practice benevolent dictators very quickly become not-so-benevolent dictators. The market gets the same outcome without anybody in charge.

One car is destroyed. Would a higher price do any good?

Now there are six cars. We would expect the price to rise. Suppose we do not let it: at $7,000 seven cars are demanded and six exist, so there is a shortage. Even when a higher price cannot bring out one more car, you would still want the price to rise, because the higher price allocates the six cars to the people who value them most. Let it rise to $8,000 and six are wanted: no shortage.

A ceiling at $7,000: what moves instead of the price?

Suppose voters call an $8,000 car unconscionable and make any price above $7,000 illegal. A real example from class: freezing rents. Now there is a shortage, and it gets resolved some other way. The seller says he cannot charge more than $7,000 for the car, but the keys are $1,000. The price control does not make cars cheaper; the instructor’s point, which the course returns to after the exam, is that price controls fail on their own stated objective. The ceiling also blocks gains from trade: a sale at $8,000 to someone who values the car at $8,000 is now illegal. And it does not change the underlying fact that there are six cars, not seven. Making it illegal for the price to rise is like smashing the thermostat because it tells you it is hot outside. It is still hot outside.

A student asked whether a friend could simply rent to them at the frozen rent. With one friend, maybe. But a landlord has several friends. One offers the $7,000 official rent; another offers $7,001; a third, $7,002. Competition among the friends bids the real price up, and in equilibrium whoever wins the apartment pays the official rent plus a $1,000 bribe. To think like an economist: solve for the equilibrium, because it is never just one friend.

Hurricanes, price-gouging laws, and gas lines

After a hurricane hits Florida, the demand for water, gasoline, and food rises, and so do their prices. Politicians respond with price-gouging laws, but there is no scientific definition of price gouging: it means the price is higher than someone feels it ought to be. Holding the price down does not create more water. People with extra water or gasoline get approached by more than one buyer, the price gets bid up anyway, and the trade moves under the table into a black market. A student added that there are other ways to allocate a scarce good. For most of human history, the main one was violence: might makes right. When President Nixon put price controls on gasoline in the 1970s, there were long lines, and people fought each other at the pumps; stations posted signs that they would close the moment anyone started a fight.

Why do politicians impose price controls?

A political-economy question from a student. One argument: politicians take advantage of voter ignorance. Voters dislike higher prices, and most do not understand that the higher price is what prevents a shortage. The higher price does not cause the shortage; holding the price down does. Why are voters ignorant of this? The probability that one vote changes an election is smaller than the chance of dying in a car accident on the way to the polls. People do things up to the point where the marginal benefit equals the marginal cost, so if the benefit of a vote is close to zero and becoming informed costs anything, the sensible strategy is not to vote, or to vote without becoming informed. The uninformed voter’s vote counts exactly as much as the informed one’s. That is why, in the instructor’s view, making every politician take microeconomics would not make much difference.

A shortage is not scarcity, and a surplus is not abundance

Shortage and surplus are technical terms that relate to price. A shortage means the price is below the equilibrium price; a surplus means it is above. In free markets, prices adjust until no gains from trade are left, so another way to describe a shortage or a surplus is gains from trade that are not being captured. Scarcity is different: people want, in essence, an unlimited number of cars, so there is not enough to satisfy everybody at a price of zero. The instructor’s meme: Scooby-Doo unmasks the villain labeled “complaints about capitalism,” and under the mask is “the human condition.” Scarcity existed under communism too; the only question is how you deal with it.

TopHat check: nine cars, and buyers want ten at $3,000

The item: a car market has nine cars available, but at a price of $3,000 buyers want ten. Which interpretation best explains the situation? The answer: a shortage created by a price held below the market-clearing level. People want ten and nine exist, so the price would have to rise until quantity demanded equals nine. It is not scarcity, because scarcity exists at every price. It is not a reduction in supply, because no cars disappeared. And it is certainly not a surplus, because quantity demanded exceeds quantity supplied. (Explaining the $7,000 row just before the poll, the instructor said that price makes quantity demanded “exceed” quantity supplied; the rule on the slide, and his own explanation, is that at $7,000 the two are equal.)

Three ideas explain how strangers get coordinated

The recap. First, middlemen: they can raise the cash price of an egg to the buyer and lower the price paid to the farmer, because they reduce transaction costs. Second, closing a market, as with taxi medallions: limit who may offer the service and ask who benefits and who loses. Third, let prices adjust: even if a fire cuts the stock of cars from seven to six, the price rises, and there is no shortage. With that, the instructor said, he had covered all the material he wanted to cover before the first exam.

Discussion · Bare shelves, long waits, and a watch you cannot buy

Scarcity versus shortage, once more

Scarcity applies all the time: you have only 24 hours in a day and must decide how to use them. A shortage happens because prices are not adjusting, and it goes away if the price rises. Burn one of the seven cars and scarcity has gotten worse; but if the price rises, there is no shortage. As long as prices are free to adjust, we should not expect to see shortages or surpluses.

Toilet paper in spring 2020

Empty shelves mean quantity demanded exceeds quantity supplied: a shortage, and a sign the price is too low. Stores that raised the price risked price-gouging accusations, so, in the Texas stores the instructor saw, they held the price and rationed by quota instead: one package per household. Meanwhile commercial toilet paper, made on different machines for offices and universities, piled up: a surplus in the commercial market and a shortage in the home market. The commercial price was too high and the home price too low, and the machines could not switch from one kind to the other.

The Friday-night wait at a restaurant

A long wait without a reservation tells you the price of the food is too low: more seats are wanted than exist. Why not raise the price on Friday night? Customers may value a menu price they can count on and pay in waiting instead. And an underpriced Friday creates a wait, the wait makes people book, and reservations tell the restaurant what demand will be, so it can plan inventory and not end up with ground beef spoiling in the fridge. Starbucks pays for the same information another way: points for ordering on its app, which reveals your demand patterns. The points share some of the gains from trade with you, a lower average price for your coffee.

The Rolex puzzle

A Rolex store would not sell the instructor a Root Beer GMT (list price $12,000) even for $15,000 on the spot; the wait was quoted at ten years. A long wait means the price is well below equilibrium. The puzzle is why a watch company would do that when comparable brands such as Omega do not. Used ones sell on the secondary market (Chrono24) for about 30% above the new list price, so resellers and the dealers who control the waiting lists capture gains that Rolex leaves on the table. Two candidate theories: the waiting list reveals demand, like the Starbucks points, or Rolex is a snob good whose buyers pay for exclusivity. The instructor doubts the second because it is hard to falsify, and he dislikes theories that cannot be falsified. He closed with one more possible piece: he had learned that Rolex is not organized as an ordinary for-profit company. He left the puzzle open, calling it a good research question.

Exam 1 logistics (as announced in class)

The review session is Thursday, September 24, run by the TA, Anna, and built from the actual exam. A study guide, also built from the exam, will be posted in the Exam 1 module. A practice exam opens on Canvas on Friday, September 25, and stays open through Monday. It is timed and does not count toward your grade; take it after the review session. Exam 1 is Tuesday, September 29: 40 multiple-choice questions. Bring a green Scantron and a pencil. The exam is open note: handwritten notes, printed notes, and the study guide are all allowed.

The instructor’s advice for an open-note exam: do not plan to look up every answer, because you will run out of time, and every question counts the same. First go through the whole exam and answer the ones you know for sure. Then go through again for the ones you are about 80% sure of. Keep going until only the hard ones are left, and use your notes on those.

Examples are memory cues; the right column is the principle each example should help you recover.

Example from class	Economic lesson
Why not $8,000? Why not $6,000?	Above the clearing price a car goes unsold (surplus); below it more are wanted than exist (shortage).
Give A all seven cars	If people can trade, the starting owner does not change where the goods end up; trade continues until no gains from trade are left.
B offers $9,000 for A’s second car	The cost of holding something is what someone else would pay for it.
The benevolent dictator	The price rations goods to those who value them most, the outcome a well-meaning planner would want, without anyone in charge.
One car burns; the price rises to $8,000	A reduction in supply with a free price is not a shortage; the higher price rations even a stock that cannot grow.
“The car is $7,000, but the keys are $1,000”	A ceiling does not make the good cheaper; the rationing moves to other charges.
Three friends bid $7,000, $7,001, $7,002 for the frozen-rent apartment	Solve for the equilibrium: competition bids the real price up, here as a bribe.
Smashing the thermostat	A price reports underlying conditions; a price control silences the report without changing the conditions.
Price-gouging laws after a hurricane	“Gouging” has no scientific definition; holding the price down leaves a shortage and a black market.
Nixon’s gasoline controls and fights at the pump	When price cannot ration, something else does: lines, and sometimes violence.
One vote and the car accident on the way to the polls	When one vote almost never decides, voters have little reason to become informed; politicians can exploit it.
Scooby-Doo unmasks “the human condition”	Scarcity exists under every system; the question is how to deal with it.
Nine cars, ten wanted at $3,000	A shortage is caused by a price held below clearing, not by scarcity or a fall in the stock.
Bare home shelves, pallets of office toilet paper	One price too low (shortage) and another too high (surplus); the machines could not switch between the two.
The Friday-night wait and the reservation	A wait signals a price below equilibrium; a firm may underprice on purpose to learn about demand.
Starbucks app points	The firm pays for information about your demand by sharing gains from trade with you.
A ten-year wait for a Root Beer GMT	A long wait means the price is below equilibrium; why a firm would do that on purpose is an open puzzle.

Question 1 — Three fans want concert tickets. At $90 they want 1, 0, and 1; at $70, 2, 1, and 1; at $50, 2, 1, and 2; at $30, 3, 2, and 2. Five tickets exist and no more can be printed. Where does the market clear, and what happens at $70 and at $30?

Add across each row: 2 tickets wanted at $90, 4 at $70, 5 at $50, 7 at $30. The market clears at $50, where the five wanted equal the five that exist. At $70 one ticket would go unsold, a surplus, and its holder would cut the price. At $30 seven are wanted for five tickets, a shortage of two, and fans would bid the price up.

Question 2 — In the same market, the first fan starts out holding all five tickets. Trading is voluntary and costless. Where do the tickets end up?

The same place as before: 2, 1, and 2 at $50. The first fan wants only two tickets at $50, so his third, fourth, and fifth are worth less than $50 to him, and the other fans will pay at least $50 for them. He sells until no gains from trade are left, just as A did when he started with all seven cars.

Question 3 — One ticket is lost, leaving four. The price is free to adjust. What is the new price, and is there a shortage?

At $70 the fans want 2 + 1 + 1 = 4, so the price rises to $70. There is no shortage: the four tickets wanted equal the four that exist. Scarcity got worse and supply fell, but the higher price rations the four tickets to the fans who value them most, as $8,000 did for the six cars.

Question 4 — Instead, the city makes any ticket price above $50 illegal after the loss. What happens?

At $50 five tickets are wanted and four exist: a shortage of one. The ceiling does not create a fifth ticket. The four still get rationed, now by something other than the posted price: a charge for the wristband, a side payment, a line, or who knows the seller. And a trade at $70 that would make both sides better off is illegal.

Question 5 — A news story says there is a “shortage of beachfront homes” because not everyone who wants one can have one. Is that a shortage in the economic sense?

No. Not everyone can have what they want: that is scarcity, and it is always true. A shortage means quantity demanded exceeds quantity supplied at the current price, and the question to ask is why the price is not rising. If beachfront prices are free to rise, they ration the homes and there is no shortage, however scarce the homes are.

Question 6 — After a hurricane a store keeps bottled water at its pre-storm price under a price-gouging law. What does the law change, and what does it not change?

It changes who gets the water and how: the shelves empty, and the water goes to whoever arrives first, waits longest, or pays under the table. It does not change the amount of water in the area, which is the underlying problem. Like smashing the thermostat, it silences the signal without changing the conditions.

Question 7 — A popular restaurant has a 90-minute wait every Friday night, yet it never raises its Friday prices. What does the wait tell you, and give one reason from class why the restaurant might keep the price.

The wait means the price is below equilibrium: more seats are wanted than exist, and customers pay part of the price in waiting. The restaurant may keep the price because customers value a price they can count on, or because the wait gets people to make reservations, which tell the restaurant what demand will be so it can plan its inventory.

Question 8 — In spring 2020, home toilet paper sold out while office toilet paper sat unsold in warehouses. Which price was too low, and which too high?

The home price was too low: bare shelves mean a shortage. The commercial price was too high: unsold stock means a surplus, which only a lower price would clear. The two could not simply balance out, because the machines that make office rolls cannot make home rolls.

Bottom line

Add up what every buyer wants at each price and the market clears where that sum equals what exists: seven cars at $7,000, whoever owned them first. If a fire leaves six, a free price rises to $8,000 and rations them with no shortage. Hold the price at $7,000 and the shortage appears; the cars are still rationed, by fees, bribes, lines, or fights, and trades that would help both sides are blocked. Scarcity is permanent; a shortage or surplus is a price that is not allowed to move. That completes Markets and Coordination and the material for Exam 1.