MARKET EQUILIBRIUM

Microeconomics Lecture 4

Market Any place people come together to trade.

Trade or exchange

may take place at a

physical or virtuallocation.

Demand - A Definition

The willingness and ability of buyers to purchase different quantities of a good at different prices during a specific time period.

Law of Demand As the price of a good rises, thequantity demanded of the good falls,and as the price of a good falls, thequantity demanded of the good

rises,ceteris paribus.

Price

Quantity

Ceteris Paribus

A Latin term meaning “all other thingsconstant” or “nothing else changes.”

Ceteris paribus is an assumption used toexamine the effect of one influence on an

outcome while holding all other influences constant.

Prices Absolute (Money) Price - The price of a

good in money terms. Relative Price (opportunity cost) - The

price of a good in terms of another good.

Supply The willingness and ability of sellers to

produce and offer to sell different quantities of a good at different prices during a specific time period.

Law of Supply As the price of a good rises, the quantity

supplied of the good rises, and as the price of a good falls, the quantity supplied of the good falls, ceteris paribus.

Price

Quantity

Equilibrium

Market Clearance Price.Equilibrium occurs at a price of $3 and a quantity of 30 units.Market equilibrium Qd= Qs

Market Equilibrium

Surplus and Shortage

Surplus (Excess Supply) - A condition in which quantity supplied is greater than quantity demanded.

Surpluses occur only at prices above equilibrium price.

Shortage (Excess Demand) - A condition in which quantity demanded is greater than quantity supplied.

Shortages occur only at prices below equilibrium price.

Consumer and Producer Surplus

Consumer Surplus

CS = Maximum buying price - Price paid

CS = the difference between the maximum price a buyer is willing and able to pay for a good or service and the price actually paid.

Producer Surplus

PS = Price received - Minimum Selling Price

PS = The difference between the price sellers receive for a good and the minimum or lowest price for which they would have sold the good.

Consumer and Producer Surplus

Total Surplus (TS)

TS = CS + PS Total Surplus (TS) is the sum of

consumers’ surplus and producers’ surplus.

Total Surplus

Equilibrium

ActivityPlot the Supply and Demand curve & find market equilibrium P&Q

Supply and demand for pizzaPrice $

per pizzaQd Qs

10 0 408 10 306 20 204 30 102 40 00 125 0

ActivityPlot the Supply and Demand curve & find market equilibrium P&Q

What would happen if demand for pizzas tripled at each price?

What would occur if the price were initially set at $4 per pizza? Supply and demand for pizza

Price $ per pizza

Qd Qs

10 0 408 10 306 20 204 30 102 40 00 125 0

Plot the Supply and Demand curve & find market equilibrium P&Q

Market Effects of Simultaneous Changes in Supply and Demand

Both the equilibrium price and the equilibrium quantity will increase.

The equilibrium price will decrease and the equilibrium quantity will increase.

Using the Model to PredictChanges in Price and Quantity

An increase in university enrollment will increase the demand for apartments, shifting the demand curve to the right. Both the equilibrium price and the equilibrium quantity will increase.

A report of pesticide residue on apples decreases the demand for apples, shifting the demand curve to the left. Both the equilibrium price and the equilibrium quantity will decrease.

Predicting the effects of changes in Supply

Technological innovation decreases production costs, shifting the supply curve to the right. The equilibrium price decreases, and the equilibrium quantity increases.

Bad weather decreases the supply of coffee beans, shifting the supply curve to the left. The equilibrium price increases, and the equilibrium quantity decreases.

Explaining Changes in Price or Quantity

At the same time the quantity increased, the price decreased. Therefore, the increase in consumption resulted from an increase in supply, not an increase in demand.

At the same time the price decreased, the quantity decreased. Therefore, the decrease in price was caused by a decrease in demand, not an increase in supply.

Price Ceilings & Floors A price ceiling is a legal maximum price

that can be charged for a good. Results in a shortage of a product (to control

inflation) Common examples include apartment rentals

and credit cards interest rates. Example: World war II butter price control

A price floor is a legal minimum price that can be charged for a good. Results in a surplus of a product Common examples include soybeans, milk,

minimum wage, support for agricultural prices.

Price Ceiling

A price ceiling is set at $2 resulting in a shortage of 20 units.

Price Floor

A price floor is set at $4 resulting in a surplus of 20 units.

Exploring Supply and Demand

. If Jackie's income rises, what happens to her demand for airplane trips? If the income of most consumers of air travel rises (and air travel is a normal good), what will happen to the market equilibruim price P and quantity Q of this good?

2. If the taste for sneakers severely

declines, what happens to their price and the quantity sold?

P falls Q falls

D

3. If the price of materials used to make

sneakers rises sharply, what happens to the price and the quantity sold of sneakers?

P rises Q falls

4. If the technology for making some

communications device (say, cellular telephones) leaps forward, what is most likely to happen to the price and the quantity sold?

P falls Q rises

5. Consider the supply and demand for

coffee in London. Suppose the price of tea rises sharply. If coffee is a substitute good for tea, what happens to the price and quantity of coffee?

P rises Q rises

6. A new rumor sweeps the country that

eggs are great diet food and they don't even raise cholesterol levels. At the same time, advances in chicken husbandry increase the number of eggs that can be produced. What happens to the price and quantity of eggs? (hint: both supply and demand are affected)

P Indeterminant Q rises

Increases in Demand and Supply

Higher demand leads to higher equilibrium price and higher equilibrium quantity.

Higher supply leads to lower equilibrium price and higher equilibrium quantity.

Decreases in Demand and Supply

Lower demand leads to lower price and lower quantity exchanged.

Lower supply leads to higher price and lower quantity exchanged.

Relative Magnitudes of Change

• The relative magnitudes of change in supply and demand determine the outcome of market equilibrium.

Relative Magnitudes of Change

• When supply and demand both increase, quantity will increase, but price may go up or down.