Chapter 5: Market Equilibrium

Markets Markets bring together buyers (“demanders”) and sellers (“suppliers”). Some markets are local while others are national or international. Markets help to determine the prices and quantities bought and sold of millions of goods and services.

Demand A curve illustrating the inverse relationship between the price of a product and the quantity demanded of it, other things equal, is the demand curve. It slopes downward to reflect the Law of Demand.

Demand

Changes in Demand A change in demand is a shift of the demand curve to the right (an increase in demand), or to the left (a decrease in demand). Shifts are cause by a change in one or more of the determinants of demand.

Changes in Quantity Demanded A change in quantity demanded is a MOVEMENT along the curve from one point to another point on a fixed demand curve. The cause of such change is an increase or decrease in the price of the product under consideration. Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Supply A curve illustrating the positive, or direct relationship between the price of a product and the quantity supplied of it, other things equal, is the supply curve. It slopes upward to reflect the Law of Supply.

Supply Supply is a schedule or curve that shows the various amounts of a product that producers are willing and able to produce (make) available for sale at each of a series of possible prices during a specific period. The Law of Supply states that, all else equal, as price rises, the quantity supplied rises, and vice versa.

Supply Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Changes in Quantity Supplied A change in quantity supplied is a MOVEMENT ALONG THE CURVE from one point to another point on a fixed supply curve. The cause of such a movement is a change in the price of the product being considered.

Changes in Supply A change in supply is a shift of the schedule or curve, means a shift to the right (an increase in supply), or to the left (a decrease in supply). SHIFT HAPPENS! Shifts are cause by a change in one or more of the determinants of supply.

Market Equilibrium In competitive markets, buyers and sellers have no control over prices. When buyers and sellers interact in a free competitive market, the equilibrium price and equilibrium quantity is determined by the intersection of the demand and supply curves. Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Market Equilibrium The equilibrium price, or market-clearing price, is the price at which the intentions of buyers and sellers match. The equilibrium quantity is the quantity demanded and quantity supplied that occurs at the equilibrium price in a competitive market.

SURPLUS Any price above the equilibrium price would create a surplus, or excess supply; quantity supplied exceeds quantity demanded. Surpluses drive prices down to equilibrium. As prices fall, the incentive to produce declines and the incentive for consumers to buy increases.

SHORTAGE Any price below the equilibrium price would create a shortage, or excess demand; quantity demanded exceeds quantity supplied. Shortages push prices up equilibrium. As prices rise, the incentive to produce increases and the incentive for consumers to buy decreases.

Market Equilibrium

Changes in Demand, Supply, and Equilibrium When supply is constant, an increase in demand will result in a higher equilibrium price and quantity. If demand falls, equilibrium price and quantity decrease.

Changes in Demand, Supply, and Equilibrium Changes in Supply With a constant demand, if supply increases, equilibrium price falls while equilibrium quantity rises. If supply decreases, equilibrium price rises, and equilibrium quantity falls.

Changes in Demand, Supply, and Equilibrium

Changes in Demand, Supply, and Equilibrium Shifts in either supply or demand change equilibrium price and quantity.

Changes in Demand, Supply, and Equilibrium Complex Cases When both supply and demand change, the effect is a combination of the individual effects. The relative sizes of the change in demand and supply will determine the effect on equilibrium price and quantity. In some cases, the effect is certain; in others the effect depends on the size of the shifts.

Changes in Demand, Supply, and Equilibrium Example: Supply Increases, Demand Decreases CASE 1 CASE 2 S1 S1 S2 S2 D2 P1 P1 P2 P2 D1 D1 D2 Q1 Q2 Q2 Q1 Price decreases, quantity decreases Price decreases, quantity increases

Changes in Demand, Supply, and Equilibrium Example: Supply Increases, Demand Decreases CASE 3 If the shift in the supply curve to the right (an increase) is equal to the shift in the demand curve to the left (a decrease), then the equilibrium price will decrease and the equilibrium quantity will not change.

Changes in Demand, Supply, and Equilibrium Change in Supply Change in Demand Change in Price Change in Quantity Increases Decreases ↓ ↑, ↓, or no change ↑ ↑, ↓, or no change

Government-Set Prices In most markets, prices are free to rise or fall with changes in demand and supply. However, sometimes the resulting price in a market is “too high” or “too low”. Government may place legal limits on how high or how low a price or prices may go. High prices may be unfair to buyers whereas low prices may be unfair to sellers.

Price Ceiling If the price of a product is unfairly high, the government can set a price ceiling, or a legal maximum price a seller may charge for a product. This purportedly enables consumers to obtain some “essential” good or service that they could not afford at the equilibrium price; however, it also creates a shortage of the good.

Price Ceiling Example Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Floor When the price of a good or service is “too low”, the government can set a price floor, or a minimum fixed price that sellers can charge. The goal is to provide a sufficient income for certain groups of resource suppliers, or producers who would otherwise receive very low incomes at the equilibrium price. However, a surplus of the good is created.

Price Floor Example

Summary Discussion of Learning Objectives Determining market price and equilibrium quantity The demand and supply curves intersect at the market clearing, or equilibrium point. Surpluses exist if the price of the good is greater than the market price. Shortages exist when the price of a good is below the market price.

Summary Discussion of Learning Objectives The English historian Thomas Carlyle once said: “Teach any parrot the words supply and demand and you’ve got an economist.”