Supply, Demand and Equilibrium The point at which Supply and Demand intersect on the graph is called “equilibrium”. This point shows the most desirable price point for both firms and consumers. Sometimes prices are set and changed by firms (supply) and something they are set and changed by consumers (demand). In every case possible, a market will strive to be at equilibrium. If a change occurs that moves one curve, the other curve will follow to get back to equilibrium…

MARKET EQUILIBRIUM Figure shows the equilibrium price and equilibrium quantity. 1. Market equilibrium at the intersection of the demand curve and the supply curve. 2. The equilibrium price is $1 a bottle. 3. The equilibrium quantity is 10 million bottles a day.

What do Prices Tell Us? 1) Prices are Signals Prices send information to buyers and sellers in a market High prices say producers should produce more, and buyers should buy less, low prices say less production, and more buying

2) How Prices Are Determined The Adjustment Process- buyers and sellers compromise or negotiate over prices, as long as the process is voluntary, both sides benefit from the transaction

Price is an Automatic Regulator Price: A Market’s Automatic Regulator Law of market forces When there is a shortage, the price rises. When there is a surplus, the price falls. Shortage can also be referred to as Excess Demand Surplus can also be referred to as Excess Supply We can see shortages and surpluses on our market graph. The law of market forces is important, so you want your students to grasp why prices are driven to the equilibrium. You can choose a good, like concert tickets to the hottest band. Draw a demand-supply graph with a reasonable equilibrium price and quantity. Ask the students what would happen if the concert promoter decided to charge only $10 a ticket. Would students line up before dawn to buy them? Yes! Explain that this is a case of excess demand. Ask them what could the promoter do to get the crowds to go away? Hopefully they will answer, “Raise ticket prices!” Show them how the market pressures the price to rise to the equilibrium price and use the graph to show how the promoter and students move up their respective supply and demand curves. You can do the same thing for excess supply. Let the promoter try to sell tickets for $1,000 each. Again, move down along the supply and demand curves as the market pressures the price to fall.

Surplus & Shortage Surplus- a situation where the quantity supplied is greater than the quantity demanded Shortage- a situation where the quantity supplied is less than the quantity demanded

MARKET EQUILIBRIUM At $1.50 a bottle: Figure shows how a market achieves equilibrium. At $1.50 a bottle: 1. Quantity is supplied 11 million bottles. 2. Quantity demanded is 9 million bottles. The magic of market equilibrium and the forces that bring it about and keep the market there need to be demonstrated with the basic diagram, with intuition, and, if you’ve got the time, with hard evidence in the form of further class activity. If you did the demand experiment, you might want to begin with that and explain that in the classroom market, the supply was fixed (so there was vertical supply curve) at the quantity of bottles that you brought to class. The equilibrium occurred where the market demand curve (demand by the students) intersected your supply curve. Then, if you did the supply experiment, you can explain that in that classroom market, demand was fixed (so there was a vertical demand curve) at the quantity that you had decided to buy. The equilibrium occurred where the market supply curve (supply by the students) intersected your demand curve. Point out that the trades you made in your classroom economy made buyers and sellers better off. If you want to devote a class to equilibrium and the gains from trade in a market, you might want to run a double oral auction. There are lots of descriptions of these and one of the best is at Charlie Holt’s http://veconlab.econ.virginia.edu/admin.htm 3. There is a surplus of 2 million bottles. 4. Price falls until the surplus is eliminated and the market is in equilibrium.

MARKET EQUILIBRIUM Figure 4.10(b) market achieves equilibrium. At 75 cents a bottle: 1. Quantity demanded is 11 million bottles. 2. Quantity supplied is 9 million bottles. 3. There is a shortage of 2 million bottles. 4. Price rises until the shortage is eliminated and the market is in equilibrium.

3) The Price System at Work What happens when prices are fixed or determine by an external force (government)? Price Ceilings- a maximum legal price is set by the government Price Floors- a minimum legal price is set by the government. Ex. Minimum wage.

MARKET EQUILIBRIUM Complex Cases Changes in Both Demand and Supply that happen at the same time. When two events occur at the same time, work out how Each event influences the market: Does each event change demand or supply? Does either event increase or decrease demand or increase or decrease supply? What are the new equilibrium price and equilibrium quantity and how have they changed?

MARKET EQUILIBRIUM The figure shows the effects of an increase in both demand and supply. An increase in demand shifts the demand curve rightward; an increase in supply shifts the supply curve rightward. 1. Equilibrium quantity increases. 2. Equilibrium price might rise or fall.

4.3 MARKET EQUILIBRIUM Increase in Both Demand and Supply Increases the equilibrium quantity. The change in the equilibrium price is ambiguous because the: Increase in demand raises the price. Increase in supply lowers the price.