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KRUGMAN’S Economics for AP® S E C O N D E D I T I O N

Section 2 Module 7

What You Will Learn in this Module Explain how supply and demand curves determine a market’s equilibrium price and equilibrium quantity Describe how price moves the market back to equilibrium in the case of a shortage or surplus Explain how equilibrium price and quantity are affected when there is a change in either supply or demand Explain how equilibrium price and quantity are affected when there is a simultaneous change in both supply and demand What You Will Learn in this Module Section 2 | Module 7

Supply, Demand and Equilibrium Equilibrium in a competitive market: when the quantity demanded of a good equals the quantity supplied of that good. The price at which this takes place is the equilibrium price (a.k.a. market-clearing price): Every buyer finds a seller and vice versa. The quantity of the good bought and sold at that price is the equilibrium quantity. Section 2 | Module 7

Finding the Equilibrium Price and Quantity Price of cotton (per pound) Market equilibrium occurs at point E, where the supply curve and the demand curve intersect. Supply $2.00 1.75 1.50 1.25 Equilibrium price 1.00 E Equilibrium 0.75 0.50 Demand 7 10 13 15 17 Quantity of cotton (billions of pounds) Equilibrium quantity Section 2 | Module 7

Price Above Its Equilibrium Level Creates a Surplus Price of cotton (per pound) There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level. Supply $2.00 Surplus 1.75 1.50 1.25 1.00 E 0.75 0.50 Demand 7 8.1 10 11.2 13 15 17 Quantity of cotton (billions of pounds) Quantity demanded Quantity supplied Section 2 | Module 7

Price Below Its Equilibrium Level Creates a Shortage Price of cotton (per pound) There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level. Supply $2.00 1.75 1.50 1.25 1.00 E 0.75 Shortage 0.50 Demand 7 9.1 10 11.5 13 15 17 Quantity of cotton (billions of pounds) Quantity supplied Quantity demanded Section 2 | Module 7

F Y I The Price of Admission The competitive market model determines the price you pay for concert tickets. Section 2 | Module 7

Equilibrium and Shifts of the Demand Curve Price of cotton An increase in demand… Supply … leads to a movement along the supply curve due to a higher equilibrium price and higher equilibrium quantity. E 2 P 2 Price rises E 1 P 1 D 2 D 1 Q Q 1 2 Quantity of cotton Section 2 | Module 7

Equilibrium and Shifts of the Supply Curve Price of cotton S S A decrease in supply… 2 1 E P 2 2 … leads to a movement along the demand curve due to a higher equilibrium price and lower equilibrium quantity. Price rises P E 1 1 Demand Q Q Quantity of cotton 2 1 Quantity falls Section 2 | Module 7

(a) One possible outcome: Price Rises, Quantity Rises Simultaneous Shifts of Supply and Demand Curves (a) One possible outcome: Price Rises, Quantity Rises Price of cotton Small decrease in supply S S 2 1 Two opposing forces determining the equilibrium quantity. E The increase in demand dominates the decrease in supply. 2 P 2 E 1 P 1 D 2 D 1 Large increase in demand Q Quantity of cotton 1 Q 2 Section 2 | Module 7

(b) Another Possibility Outcome: Price Rises, Quantity Falls Simultaneous Shifts of Supply and Demand Curves (b) Another Possibility Outcome: Price Rises, Quantity Falls Price of cotton Two opposing forces determining the equilibrium quantity. Large decrease in supply S 2 S 1 E 2 P 2 E Small increase in demand 1 P 1 D 2 D 1 Quantity of cotton Section 2 | Module 7 Q Q

F Y I Makin’ Bacon? A decrease in the supply of bacon may cause consumers to squeal, but it won’t cause a lasting shortage, because higher bacon prices will decrease the quantity demanded and increase the quantity supplied. Section 2 | Module 7

Simultaneous Shifts of Supply and Demand Summary Simultaneous Shifts of Supply and Demand Supply Increases Supply Decreases Demand Increases Price: cannot be determined Quantity: up Price: up Quantity: cannot be determined Demand Decreases Price: down Quantity: down Section 2 | Module 7

Summary The equilibrium price, or market-clearing price, is the price at which the quantity demanded is equal to the quantity supplied. When quantity supplied is equal to quantity demanded, this is the equilibrium quantity. When the price is above its market-clearing level, there is a surplus that pushes the price down. When the price is below its market-clearing level, there is a shortage that pushes the price up. Section 2 | Module 7