Equilibrium and Disequilibrium

Outline I. Introduction A. Shortages B. Surpluses C. Equilibrium

Outline (Cont.) II. Changes in Equilibrium A. Change in Demand B. Change in Supply C. Change in Both Demand and Supply III. Disequilibrium A. Price Floors B. Price Ceilings

Shortage Let’s say that Loony’s uptown decides to sell their CDs for $3 each. Let’s say that Loony’s uptown decides to sell their CDs for $3 each. More than likely there will be a lot more people wanting to buy CDs than Loony’s has to sell. More than likely there will be a lot more people wanting to buy CDs than Loony’s has to sell. Why? Because at such a low price, the quantity demanded is quite high. But Loony’s does not want to sell that many at such a low price. Why? Because at such a low price, the quantity demanded is quite high. But Loony’s does not want to sell that many at such a low price.

Shortage This situation is called a shortage This situation is called a shortage Shortage - when Q d > Q s at current market price. Shortage - when Q d > Q s at current market price. –Amount of Shortage = Q d - Q s Note - it is not correct to say Demand exceeds Supply, but rather quantity demanded exceeds quantity supplied. Note - it is not correct to say Demand exceeds Supply, but rather quantity demanded exceeds quantity supplied.

Shortage Result of Shortage: If you are the manager of Loony’s and you find that you are selling out of CDs at $3, what do you want to do? If you are the manager of Loony’s and you find that you are selling out of CDs at $3, what do you want to do? –Raise the price Buyers can’t get all they want. Therefore, competition among buyers drive prices up. Buyers can’t get all they want. Therefore, competition among buyers drive prices up. P will increase P will increase

Shortage

Shortage P Q 0

Shortage P Q D 0

Shortage P Q S D 0

Shortage P Q S D 0 P sh QsQs QdQd Amount of Shortage

Results of Shortage P Q S D 0 P sh QsQs QdQd

Results of Shortage P Q S D E P* Q* 0 P sh QsQs QdQd

Surplus Let’s say that as the manager, you raised the prices of CDs to $20. Let’s say that as the manager, you raised the prices of CDs to $20. At $20 you would love to sell a lot of CDs, but not a lot of people are willing to pay $20 for a CD. At $20 you would love to sell a lot of CDs, but not a lot of people are willing to pay $20 for a CD. So the CDs keep piling up as they come in from your supplier, but they don’t seem to be going out the door in sales. So the CDs keep piling up as they come in from your supplier, but they don’t seem to be going out the door in sales.

Surplus This situation is called a surplus This situation is called a surplus Surplus - when Q s > Q d at current market price. Surplus - when Q s > Q d at current market price. Amount of surplus = Q s - Q dAmount of surplus = Q s - Q d Note - not correct to say Supply exceeds Demand, but rather that quantity supplied exceeds quantity demanded. Note - not correct to say Supply exceeds Demand, but rather that quantity supplied exceeds quantity demanded.

Results of Surplus Result of Surplus: As manager you have to decide what do with all these CDs that are piling up and not selling. What do you do? As manager you have to decide what do with all these CDs that are piling up and not selling. What do you do? –Have a sale!

Results of Surplus Firms have more than they can sell. Therefore, firms lower price to sell the product. Firms have more than they can sell. Therefore, firms lower price to sell the product. As price decreases, Q d increases and Q s decreases As price decreases, Q d increases and Q s decreases P will decrease P will decrease

Surplus

Surplus P Q 0

Surplus P Q S 0

Surplus P Q S D 0

Surplus P Q S D 0 P sur QdQd QsQs Amount of Surplus

Results of Surplus P Q S D 0 P sur QdQd QsQs Amount of Surplus

Results of Surplus P Q S D E P* Q* 0 P sur QdQd QsQs Amount of Surplus

Equilibrium in the Market Note that if the price is below P* then there will be a shortage causing price to rise Note that if the price is below P* then there will be a shortage causing price to rise If the price is above P* then there will be a surplus causing price to fall If the price is above P* then there will be a surplus causing price to fall It’s as if P* is a magnet that keeps drawing price to it (and consequently quantity to Q*) It’s as if P* is a magnet that keeps drawing price to it (and consequently quantity to Q*) This magnet is sometimes called “The Invisible Hand” This magnet is sometimes called “The Invisible Hand”

Equilibrium in the Market Equilibrium - where quantity demanded equals quantity supplied. Equilibrium - where quantity demanded equals quantity supplied. Equilibrium Price (P*) - price where equilibrium occurs. Equilibrium Price (P*) - price where equilibrium occurs.

Equilibrium P Q S D E P* Q* 0

Equilibrium in the Market What Occurs at Equilibrium Demand Side - those who get the good are those willing and able to pay the P*. Demand Side - those who get the good are those willing and able to pay the P*. Supply Side - only those firms which are able to produce at or below the cost of P* will remain in business. Supply Side - only those firms which are able to produce at or below the cost of P* will remain in business.

Changes in Equilibrium Remember that Supply and Demand are drawn under the ceteris paribus assumption. Remember that Supply and Demand are drawn under the ceteris paribus assumption. Any factors which cause Supply and/or Demand to change will affect equilibrium price and quantity. Any factors which cause Supply and/or Demand to change will affect equilibrium price and quantity.

Change in Demand Demand will change for any of the factors discussed previously. Demand will change for any of the factors discussed previously. For instance, let’s say the demand for CDs increased due to an increase in income For instance, let’s say the demand for CDs increased due to an increase in income

Increase in Demand

P Q 0

P Q 0 D

P Q S D 0

P Q S D EP* Q* 0

Increase in Demand P Q S D EP* Q* 0 D’

Increase in Demand P Q S D EP* Q* 0 D’ E’ P*’ Q*’

Change in Supply Supply will change for any of the factors discussed previously. Supply will change for any of the factors discussed previously. For instance, let’s say that the government lowers taxes on CDs For instance, let’s say that the government lowers taxes on CDs

Increase in Supply

P Q 0

P Q D 0

P Q S D 0

P Q S D EP* Q* 0

Increase in Supply P Q S D EP* Q* 0 S’

Increase in Supply P Q S D EP* Q* 0 S’ P*’ Q*’ E’

Changes in Demand and Supply To determine the impact of both supply and demand changing: First examine what happens to equilibrium price and quantity when just demand shifts. First examine what happens to equilibrium price and quantity when just demand shifts. Second, examine what happens to equilibrium price and quantity when just supply changes Second, examine what happens to equilibrium price and quantity when just supply changes Finally, add the two effects together. Finally, add the two effects together.

Changes in Demand and Supply General Results: When supply and demand move in the same direction When supply and demand move in the same direction It is difficult to determine Equilibrium price from the original Equilibrium point.It is difficult to determine Equilibrium price from the original Equilibrium point. When supply and demand move in opposite directions When supply and demand move in opposite directions It is difficult to determine Equilibrium quantity from the original Equilibrium point.It is difficult to determine Equilibrium quantity from the original Equilibrium point.

Increase in Supply and Demand

P Q 0

P Q S 0

P Q S D 0

P Q S D E P* Q* 0

Increase in Supply and Demand P Q S D E P* Q* 0 D’

Increase in Supply and Demand P Q S D E P* Q* 0 D’ S’

Increase in Supply and Demand P Q S D E P* Q* 0 D’ E’ P*’ Q*’ S’

Increase in Supply and Demand

P Q 0

P Q D 0

P Q S D 0

P Q S D E P* Q* 0

Increase in Supply and Demand P Q S D E P* Q* 0 S’

Increase in Supply and Demand P Q S D E P* Q* 0 D’ S’

Increase in Supply and Demand P Q S D E P* Q* 0 D’ E’ P*’ Q*’ S’

Increase in Supply and Demand

P Q 0

P Q S 0

P Q S D 0

P Q S D E P* Q* 0

Increase in Supply and Demand P Q S D E P* Q* 0 S’

Increase in Supply and Demand P Q S D E P* Q* 0 D’ S’

Increase in Supply and Demand P Q S D E P* Q* 0 D’ E’ P*’= Q*’ S’