Unit 2, Lesson 6 Supply and Demand and Market Equilibrium AOF Business Economics Unit 2, Lesson 6 Supply and Demand and Market Equilibrium This presentation brings together the concepts of supply and demand and explains how they interact with one another in order to set the price of a good or service. Supply and demand schedules are introduced in a single table and then graphed in a supply-demand curve, which presents key concepts such as price equilibrium, surplus, and shortage through the running example of chocolate bars. Graphs measuring the factors that cause changes in supply, such as the arrival of competition in the marketplace, the introduction of new technologies, and the cost of resources used to produce certain goods are presented and described. These graphs make clear the importance of the price mechanism and the dynamic and responsive nature of the free market system. Copyright © 2008-2009 National Academy Foundation. All rights reserved.

Supply and demand interact through price Supply meets demand in the marketplace for goods and services Interaction between buyers and sellers moves these two forces into balance Price equilibrium is the point at which supply and demand meet Supply and demand are both driven by price. However, it becomes clear from the example of the chocolate bar production and consumption schedules that price is pushing consumers and producers in opposite directions. This market tension and its resolution through price equilibrium is the dynamic force of a supply and demand free market system. Using the supply and demand schedules here, it becomes clear that the producers and the consumers are on the same page at only one point ($0.75 per chocolate bar). This price reflects the chocolate’s utility to the consumer and acceptable profit to the producer. At this point, no resources are inefficiently used, no consumers who want one go without a chocolate bar, and no producers are forced to sell the product for a price that is less than acceptable. Why is there constant tension between supply and demand? Copyright © 2008-2009 National Academy Foundation. All rights reserved.

Price equilibrium determines supply and demand For economists and businesses alike, the information that a supply and demand curve graph presents is extremely important. It allows businesses to plan production and make predictions about revenues, income, and production capabilities. Copyright © 2008-2009 National Academy Foundation. All rights reserved.

Surpluses and shortages are forms of supply and demand disequilibrium Communication in the marketplace between consumers and producers is a process of trial and error. Consumers communicate the highest price they are willing to pay for a good, and producers communicate the lowest cost at which they are willing to sell the good. Eventually, through a system of trial and error, the consumer and producer find equilibrium, a price they can agree on. But what happens when they can’t agree on a price? As mentioned already, different factors impact this regularly, so producers are constantly trying to track consumer behavior in order to get the best price for the goods they sell. This, however, is not an exact science. Producers often overshoot or undershoot the mark and find themselves either stuck with surplus (extra) goods that must be priced lower than they desire in order to be sold. Or conversely, they find themselves missing out on a sale because they have a shortage (under-produced) and have less than the market demanded. By keeping an eye on price, producers look to stay as close to equilibrium as possible in order to maximize sales of their products. Despite companies getting better at matching supply with demand, new products and new producers continue to create market disequilibrium on the demand side. The substitution effect (if there are lots of competing similar products) and the income effect also impact levels of demand. And changing tastes, employment levels, and consumer expectations do the same thing from the consumption side. All together, this makes for a highly dynamic and fluid marketplace. Copyright © 2008-2009 National Academy Foundation. All rights reserved.

Many factors impact price equilibrium As just mentioned, a number of factors impact supply and demand. While all of these are treated in greater detail in the next class, activity, competition, input costs, and technology serve to explain how economists and businesses understand and track these changes. With all supply and demand, the feedback mechanism (the way that these changes are reflected) is through price. Copyright © 2008-2009 National Academy Foundation. All rights reserved.

Supply and demand equilibrium = efficient markets When buyers and sellers reach an equilibrium price, the market operates most efficiently Companies will continue to offer the goods and services at this price Consumers will continue to buy the goods and services at this price The balance between price and demand reflects the two forces at work in a free market economy. On one hand, consumers want to pay as little as possible for the goods and services they buy. On the other hand, producers want to sell as many of their goods and services for as high a price as possible. The meeting point between these two objectives reflects a properly functioning economy. Copyright © 2008-2009 National Academy Foundation. All rights reserved.