Application of The Theory of Demand and Supply Economics, R.A. Arnold, 9th ed (Ch. 3 & 4)

From One Equilibrium to Another In Ch. 3 we saw a market may experience a shortage or surplus but then it moves towards equilibrium (by the combined actions of buyers and sellers). And a market should remain in equilibrium unless the demand or supply curve shifts. If the demand or supply curve shifts then the market may move to a new equilibrium. This is illustrated in the next slide. In diagram (a) the market is initially in equilibrium (point 1). Then the number of buyers increase and the demand curve shifts right (to D2). The market moves to a new equilibrium point (2). This gives us the new equilibrium price (P2) and Q, which is greater than the previous equilibrium price (P1) and Q. So if the demand increases the market price and Q is likely to increase (a prediction of the model). We can similarly analyse the other diagrams.

Equilibrium and Predictions: An Application of The Theory of Supply and Demand Further examples (Remember: shortage in market causes price to rise and surplus causes price to fall): Housing market: Empty flats in Uttara is an indication of surplus in the housing market. In the future we might expect house rents to decline. Education market: Current situation indicates a shortage in this market. Many students can’t get admitted due to limited seats. In the future tuition fees of private universities may increase. **Remember: a good theory should be able to accurately predict what happens in the real world (Ch. 1)**

The Economy and its Markets An economy or society that allocates its resources through the price changes that occurs in the market is called a market economy. E.g. Assume: Bangladesh (BD) has a limited amount of land and labor (resources) and it can use (allocate) it to produce rice or clothes. How will BD decide how much resources to use in rice production and how much in clothes production?

Continued The market of rice and clothes can help in making the decision (allocation). If the price of rice increases in the market of rice then QS of rice will increase (law of supply), so more labor and land will be used (allocated) to produce rice. Hence, the market helps in the allocation of resources of the economy.