Marketsslide 1 PRICE DETERMINATION IN MARKETS The market demand curve shows the amount demanded at every price. The market supply curve shows the amount supplied at every price. The question now is whether there is some price at which the quantities supplied and demanded are the same.

Marketsslide 2 EQUILIBRIUM PRICE DEFINED The equilibrium price of a good is: a price at which quantity supplied equals quantity demanded. a price at which excess demand equals zero. At the equilibrium price there is no net tendency for price to change.

Marketsslide 3 Excess demand exists when, at the current price, the quantity demanded is greater than quantity supplied. Excess supply exists when, at the current price, the quantity supplied is greater than the quantity demanded.

Marketsslide 4 Excess supply = Q s - Q D Market for tacos supply demand price quantity p = $3 QDQD QSQS EXCESS SUPPLY

Marketsslide 5 Excess demand = Q D - Q S Market for tacos supply demand price quantity p = $1 QDQD QSQS EXCESS DEMAND

Marketsslide 6 When there is EXCESS DEMAND for a good, price will tend to rise. When there is EXCESS SUPPLY of a good, price will tend to fall.

Marketsslide 7 When excess demand equals zero, price must be the equilibrium price, and we say the market is in equilibrium. If you want to find out the price at which a market is in equilibrium, then look for the price where the excess demand is zero.

Marketsslide 8 Economists are interested in the explaining equilibrium prices. In particular, they are anxious to explain why equilibrium prices change.

Marketsslide 9 What is the equilibrium price in the market for tacos? Show it on the diagram. What is the equilibrium quantity of tacos? p = $2 P Q supply demand TACO MARKET $1 $3 $4 Go to hidden slide

Marketsslide 10 The market for tacos is in equilibrium at a price of $2 per taco. p = $2 QEQE P Q supply demand TACO MARKET

Marketsslide 11 How can the price of tacos change? Only if there is a change in supply, or if there is a change in demand. But remember, we already know the list of reasons why supply and demand can change.

Marketsslide 12 Changes in demand can be caused by: Changes in supply can be caused by: Go to hidden slide

Marketsslide 13 Changes in demand can be caused by Changes in supply can be caused by changes in consumer incomes changes in the prices of substitutes changes in the prices of complements changes in tastes changes in prices of inputs changes in technology changes in taxes

Marketsslide 14 The following is a series of sample problems showing changes in the equilibrium prices of some goods.

Marketsslide 15 P Q p0p0 q0q0 Classes at Lansing Community College are an inferior good. Peoples incomes fall, perhaps due to a recession. What is the effect on LCC tuition and enrollment? supply high income LCC ENROLLMENT Go to hidden slide

Marketsslide 16 Because classes at LCC are inferior, a decrease in income causes demand to increase. This creates an excess demand and price tends to rise. P Q p0p0 q0q0 supply high income low income LCC ENROLLMENT p1p1 q1q1 The new equilibrium will have higher tuition and enrollment Excess demand

Marketsslide 17 THE MARKET FOR APARTMENTS IN EAST LANSING IS IN EQUILIBRIUM, AND MSU RAISES THE PRICE OF DORM ROOMS. WHAT IS THE EFFECT ON THE MARKET FOR APARTMENTS IN EAST LANSING? P Q p0p0 q0q0 supply demand E.L. APARTMENTS Go to hidden slide

Marketsslide 18 P Q p0p0 q0q0 old MSU price supply E.L. APARTMENTS Excess demand new (higher) MSU price p1p1 q1q1 The excess demand for housing causes prices to rise. The price of MSU dorm rooms increases. Here are the steps in the move to a new equilibrium.

Marketsslide 19 Nachos and beer are complements. The price of beer rises. What is the effect on the market for nachos? P Q p0p0 q0q0 supply old beer price NACHO MARKET Go to hidden slide

Marketsslide 20 P Q supply p0p0 q0q0 old beer price NACHOS higher beer price p1p1 q1q1 Excess supply Nachos and beer are complements. The price of beer rises. As a result the demand for nachos falls. Here's the process: So price and quantity are both lower.

Marketsslide 21 People come to believe that eating apples is good for them. The more apples they eat, the more likely they are to stay well. What is the effect on the market for apples? P Q p0p0 q0q0 APPLE MARKET supply demand Go to hidden slide

Marketsslide 22 There is a change in preferences that affects demand. Here's the process. P Q p0p0 q0q0 APPLE MARKET supply demand new demand p1p1 q1q1 Demand increases, so price and quantity are higher.

Marketsslide 23 p (tuition) Q p0p0 q0q0 Enrollment supply at original wage demand Classes at universities are produced using faculty labor services, and other inputs like buildings and computers. The faculty salaries increase by 10%. What is the effect on tuition and enrollment at universities? Go to hidden slide

Marketsslide 24 P Q p0p0 q0q0 enrollment supply at original wage demand Universities want to sell fewer enrollment places at the higher level of faculty salaries. This changes supply. Here's the process. supply at higher faculty wages Supply decreases, creating excess demand. p1p1 q1q1 Price (tuition) is higher, and enrollment drops.

Marketsslide 25 MSU agricultural scientists develop a new strain of corn that increases yields by about 15%. What is the effect of the improvement in technology on the market for corn? P Q p0p0 q0q0 CORN MARKET demand supply Go to hidden slide

Marketsslide 26 P Q p0p0 q0q0 CORN MARKET demand supply supply with improved technology p1p1 q1q1 The improvement changes supply, creating an excess supply of corn. Here's the process. Excess supply In the new equilibrium price is lower and quantity higher.

Marketsslide 27 THE MARKET FOR MEDICAL CARE IS IN EQUILIBRIUM, AND CONSUMERS INCOMES INCREASE. WHAT IS THE EFFECT ON MARKET PRICE? p0p0 Q0Q0 supply D at lower income P Q MEDICAL CARE MARKET Go to hidden slide

Marketsslide 28 p0p0 Q0Q0 supply D at lower income p1p1 Q1Q1 P Q D at higher income MEDICAL CARE MARKET If medical care is normal, the increase in incomes causes an increased demand for medical care at the price p 0. Here's how the process works. Excess demand. The new equilibrium has higher price and higher quantity.

Marketsslide 29 SUPPLY/DEMAND SUMMARY Market price serves as the adjustment mechanism to move markets to equilibrium. Price changes in response to the existence of excess demand or excess supply. Changes in demand and changes in supply lead to changes in equilibrium prices and quantities.