Market Equilibrium 1 Module 4

market equilibrium,  Define a market equilibrium, and use a demand- supply graph to represent a market equilibrium. 2 ObjectivesObjectives

shortage,  Understand what is a shortage, how to calculate the amount of shortage, and how to eliminate a shortage in a free market. 3 ObjectivesObjectives

market equilibrium,  Define a market equilibrium, and use a demand- supply graph to represent a market equilibrium. shortage  Understand what is a shortage, how to calculate the amount of shortage, and how to eliminate a shortage in a free market. surplus,  Understand what is a surplus, how to calculate the amount of surplus, and how to eliminate a surplus in a free market. 4 ObjectivesObjectives

market equilibrium  Define a market equilibrium, and use a demand- supply graph to represent a market equilibrium. shortage  Understand what is a shortage, how to calculate the amount of shortage, and how to eliminate a shortage in a free market. surplus  Understand what is a surplus, how to calculate the amount of surplus, and how to eliminate a surplus in a free market. changes in equilibrium  Analyze changes in equilibrium using a demand- supply graph. 5 ObjectivesObjectives

6 Define a market equilibrium, use a demand-supply graph to represent a market equilibrium Objective 1 and  A market is represented by both demand and supply curves to capture the fact that buyers and sellers interact in a market.

7 market equilibrium  A market equilibrium is a situation where quantity demanded equal quantity supplied. Objective 1 Define a market equilibrium... Quantity demanded equals quantity supplied

8 Price per cup ($) Quantity Demanded (cups per week) Quantity Supplied (cups per week) Market Demand and Supply Schedule Coffee Market Demand and Supply Graph Objective 1: … market equilibrium

Price per cup ($) Quantity Demanded (cups per week) Quantity Supplied (cups per week) Market Demand and Supply Schedule 9 Objective 1: … market equilibrium shortages surpluses  In an equilibrium there are no shortages or surpluses.

10 At a price of $1.50, quantity demanded is 800 and quantity supplied is 200, resulting in a shortage of 600 cups. Understand what is a shortage, how to calculate the amount of a shortage…. Objective 2  What happens at a price other than the equilibrium price? For example, consider a price below equilibrium, such as $1.50.

11 shortage or excess demand below  A shortage or excess demand arises when the price is below the market equilibrium price. At a price of $1.50, quantity demanded is 800 and quantity supplied is 200, resulting in a shortage of 600 cups. Understand what is a shortage, how to calculate the amount of a shortage … Objective 2

12 shortage or excess demand below  A shortage or excess demand arises when the price is below the market equilibrium price. quantity demanded and quantity supplied  It is measured by the difference between quantity demanded and quantity supplied at that price. At a price of $1.50, quantity demanded is 800 and quantity supplied is 200, resulting in a shortage of 600 cups. Objective 2: … what is a shortage, how to calculate the amount of a shortage …

13 Objective 2: … how to eliminate a shortage

14 price must rise  In a free market, price must rise to eliminate a shortage. Objective 2: … how to eliminate a shortage

15 price must rise  In a free market, price must rise to eliminate a shortage.  As price rises, quantity supplied increases and quantity demanded decreases (movement along the demand and supply curves).  This price adjustment continues until the shortage is eliminated and market is equilibrated at $3. Objective 2: … how to eliminate a shortage

16 Objective 3 Understand what is a surplus, how to calculate the amount of a surplus … At a price of $4.00, quantity demanded (point “b”) is 300 and quantity supplied (point “c”) is 700, resulting in surplus of 400 cups.  What happens at a price above the equilibrium price, such as $4.00?

17 surplus or excess supply above  A surplus or excess supply arises when the price is above the free market equilibrium. Objective 3 Understand what is a surplus, how to calculate the amount of a surplus … At a price of $4.00, quantity demanded is 300 and quantity supplied is 700, resulting in surplus of 400 cups.

18 surplus or excess supply above  A surplus or excess supply arises when the price is above the free market equilibrium. difference between quantity supplied and quantity demanded at that price.  It is measured by the difference between quantity supplied and quantity demanded at that price. Objective 3: … what is a surplus, how to calculate the amount of a surplus … At a price of $4.00, quantity demanded is 300 and quantity supplied is 700, resulting in surplus of 400 cups.

Objective 3: … how to eliminate a surplus 19

20 Objective 3: … how to eliminate a surplus price must fall  In a free market, price must fall to eliminate a surplus.

21 Objective 3: … how to eliminate a surplus price must fall  In a free market, price must fall to eliminate a surplus.  As price falls, quantity supplied decreases and quantity demanded increases (movement along the demand and supply curves).  This price adjustment continues until the surplus is eliminated and market is equilibrated at $3.

22 More terminology … shortageexcess demand.  A shortage is also called an excess demand. surplusexcess supply.  A surplus is also called an excess supply.

23  Quantity Traded equilibrium  Quantity Traded means the quantity sold or the quantity exchanged between buyers and sellers.  In an equilibrium, the quantity traded equals the quantity demanded equals the quantity supplied. Quantity traded …

24 above quantity demanded  When the market price is above the market equilibrium price, the quantity traded equals the quantity demanded. Quantity traded … Quantity traded equals quantity demanded

25 below quantity supplied  When the market price is below the market equilibrium price, the quantity traded equals the quantity supplied. Quantity traded … Quantity traded equals quantity supplied

26  market price  The market price is determined by forces of demand and supply. Market price and quantity traded …  Quantity traded means quantity exchanged (between sellers and buyers) or quantity sold. quantity traded  At any price there is a quantity traded as long as suppliers are willing to sell their product and buyers are willing to buy the product at that price.

Objective 4 Analyzing Changes in Equilibrium 27  In this segment, we will use the demand- supply model to predict what happens to equilibrium price and quantity following an economic event.  To determine what happens to equilibrium price and equilibrium quantity, we need both the demand and supply curves.

28  Unless stated otherwise, the analysis begins initialequilibrium from an initial equilibrium. Objective 4 Analyzing Changes in Equilibrium

29 initialequilibrium  Unless stated otherwise, the analysis begins from an initial equilibrium.  The simple 3-step process: Step 1: Step 1: Determine whether the event shifts the demand curve or the supply curve or both. Objective 4 Analyzing Changes in Equilibrium

30 initialequilibrium  Unless stated otherwise, the analysis begins from an initial equilibrium.  The simple 3-step process: Step 1: Step 1: Determine whether the event shifts the demand curve or the supply curve or both Step 2: Step 2: Determine which direction the curve shifts. Objective 4 Analyzing Changes in Equilibrium

31 initialequilibrium  Unless stated otherwise, the analysis begins from an initial equilibrium.  The simple 3-step process: Step 1: Step 1: Determine whether the event shifts the demand curve or the supply curve or both Step 2: Step 2: Determine which direction the curve shifts. Step 3: Step 3: Use the supply-and-demand diagram to see how the shift changes the equilibrium price and quantity. Objective 4 Analyzing Changes in Equilibrium

Example 1: Example 1: What happens to equilibrium price and quantity in the beef market if the price of corn feed falls? 32 Objective 4: … Changes in Equilibrium

33 Example 1: Example 1: What happens to equilibrium price and quantity in the beef market if the price of corn feed falls? Objective 4: … Changes in Equilibrium

34 Example 1: Example 1: What happens to equilibrium price and quantity in the beef market if the price of corn feed falls? Objective 4: … Changes in Equilibrium  Solving the problem Step 1: Which curve shifts? A fall in the price of corn feed lowers the cost of producing beef. Hence, the supply curve shifts.

35 Example 1: Example 1: What happens to equilibrium price and quantity in the beef market if the price of corn feed falls? Objective 4: … Changes in Equilibrium  Solving the problem Step 1: Which curve shifts? A fall in the price of corn feed lowers the cost of producing beef. Hence, the supply curve shifts. Step 2: Which direction? The supply curve shifts right. (Supply increases.)

36 Example 1: Example 1: What happens to equilibrium price and quantity in the beef market if the price of corn feed falls?  Solving the problem Step 1: Which curve shifts? A fall in the price of corn feed lowers the cost of producing beef. Hence, the supply curve shifts. Step 2: Which direction? The supply curve shifts right. Step 3: What happens to equilibrium price and quantity? The equilibrium price falls and the equilibrium quantity increases. Objective 4: … Changes in Equilibrium

37 surplus  At the initial price P 0, following the increase in supply, there is a surplus. Let’s take a closer look at the adjustment process in the beef market. Objective 4…Changes in Equilibrium

38 surplus  At the initial price P 0, following the increase in supply, there is a surplus. fall  It is this surplus that causes price to fall. Let’s take a closer look at the adjustment process in the beef market. Objective 4: … Changes in Equilibrium

Example 2 Example 2: What happens in the market for Spam, an inferior good, if students’ incomes decrease? 39 Objective 4: … Changes in Equilibrium

40 Example 2 Example 2: What happens in the market for Spam, an inferior good, if students’ incomes decrease?  Unless stated otherwise, always begin with an initial equilibrium. Objective 4: … Changes in Equilibrium

41  Solving the problem Step 1: Step 1: Which curve shifts? Income, a demand determinant, falls. Hence, the demand curve shifts. Example 2 Example 2: What happens in the market for Spam, an inferior good, if students’ incomes decrease? Objective 4: … Changes in Equilibrium

42  Solving the problem Step 1: Step 1: Which curve shifts? Income, a demand determinant, falls. Hence, the demand curve shifts. Step 2 Step 2: Which direction? Spam is an inferior good. A decrease in income leads to an increase in demand. Thus, the demand curve shifts right. Example 2 Example 2: What happens in the market for Spam, an inferior good, if students’ incomes decrease? Objective 4: … Changes in Equilibrium

43  Solving the problem Step 1: Step 1: Which curve shifts? Income, a demand determinant, falls. Hence, the demand curve shifts. Step 2 Step 2: Which direction? Spam is an inferior good. A decrease in income leads to an increase in demand. Thus, the demand curve shifts right. Step 3: Step 3: What happens to equilibrium price and quantity? The equilibrium price and the equilibrium quantity increase. Example 2 Example 2: What happens in the market for spam, an inferior good, if students’ incomes decrease? Objective 4: … Changes in Equilibrium

shortage  At the initial price P 0, following the increase in demand, there is a shortage. Objective 4: … Changes in Equilibrium Let’s take a closer look at the adjustment process in the spam market. 44

45 shortage  At the initial price P 0, following the increase in demand, there is a shortage. rise  It is this shortage that causes price to rise. Objective 4: … Changes in Equilibrium Let’s take a closer look at the adjustment process in the spam market.

Objective 4: … Changes in equilibrium: both demand and supply curves shift 47  We will now consider the situation where both demand and supply curves shift at the same time or simultaneous shifts of the demand and supply curves.

47 Objective 4: … Changes in equilibrium: both demand and supply curves shift  There are four possible combinations of simultaneous shifts:

48 Objective 4: … Changes in equilibrium: both demand and supply curves shift  There are four possible combinations of simultaneous shifts: 1. Increase in both demand and supply

49 Objective 4….Changes in equilibrium: both demand and supply curves shift  There are four possible combinations of simultaneous shifts: 1. Increase in both demand and supply 2. Decrease in both demand and supply

50 Objective 4….Changes in equilibrium: both demand and supply curves shift  There are four possible combinations of simultaneous shifts: 1. Increase in both demand and supply 2. Decrease in both demand and supply 3. Increase in demand and decrease in supply

51 Objective 4….Changes in equilibrium: both demand and supply curves shift  There are four possible combinations of simultaneous shifts: 1. Increase in both demand and supply 2. Decrease in both demand and supply 3. Increase in demand and decrease in supply 4. Decrease in demand and increase in supply

52 Objective 4: … Changes in equilibrium: both demand and supply curves shift  Methodology to analyze simultaneous shifts: Step 1: Step 1: Analyze the demand shift and the supply separately shift separately using the 3-step process.

53  Methodology to analyze simultaneous shifts: Step 1: separately Step 1: Analyze the demand shift and the supply shift separately using the 3-step process. Step 2:Add Step 2: Add the results from each shift to arrive at the combined effects. Objective 4: … Changes in equilibrium: both demand and supply curves shift

Example 3: Example 3: Suppose a frost destroys the grape crop. At the same time, the demand for wines has increased. Analyze the impact of these events in the wine market. 54 Objective 4: … Changes in equilibrium: both demand and supply curves shift

55 Example 3: Example 3: Suppose a frost destroys the grape crop. At the same time, the demand for wines has increased. Analyze the impact of these events in the wine market. Solving the problem Step 1: Step 1: Analyze the events using the 3-step process. Event 1: A frost destroys the grape crop. Event 2: The demand for wines has increased. 56 Objective 4: … Changes in equilibrium: both demand and supply curves shift

56 Example 3: Example 3: Suppose a frost destroys the grape crop. At the same time, the demand for wines has increased. Analyze the impact of these events in the wine market.  Let’s start with event 1: Frost destroys the grape crop. Solving the problem Step 1: Step 1: Analyze the events using the 3-step process. Event 1: A frost destroys the grape crop. Event 2: The demand for wines has increased. Objective 4: … Changes in equilibrium: both demand and supply curves shift

57 Example 3: Example 3: Suppose a frost destroys the grape crop. At the same time, the demand for wines has increased. Analyze the impact of these events in the wine market.  Let’s start with event 1: Frost destroys the grape crop.  Supply decreases causing the supply curve to shift leftwards. Solving the problem Step 1: Step 1: Analyze the events using the 3-step process. Event 1: A frost destroys the grape crop. Event 2: The demand for wines has increased. Objective 4: … Changes in equilibrium: both demand and supply curves shift

58 Example 3: Example 3: Suppose a frost destroys the grape crop. At the same time, the demand for wines has increased. Analyze the impact of these events in the wine market.  Let’s start with event 1: Frost destroys the grape crop.  Supply decreases causing the supply curve to shift leftwards.  In the new equilibrium, P* ↑ and Q* ↓ Solving the problem Step 1: Step 1: Analyze the events using the 3-step process. Event 1: A frost destroys the grape crop. Event 2: The demand for wines has increased. Objective 4: … Changes in equilibrium: both demand and supply curves shift

59 Example 3: Example 3: Suppose a frost destroys the grape crop. At the same time, the demand for wines has increased. Analyze the impact of these events in the wine market. Step 1: Step 1: Analyze Event 2 (the demand for wines has increased) using the 3-step process. Objective 4: … Changes in equilibrium: both demand and supply curves shift

60 Example 3: Example 3: Suppose a frost destroys the grape crop. At the same time, the demand for wines has increased. Analyze the impact of these events in the wine market. Step 1: Step 1: Analyze Event 2 (the demand for wines has increased) using the 3-step process.  This event shifts the wine demand curve to the right. Objective 4: … Changes in equilibrium: both demand and supply curves shift

Example 3: Example 3: Suppose a frost destroys the grape crop. At the same time, the demand for wines has increased. Analyze the impact of these events in the wine market. Step 1: Step 1: Analyze Event 2 (the demand for wines has increased) using the 3-step process.  This event shifts the wine demand curve to the right.  In the new equilibrium, P* ↑ and Q* ↑ 61 Objective 4: … Changes in equilibrium: both demand and supply curves shift

Step 2: Step 2: Add the results from each shift to arrive at the combined effects. 62 Objective 4: … Changes in equilibrium: both demand and supply curves shift

63 Step 2: Step 2: Add the results from each shift to arrive at the combined effects. The combined effects of the two events are: Objective 4: … Changes in equilibrium: both demand and supply curves shift Via the supply effect P* ↑ Q* ↓ Via the demand effect P* ↑ Q* ↑

64 Step 2: Step 2: Add the results from each shift to arrive at the combined effects. The combined effects of the two events are:  Price rises unambiguously. Objective 4: … Changes in equilibrium: both demand and supply curves shift Via the supply effect P* ↑ Q* ↓ Via the demand effect P* ↑ Q* ↑ P* ↑ P* ↑

65 Step 2: Step 2: Add the results from each shift to arrive at the combined effects. The combined effects of the two events are:  Price rises unambiguously.  The effect on quantity is indeterminate; it depends on which effect dominates. Objective 4: … Changes in equilibrium: both demand and supply curves shift Via the supply effect P* ↑ Q* ↓ Via the demand effect P* ↑ Q* ↑ P* ↑ Q*? P* ↑ Q*?

66  Price rises unambiguously.  The effect on quantity is indeterminate; it depends on which effect dominates. supply effect dominates  If the supply effect dominates, equilibrium quantity falls. Objective 4: … Changes in equilibrium: both demand and supply curves shift Step 2: Step 2: Add the results from each shift to arrive at the combined effects. The combined effects of the two events are: Via the supply effect P* ↑ Q* ↓ Via the demand effect P* ↑ Q* ↑ P* ↑ Q*? P* ↑ Q*?

67 Step 2: Step 2: Add the results from each shift to arrive at the combined effects. The combined effects of the two events are:  Price rises unambiguously.  The effect on quantity is indeterminate; it depends on which effect dominates. supply effect dominates  If the supply effect dominates, equilibrium quantity falls. demand effect dominates  If the demand effect dominates, equilibrium quantity rises. Objective 4: … Changes in equilibrium: both demand and supply curves shift Via the supply effect P* ↑ Q* ↓ Via the demand effect P* ↑ Q* ↑ P* ↑ Q*? P* ↑ Q*?

68 Step 2: Step 2: Add the results from each shift to arrive at the combined effects. The combined effects of the two events are:  Price rises unambiguously.  The effect on quantity is indeterminate; it depends on which effect dominates. supply effect dominates,  If the supply effect dominates, equilibrium quantity falls. demand effect dominates,  If the demand effect dominates, equilibrium quantity rises. equal  If the demand and supply are of equal magnitudes, the equilibrium quantity remains the same. Objective 4: … Changes in equilibrium: both demand and supply curves shift Via the supply effect P* ↑ Q* ↓ Via the demand effect P* ↑ Q* ↑ P* ↑ Q*?

69 Market Equilibrium End of Module 4 Song: Supply and Demand Album: Other People’s Heavens Artists: Chris Brown and Kate Fenner