1. Market Equilibrium Week 3
Econ 201/202
Market Equilibrium
Week 3

2. Equilibrium (cont’d)

3. What does EQUILIBRIUM mean?
At the market equilibrium price:
Quantity demanded by consumers = quantity supplied by firms/producers/sellers
Without a change in any of the ceterius paribus conditions, the price will remain unchanged
Demand: Income, Price of Substitutes and Complements, Future Prices, Quality, Number of Consumers
Supply: Input Prices, Technology, Number of Suppliers, Future Prices (Input, Good)

4. How Do We Get There? Consumers Suppliers Equilibrium occurs only when
Willing to buy another unit, if market price <= to marginal (use) value of consuming it
Suppliers
Willing to sell/produce another unit, if market price >= marginal (additional) costs of producing the last unit
Equilibrium occurs only when
MVconsumer = Pmarket = MCproducer

5. And If That Doesn’t Happen?
MV < P > MC
Sellers are willing to continue to supply more goods
Consumers are unwilling to buy
Excess supply will lead to sellers dropping their prices down in the future to clear inventory
MV > P < MC
Sellers not willing to supply as much as consumers will demand (excess demand)
Excess demand will lead to consumers bidding prices up to get the “shortage”

6. Another Variation
At each price, determine whether there would be a shortage (Qd > Qs) or a surplus (Qs > Qd)
If there was a shortage, how would price adjust to clear the market?
If there is a surplus, how would price adjust to clear the market?
# of Pizzas Demanded
Price Per Pizza
# of Pizzas Supplied
Shortage or Surplus
1000
$10
400
900
$12
450
800
$14
500
700
$16
550
600
$18
$20
650

7. Answers # of Pizzas Demanded Price Per Pizza # of Pizzas Supplied
Shortage (-) or Surplus (+)
1000
$10
400
-600
900
$12
450
-450
800
$14
500
-300
700
$16
550
-150
600
$18
$20
650
150

8. The Cobweb Theorem S D1 D Price (£)
Assume the initial equilibrium price is £7 and the quantity 9. If demand rises, the shortage pushes the price up to £11 per turkey.
Farmers respond by planning to increase supply, ten months later, the supply of turkeys is 15 million. At this level, there will be a surplus of turkeys and the price drops.
The price falls to £5 and farmers react by cutting plans for turkey production. Ten months later, supply on the market will be 8 million.
This creates a massive shortage of 9 million turkeys and the price is forced up – and so the process continues!
A divergent cobweb leads to price instability over time.
In a ‘divergent cobweb’ -also termed an unstable cobweb - the price tends to move away from equilibrium. 11 7 5 D1 D 8 9 15 17
Quantity Bought and Sold (millions)

9. Cobweb Theorem http://www.bized.co.uk/current/mind/2004_5/251004.ppt
Hungarian-born economist Nicholas Kaldor ( )
Simple dynamic model of cyclical demand with time lags between the response of production and a change in price (most often seen in agricultural sectors).
Cobweb theory is the process of adjustment in markets
Traces the path of prices and outputs in different equilibrium situations. Path resembles a cobweb with the equilibrium point at the center of the cobweb.
Sometimes referred to as the hog-cycle (after the phenomenon observed in American pig prices during the 1930s).

10. So What Do Buyers Get Out of This?
Consumer surplus
Difference between what you are willing-to-pay and what you have to pay
Willingness-to-pay
Everything under the demand curve up to the last unit that you bought
What you had to pay
Average price paid x number of units purchased

11. Consumer Surplus Demand Curve is Also Marginal Value and Avg RevenueCS
Amount Paid
Total WTP =
CS + Amt Paid

12. In Class Example TV(Q-1)+MV(Q) Tot Val- Tot Paid Avg P*Qd
Also = Avg Rev
TV(Q)-TV(Q-1)
Also = MV(Q)

13. What Do Sellers Get Out of This?
Producer Surplus
The difference between what they get paid (total revenues) and what it costs them
Total Revenues
> = Average Price x Quantity Purchased
Total Costs
> = Sum of Marginal Costs up to the amount supplied (QS)
Or = the area under the supply curve up to Qs

14. What is the Value of the Market
To Consumers = Consumer Surplus
To Producers = Producer Surplus
Value equals the sum of both CS and PS