1. Econ 201 Market Equilibrium Week 2

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 –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 –MV consumer = P market = MC producer

5. And If That Doesn’t Happen? MV 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 Demand ed Price Per Pizza # of Pizzas Supplie d Shortage or Surplus 1000$10400 900$12450 800$14500 700$16550 600$18600 500$20650

7. Answers # of Pizzas DemandedPrice Per Pizza# of Pizzas SuppliedShortage (-) or Surplus (+) 1000$10400-600 900$12450-450 800$14500-300 700$16550-150 600$186000 500$20650150 Qty Dem (P=$18) = Qty Sup(p=$18): Solve for P* such that Qd(P*) = Qs(P*)

8. The Cobweb Theorem D S 7 Price (£) Quantity Bought and Sold (millions) 9 D1 In a ‘divergent cobweb’ - also termed an unstable cobweb - the price tends to move away from equilibrium. Assume the initial equilibrium price is £7 and the quantity 9. If demand rises, the shortage pushes the price up to £11 per turkey. 11 15 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. 8 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. 5 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. 17

9. Cobweb Theorem http://www.bized.co.uk/current/mind/2004_5/251004.ppt Hungarian-born economist Nicholas Kaldor (1908-1986)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 Revenue Amount Paid CS Total WTP = CS + Amt Paid

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

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 (Q S ) Or = the area under the supply curve up to Q s

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