Demand and supply analysis Market equilibrium and Efficiency What is Market Equilibrium It occurs at the price where the quantity demanded and quantity supplied are equal Also called the market-clearing price everything put on the market, at that price, is sold The Determination of Price Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves Equilibrium price and output : The Market Demand and Supply of Potatoes (Monthly) The determination of market equilibrium (potatoes: monthly) Quantity (tonnes: 000s) E D C B A a b c d e Supply Demand Price (pence per kg) The Determination of Price Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium The Determination of Price Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium surplus price falls Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium surplus price falls Quantity (tonnes: 000s) E C B A a b c e Supply Demand Price (pence per kg) D d SURPLUS ( ) The determination of market equilibrium (potatoes: monthly) Excess Supply or The Determination of Price Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium surplus price falls effect of price being below equilibrium Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium surplus price falls effect of price being below equilibrium The Determination of Price Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium surplus price falls effect of price being below equilibrium shortage price rises Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium surplus price falls effect of price being below equilibrium shortage price rises Quantity (tonnes: 000s) E D C B A a b c d e Supply Demand Price (pence per kg) SHORTAGE ( ) The determination of market equilibrium (potatoes: monthly) Or Excess Demand The Determination of Price Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium surplus price falls effect of price being below equilibrium shortage price rises equilibrium: where D = S Equilibrium price and output response to shortages and surpluses significance of equilibrium Demand and supply curves effect of price being above equilibrium surplus price falls effect of price being below equilibrium shortage price rises equilibrium: where D = S D d QeQe Quantity (tonnes: 000s) E B A a b e Supply Demand Price (pence per kg) The determination of market equilibrium (potatoes: monthly) Price of 60 is the market clearing price The Determination of Price Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls P Q O Pe1Pe1 Qe1Qe1 S D1D1 g Effect of a shift in the demand curve An increase in demand P Q O Pe1Pe1 Qe1Qe1 S D1D1 g Effect of a shift in the demand curve P Q O Pe1Pe1 Qe1Qe1 S D1D1 D2D2 g P Q O Pe1Pe1 Qe1Qe1 S g h D1D1 D2D2 Pe2Pe2 Qe2Qe2 i As producers realize they can raise the price, they produce more, a movement upwards along the S curve. As consumers see the higher prices, they decrease the qty demanded, a movement up & left along the new D curve. P Q O Pe1Pe1 Qe1Qe1 S D1D1 D2D2 g A decrease in demand Effect of a shift in the demand curve P Q O Pe1Pe1 Qe1Qe1 S D1D1 D2D2 g Pe2Pe2 Qe2Qe2 n m A decrease in D results in surplus; producers will then cut prices to entice buyers (increasing qty demanded, moving down along the D curve. The Determination of Price Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls Effects of shifts in the supply curve Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls Effects of shifts in the supply curve The Determination of Price Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls Effects of shifts in the supply curve movement along D curve and new S curve Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls Effects of shifts in the supply curve movement along D curve and new S curve The Determination of Price Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls Effects of shifts in the supply curve movement along D curve and new S curve rise in supply (rightward shift) P falls Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls Effects of shifts in the supply curve movement along D curve and new S curve rise in supply (rightward shift) P falls The Determination of Price Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls Effects of shifts in the supply curve movement along D curve and new S curve rise in supply (rightward shift) P falls fall in supply (leftward shift) P rises Effects of shifts in the demand curve movement along S curve and new D curve rise in demand (rightward shift) P rises fall in demand (leftward shift) P falls Effects of shifts in the supply curve movement along D curve and new S curve rise in supply (rightward shift) P falls fall in supply (leftward shift) P rises P Q O Pe1Pe1 Qe1Qe1 D S1S1 g Effect of a shift in the supply curve A decrease in supply P Q O Pe1Pe1 Qe1Qe1 D S1S1 g Effect of a shift in the supply curve P Q O Pe1Pe1 Qe1Qe1 D S1S1 S2S2 g P Q O Pe1Pe1 Pe3Pe3 Qe3Qe3 Qe1Qe1 D S1S1 S2S2 jg k The reduce supply causes a shortage at the old equilibrium price. Producers therefore begin to increase prices & consumers respond by decreasing the qty demanded. P Q O Pe1Pe1 Qe1Qe1 D S1S1 g An increase in supply S2S2 Effect of a shift in the supply curve P Q O Pe1Pe1 Qe1Qe1 D S1S1 g S2S2 p Pe2Pe2 Qe2Qe2 q Time for you to draw Using fully labeled diagrams, illustrate what will happen to the equilibrium price and quantity in each of the situations, and then explain what has happened. There has been a health scare relating to the consumption of chicken. P Q O Pe1Pe1 Qe1Qe1 S D1D1 D2D2 Pe2Pe2 Qe2Qe2 Effect of a shift in the demand curve A decrease in demand There has been an increase in the costs of production in the motorcycle industry. P Q O Pe1Pe1 Qe1Qe1 D S1S1 g Effect of a shift in the supply curve A decrease in supply P Q O Pe1Pe1 Qe1Qe1 D S1S1 g Effect of a shift in the supply curve P Q O Pe1Pe1 Qe1Qe1 D S1S1 S2S2 g P Q O Pe1Pe1 Pe3Pe3 Qe3Qe3 Qe1Qe1 D S1S1 S2S2 jg k There has been an improvement in production technology in the textile industry. P Q O Pe1Pe1 Qe1Qe1 D S1S1 g An increase in supply S2S2 Effect of a shift in the supply curve P Q O Pe1Pe1 Qe1Qe1 D S1S1 g S2S2 p Pe2Pe2 Qe2Qe2 q Manufacturers in the sportswear industry have decided to raise the price of training shoes. P Q O P e QeQe S D1D1 Increase in Price An increase in price Q2Q2 Q1Q1 P1P1 SURPLUS Role of Price in Resource Allocation Price Mechanism Forces of supply and demand move markets to equilibrium Helps to allocate scarce resources Resources are allocated and re-allocated in response to changes in price If there is an increase in the price of a good, due to an increase in demand for the good, this gives a signal to producers that consumers wish to buy this good Higher price will give producers an incentive to produce more of a good P Q O Pe1Pe1 Qe1Qe1 S g h D1D1 D2D2 Pe2Pe2 Qe2Qe2 i Effect of a shift in the demand curve As producers realize they can raise the price, they produce more, a movement upwards along the S curve. As consumers see the higher prices, they decrease the qty demanded, a movement up & left along the new D curve. New higher equilibrium price signals product scarcity. Qe3Qe3 P Q O Pe1Pe1 Qe1Qe1 D S1S1 g An increase in supply S2S2 Effect of a shift in the supply curve P Q O Pe1Pe1 Qe1Qe1 D S1S1 g S2S2 p Pe2Pe2 Qe2Qe2 q Q3Q3 Answer Worksheet 3.2 Questions Gas Prices: From Disequilibrium to Equilibrium Market Efficiency Consumer Surplus Producer Surplus Consumer Surplus Producer Surplus Consumer Surplus The difference between the price that a consumer is prepared to pay and the actual price paid Related to the value we place on items Linked to the degree of utility Useful concept in analyzing welfare gains and losses as a result of resource allocation Emphasis on the MARKET demand of those in the market there are some who are willing to pay higher prices than the market price Consumer Surplus Price () Quantity Market Price = 5 20 consumers willing to pay 5 15 Consumers WILLING to pay 9 These 15 consumers get 15 x 4 of consumer surplus S D Producer Surplus Difference between the market price received by the seller and the price they would have been prepared to supply at Producer Surplus Price () Quantity S D Community Surplus Price () Quantity S D