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Econ 201 Market Equilibrium Week 2

Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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Page 1: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

Econ 201

Market Equilibrium

Week 2

Page 2: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

Equilibrium (cont’d)

Page 3: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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)

Page 4: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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– MVconsumer = Pmarket = MCproducer

Page 5: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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”

Page 6: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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 $18 600  

500 $20 650  

Page 7: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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 $18 600 0

500 $20 650 150

Qty Dem (P=$18) = Qty Sup(p=$18): Solve for P* such that Qd(P*) = Qs(P*)

Page 8: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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

Page 9: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

Cobweb Theorem

• http://www.bized.co.uk/current/mind/2004_5/251004.ppt• Hungarian-born economist Nicholas Kaldor (1908-1986)• 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).

Page 10: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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

Page 11: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

Consumer Surplus

Demand Curve

$0$2

$4$6

$8$10

$12

1 2 3 4 5 6 7 8 9 10

Quantity Demanded

Av

era

ge

Pric

e (

pric

e

pe

r u

nit

)Demand Curve is

Also Marginal Valueand Avg Revenue

Amount Paid

CS

Total WTP =CS + Amt Paid

Page 12: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

In Class Example

Avg Pric Qty Dem Tot Amt Paid Tot Value (WTP) Marg Val Cons Surp$10 1 $10 $10 $10 $0$9 2 $18 $19 $9 $1$8 3 $24 $27 $8 $3$7 4 $28 $34 $7 $6$6 5 $30 $40 $6 $10$5 6 $30 $45 $5 $15$4 7 $28 $49 $4 $21$3 8 $24 $52 $3 $28$2 9 $18 $54 $2 $36$1 10 $10 $55 $1 $45

Avg P*Qd TV(Q-1)+MV(Q)

Also = MV(Q) TV(Q)-TV(Q-1)

Tot Val- Tot Paid

Also = Avg Rev

Page 13: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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

Page 14: Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)

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