Equilibrium. Market Equilibrium ïµ A market is in equilibrium when total quantity demanded by buyers equals total quantity supplied by sellers. ïµ An equilibrium

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Equilibrium Slide 2 Market Equilibrium A market is in equilibrium when total quantity demanded by buyers equals total quantity supplied by sellers. An equilibrium situation is one where agents are choosing the best possible actions and the behaviors of all agents are mutually consistent. Slide 3 Market Equilibrium It turns out that the equilibrium outcome of a competitive market is Pareto efficient. At any amount of output less than the equilibrium level there is at least one producer willing to supply extra quantity of the good at a price that is less than the price at least one consumer is willing to pay. Therefore, we can improve the situation of at least two people without hurting anybody else. Slide 4 Market Equilibrium The equilibrium outcome of a competitive market is the only Pareto efficient outcome. Slide 5 Market Equilibrium p D(p) q=D(p) Market demand Slide 6 Market Equilibrium p S(p) Market supply q=S(p) Slide 7 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) Slide 8 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* q* Slide 9 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* q* D(p*) = S(p*); the market is in equilibrium. Slide 10 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* S(p) D(p) < S(p); an excess of quantity supplied over quantity demanded. p D(p) Slide 11 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* S(p) D(p) < S(p); an excess of quantity supplied over quantity demanded. p D(p) Market price must fall towards p*. Slide 12 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* D(p) D(p) > S(p); an excess of quantity demanded over quantity supplied. p S(p) Slide 13 Market Equilibrium p D(p), S(p) q=D(p) Market demand Market supply q=S(p) p* D(p) D(p) > S(p); an excess of quantity demanded over quantity supplied. p S(p) Market price must rise towards p*. Slide 14 Market Equilibrium The effects of setting a maximum price The effects of setting a minimum price Slide 15 Market Equilibrium Demand shifts and motives: -income, -preferences, -prices of substitutes or complements have changed, -expectations of future changes in income or prices, -population, -taxes on consumption Slide 16 Market Equilibrium Supply shifts and motives: -production technology, -changes in the prices of production factors (wages, prices of raw materials, interest rate, ), -number of producers, -expectations of future price changes, -taxes on production Slide 17 Market Equilibrium The effects of elasticities on price and quantity variations: when one curve is very inelastic, price accommodates; when one curve is very elastic, quantity accommodates (One of DeBeers main roles is to maintain the notion that diamonds are a scarce commodity. This they do by means of advertising and by purchasing excess supplies when that is needed to avoid price decreases: as a matter of principle, prices are never lowered by DeBeers.) Slide 18 Market Equilibrium An example of calculating a market equilibrium when the market demand and supply curves are linear. Slide 19 Market Equilibrium p D(p), S(p) D(p) = a-bp Market demand Market supply S(p) = c+dp p* q* Slide 20 Market Equilibrium p D(p), S(p) D(p) = a-bp Market demand Market supply S(p) = c+dp p* q* What are the values of p* and q*? Slide 21 Market Equilibrium At the equilibrium price p*, D(p*) = S(p*). Slide 22 Market Equilibrium At the equilibrium price p*, D(p*) = S(p*). That is, Slide 23 Market Equilibrium At the equilibrium price p*, D(p*) = S(p*). That is, which gives Slide 24 Market Equilibrium At the equilibrium price p*, D(p*) = S(p*). That is, which gives and Slide 25 Market Equilibrium p D(p), S(p) D(p) = a-bp Market demand Market supply S(p) = c+dp Slide 26 Market Equilibrium Can we calculate the market equilibrium using the inverse market demand and supply curves? Yes, it is the same calculation. Slide 27 Market Equilibrium Two special cases: quantity supplied is fixed, independent of the market price, and quantity supplied is extremely sensitive to the market price. Slide 28 Market Equilibrium p q D -1 (q) = (a-q)/b Market demand q* = c p* = D -1 (q*); that is, p * = (a-c)/b. p* = (a-c)/b Market quantity supplied is fixed, independent of price. Slide 29 Market Equilibrium Market quantity supplied is extremely sensitive to price. S -1 (q) = p*. p q p* D -1 (q) = (a-q)/b Market demand q* = a-bp* p* = D -1 (q*) = (a-q*)/b so q* = a-bp* Slide 30 Quantity Taxes A quantity tax levied at a rate of t is a tax of t paid on each unit traded. If the tax is levied on sellers then it is an excise tax. If the tax is levied on buyers then it is a sales tax. Slide 31 Quantity Taxes What is the effect of a quantity tax on a markets equilibrium? How are prices affected? How is the quantity traded affected? Who pays the tax? How are gains-to-trade altered? Slide 32 Quantity Taxes A tax rate t makes the price paid by buyers, p b, higher by t from the price received by sellers, p s. Slide 33 Quantity Taxes Even with a tax the market must clear. I.e. quantity demanded by buyers at price p b must equal quantity supplied by sellers at price p s. Slide 34 Quantity Taxes and describe the markets equilibrium. Notice that these conditions apply no matter if the tax is levied on sellers or on buyers. Slide 35 Quantity Taxes and describe the markets equilibrium. Notice that these two conditions apply no matter if the tax is levied on sellers or on buyers. Hence, a tax rate t has the same effect no matter the side of the market on which it is levied. Slide 36 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* No tax Slide 37 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* t An excise tax raises the market supply curve by t Slide 38 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* An excise tax raises the market supply curve by t, raises the buyers price and lowers the quantity traded. t pbpb qtqt Slide 39 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* An excise tax raises the market supply curve by $t, raises the buyers price and lowers the quantity traded. t pbpb qtqt And sellers receive only p s = p b - t. psps Slide 40 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* No tax Slide 41 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* A sales tax lowers the market demand curve by t t Slide 42 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* An sales tax lowers the market demand curve by t, lowers the sellers price and reduces the quantity traded. t qtqt psps Slide 43 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* An sales tax lowers the market demand curve by t, lowers the sellers price and reduces the quantity traded. t pbpb pbpb qtqt pbpb And buyers pay p b = p s + t. psps Slide 44 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* A sales tax levied at rate t has the same effects on the markets equilibrium as does an excise tax levied at rate t. t pbpb pbpb qtqt pbpb psps Slide 45 Quantity Taxes & Market Equilibrium Who pays the tax of t per unit traded? The division of the t between buyers and sellers is the economic incidence of the tax. Slide 46 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps Slide 47 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps Tax paid by buyers Slide 48 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps Tax paid by sellers Slide 49 Quantity Taxes & Market Equilibrium p D(p), S(p) Market demand Market supply p* q* pbpb pbpb qtqt pbpb psps Tax paid by buyers Tax paid by sellers Slide 50 Quantity Taxes & Market Equilibrium E.g. suppose the market demand and supply curves are linear. Slide 51 Quantity Taxes & Market Equilibrium and Slide 52 Quantity Taxes & Market Equilibrium and With the tax, the market equilibrium satisfies andso and Slide 53 Quantity Taxes & Market Equilibrium and With the tax, the market equilibrium satisfies andso and Substituting for p b gives Slide 54 Quantity Taxes & Market Equilibrium and give The quantity traded at equilibrium is Slide 55 Quantity Taxes & Market Equilibrium As t 0, p s and p b the equilibrium price if there is no tax (t = 0) and q t the quantity traded at equilibrium when there is no tax. Slide 56 Quantity Taxes & Market Equilibrium As t increases, p s falls, p b rises, andq t falls. Slide 57 Quantity Taxes & Market Equilibrium The tax paid per unit by the buyer is Slide 58 Quantity Taxes & Market Equilibrium The tax paid per unit by the buyer is The tax paid per unit by the seller is Slide 59 Quantity Taxes & Market Equilibrium The total tax paid (by buyers and sellers combined) is Slide 60 Tax Incidence and Own-Price Elasticities The incidence of a quantity tax depends upon the own-price elasticities of demand and supply. Slide 61 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* t pbpb qtqt psps Slide 62 Tax Incidence and Own-Price Elasticities p D(p), S(p) Market demand Market supply p* q* t pbpb qtqt psps Change to buyers price is p b - p*. Change to quantity demanded is q. qq Slide 63 Tax Incidence and Own-Price Elasticities Around p = p* the own-price elasticity of demand is approximately Slide 64 Tax Incidence and Own-Price Elasticities Around p = p* the own-price elasticity of demand is approximately Slide 65 Tax Incidence a

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