Market Equilibrium 1 Module 4. market equilibrium, Define a market equilibrium, and use a demand- supply graph to represent a market equilibrium. 2

Market EquilibriumMarket Equilibrium

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Module 4Module 4

Define a market equilibriummarket equilibrium,, and use a demand-supply graph to represent a market equilibrium.

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ObjectivesObjectivesObjectivesObjectives


Understand what is a shortage,shortage, how to calculate the amount of shortage, and how to eliminate a shortage in a free market.

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Understand what is a shortageshortage, how to calculate the amount of shortage, and how to eliminate a shortage in a free market.

Understand what is a surplus,surplus, how to calculate the amount of surplus, and how to eliminate a surplus in a free market.

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Define a market equilibriummarket equilibrium, and use a demand-supply graph to represent a market equilibrium.

Understand what is a shortageshortage, how to calculate the amount of shortage, and how to eliminate a shortage in a free market.

Understand what is a surplussurplus, how to calculate the amount of surplus, and how to eliminate a surplus in a free market.

Analyze changes in equilibriumchanges in equilibrium using a demand-supply graph.

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Define a market equilibrium, use a demand-supply graph to represent a market equilibriumDefine a market equilibrium, use a demand-supply graph to represent a market equilibrium

Objective 1Objective 1

A market is represented by both demand andand supply curves to capture the fact that buyers and sellers interact in a market.

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A market equilibriummarket equilibrium is a situation where quantity demanded equal quantity supplied.


Define a market equilibrium ...Define a market equilibrium ...

Quantity demanded Quantity demanded equals quantity equals quantity suppliedsupplied

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Price per cup($)

Quantity Demanded(cups per

week)

Quantity Supplied(cups per

week)

5.00 100 900

4.50 200 800

4.00 300 700

3.50 400 600

3.00 500 500

2.50 600 400

2.00 700 300

1.50 800 200

1.00 900 100

0.50 1000 0

Market Demand and Supply Market Demand and Supply ScheduleSchedule

Coffee Market Demand and Coffee Market Demand and Supply GraphSupply Graph

Objective 1: … market equilibriumObjective 1: … market equilibrium

Price per cup($)

Quantity Demanded(cups per

week)

Quantity Supplied(cups per

week)

5.00 100 900

4.50 200 800

4.00 300 700

3.50 400 600

3.00 500 500

2.50 600 400

2.00 700 300

1.50 800 200

1.00 900 100

0.50 1000 0

Market Demand and Supply ScheduleMarket Demand and Supply Schedule

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Objective 1: … market equilibriumObjective 1: … market equilibrium

In an equilibrium there are no shortagesshortages or surplusessurpluses.

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At a price of $1.50, quantity demanded is 800 and quantity supplied is 200, resulting in a shortage of 600 cups.

Understand what is a shortage, how to calculate Understand what is a shortage, how to calculate the amount of a shortage….the amount of a shortage….


What happens at a price other than the equilibrium price? For example, consider a price below equilibrium, such as $1.50.

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A shortage or excess demandshortage or excess demand arises when the price is belowbelow the market equilibrium price.


Understand what is a shortage, how to calculate Understand what is a shortage, how to calculate the amount of a shortage …the amount of a shortage …


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A shortage or excess demandshortage or excess demand arises when the price is belowbelow the market equilibrium price.

It is measured by the difference between quantity quantity demanded and quantity supplieddemanded and quantity supplied at that price.


Objective 2: … what is a shortage, how to Objective 2: … what is a shortage, how to calculate the amount of a shortage …calculate the amount of a shortage …

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Objective 2: … how to eliminate a shortage Objective 2: … how to eliminate a shortage

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In a free market, price must riseprice must rise to eliminate a shortage.

Objective 2: … how to eliminate a shortage Objective 2: … how to eliminate a shortage

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In a free market, price must riseprice must rise to eliminate a shortage. As price rises, quantity supplied increases and quantity

demanded decreases (movement along the demand and supply curves).

This price adjustment continues until the shortage is eliminated and market is equilibrated at $3.

Objective 2: … how to eliminate a shortageObjective 2: … how to eliminate a shortage

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Objective 3Objective 3Understand what is a surplus, how to calculate the Understand what is a surplus, how to calculate the amount of a surplus …amount of a surplus …

At a price of $4.00, quantity demanded (point “b”) is 300 and quantity supplied (point “c”) is 700, resulting in surplus of 400 cups.

What happens at a price above the equilibrium price, such as $4.00?

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A surplus or excess supplysurplus or excess supply arises when the price is aboveabove the free market equilibrium.

Objective 3Objective 3Understand what is a surplus, how to calculate the Understand what is a surplus, how to calculate the amount of a surplus …amount of a surplus …

At a price of $4.00, quantity demanded is 300 and quantity supplied is 700, resulting in surplus of 400 cups.

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A surplus or excess supplysurplus or excess supply arises when the price is aboveabove the free market equilibrium.

It is measured by the difference between quantity difference between quantity supplied and quantity demanded at that price.supplied and quantity demanded at that price.

Objective 3: … what is a surplus, how to calculate the Objective 3: … what is a surplus, how to calculate the amount of a surplus …amount of a surplus …

At a price of $4.00, quantity demanded is 300 and quantity supplied is 700, resulting in surplus of 400 cups.

Objective 3: … how to eliminate a surplusObjective 3: … how to eliminate a surplus

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In a free market, price must fallprice must fall to eliminate a surplus.

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In a free market, price must fallprice must fall to eliminate a surplus. As price falls, quantity supplied decreases and quantity

demanded increases (movement along the demand and supply curves).

This price adjustment continues until the surplus is eliminated and market is equilibrated at $3.

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More terminology … More terminology …

A shortageshortage is also called an excess demand.excess demand.

A surplussurplus is also called an excess supply.excess supply.

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Quantity TradedQuantity Traded means the quantity sold or the quantity exchanged between buyers and sellers.

In an equilibriumequilibrium, the quantity traded equals the quantity demanded equals the quantity supplied.

Quantity traded …Quantity traded …

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When the market price is aboveabove the market equilibrium price, the quantity traded equals the quantity demandedquantity demanded.


Quantity traded equals quantity demanded

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When the market price is belowbelow the market equilibrium price, the quantity traded equals the quantity suppliedquantity supplied.


Quantity traded equals quantity supplied

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The market price market price is determined by forces of demand and supply.

Market price and quantity traded …Market price and quantity traded …

Quantity traded means quantity exchanged (between sellers and buyers) or quantity sold.

At any price there is a quantity tradedquantity traded as long as suppliers are willing to sell their product and buyers are willing to buy the product at that price.


Analyzing Changes in EquilibriumAnalyzing Changes in Equilibrium

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In this segment, we will use the demand-supply model to predict what happens to equilibrium price and quantity following an economic event.

To determine what happens to equilibrium price and equilibrium quantity, we need both the demand and supply curves.

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Unless stated otherwise, the analysis begins from an initialinitial equilibriumequilibrium.



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The simple 3-step process:

Step 1:Step 1: Determine whether the event shifts the demand curve or the supply curve or

both.



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Step 1:Step 1: Determine whether the event shifts the demand curve or the supply curve or

both

Step 2:Step 2: Determine which direction the curve shifts.



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Step 1:Step 1: Determine whether the event shifts the demand curve or the supply curve or both

Step 2:Step 2: Determine which direction the curve shifts.

Step 3:Step 3: Use the supply-and-demand diagram to see how the shift changes the equilibrium

price and quantity.



Example 1:Example 1: What happens to equilibrium price and quantity in the beef market if the price of corn feed falls?

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Objective 4: … Changes in EquilibriumObjective 4: … Changes in Equilibrium

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Solving the problemSolving the problem

Step 1:Step 1: Which curve shifts?Which curve shifts?A fall in the price of corn feed lowers the cost of producing beef. Hence, the supply curve shifts.

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Objective Objective 4: … Changes4: … Changes in Equilibrium in Equilibrium



Step 2:Step 2: Which direction?Which direction? The supply curve shifts right.(Supply increases.)

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Step 2:Step 2: Which direction?Which direction? The supply curve shifts right.

Step 3:Step 3: What happens to What happens to equilibrium price and quantity?equilibrium price and quantity? The equilibrium price falls and the equilibrium quantity increases.


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At the initial price P0, following the increase in supply, there is a surplussurplus.

Let’s take a closer look at the adjustment Let’s take a closer look at the adjustment process in the beef market.process in the beef market.

Objective 4…Changes in EquilibriumObjective 4…Changes in Equilibrium

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At the initial price P0, following the increase in supply, there is a surplussurplus.

It is this surplus that causes price to fallfall.

Let’s take a closer look at the adjustment Let’s take a closer look at the adjustment process in the beef market.process in the beef market.


Example 2Example 2: What happens in the market for Spam, an inferior good, if students’ incomes decrease?

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Example 2Example 2: What happens in the market for Spam,an inferior good, if students’ incomes decrease?

Unless stated otherwise, always begin with an initial equilibrium.


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Step 1:Step 1: Which curve shifts? Income, a demand determinant, falls. Hence, the demand curve shifts.



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Step 2Step 2: Which direction? Spam is an inferior good. A decrease in income leads to an increase in demand. Thus, the demand curve shifts right.



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Step 2Step 2: Which direction? Spam is an inferior good. A decrease in income leads to an increase in demand. Thus, the demand curve shifts right.

Step 3:Step 3: What happens to equilibrium price and quantity?The equilibrium price and the equilibrium quantity increase.

Example 2Example 2: What happens in the market for spam, an inferior good, if students’ incomes decrease?


At the initial price P0, following the increase in demand, there is a shortageshortage.


Let’s take a closer look at the adjustment process Let’s take a closer look at the adjustment process in the spam market.in the spam market.

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At the initial price P0, following the increase in demand, there is a shortageshortage.

It is this shortage that causes price to riserise.


Let’s take a closer look at the adjustment process Let’s take a closer look at the adjustment process in the spam market.in the spam market.

Objective 4: … Changes in equilibrium: Objective 4: … Changes in equilibrium: both demand and supply curves shift both demand and supply curves shift

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We will now consider the situation where both demand and supply curves shift at the same time or simultaneous shifts of the demand and supply curves.

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Objective 4: … Changes in equilibrium: Objective 4: … Changes in equilibrium: both demand and supply curves shiftboth demand and supply curves shift

There are four possible combinations of simultaneous shifts:

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1. Increase in both demand and supply

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Objective 4….Changes in equilibrium: Objective 4….Changes in equilibrium: both demand and supply curves shiftboth demand and supply curves shift


1. Increase in both demand and supply2. Decrease in both demand and supply

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1. Increase in both demand and supply2. Decrease in both demand and supply 3. Increase in demand and decrease in supply

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1. Increase in both demand and supply2. Decrease in both demand and supply 3. Increase in demand and decrease in supply4. Decrease in demand and increase in supply

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Methodology to analyze simultaneous shifts:

Step 1:Step 1: Analyze the demand shift and the supply shift separatelyseparately using the 3-step process.

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Methodology to analyze simultaneous shifts:

Step 1:Step 1: Analyze the demand shift and the supply shift separatelyseparately using the 3-step process.

Step 2:Step 2: AddAdd the results from each shift to arrive at the combined effects.


Example 3:Example 3: Suppose a frost destroys the grape crop. At the same time, the demand for wines has increased. Analyze the impact of these events in the wine market.

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Step 1:Step 1: Analyze the events using the 3-step process.Event 1: A frost destroys the grape crop.Event 2: The demand for wines has increased.

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Let’s start with event 1: Frost destroys the grape crop.




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Supply decreases causing the supply curve to shift leftwards.




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Supply decreases causing the supply curve to shift leftwards.

In the new equilibrium,P* ↑ and Q* ↓




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Step 1:Step 1: Analyze Event 2 (the demand for wines has increased) using the 3-step process.


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This event shifts the wine demand curve to the right.




This event shifts the wine demand curve to the right.

In the new equilibrium, P* ↑ and Q* ↑

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Step 2:Step 2: Add the results from each shift to arrive at the combined effects.

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The combined effects of the two events are:


Via the supply effect P* ↑ Q* ↓Via the supply effect P* ↑ Q* ↓

+ ++ +

Via the demand effect P* ↑ Q* ↑ Via the demand effect P* ↑ Q* ↑

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Price rises unambiguously.



+ ++ +


P* ↑P* ↑

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The effect on quantity is indeterminate; it depends on which effect dominates.



+ ++ +


P* ↑ Q*?P* ↑ Q*?

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If the supplysupply effect dominateseffect dominates, equilibrium quantity falls.





+ ++ +


P* ↑ Q*?P* ↑ Q*?

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If the supplysupply effect dominateseffect dominates, equilibrium quantity falls.If the demand effect dominatesdemand effect dominates, equilibrium quantity rises.



+ ++ +


P* ↑ Q*?P* ↑ Q*?

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If the supply effect dominates,supply effect dominates, equilibrium quantity falls. If the demand effect dominates,demand effect dominates, equilibrium quantity rises. If the demand and supply are of equalequal magnitudes, the

equilibrium quantity remains the same.

Objective 4: … Changes in equilibrium: both demand and supply Objective 4: … Changes in equilibrium: both demand and supply curves shiftcurves shift


+ ++ +


P* ↑ Q*?P* ↑ Q*?

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Market EquilibriumMarket Equilibrium

End of Module 4End of Module 4

Song: Supply and DemandAlbum: Other People’s HeavensArtists: Chris Brown and Kate Fenner

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Market Equilibrium 1 Module 4. market equilibrium, Define a market equilibrium, and use a demand- supply graph to represent a market equilibrium. 2