Market Equilibrium

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MARKET EQUILIBRIUMPrice determination using Demand and Supply P = f (Qd,Qs) (Qd,Qs)

MARKET EQUILIBRIUMThe interaction of buyers and sellers in the market leads to market equilibrium. Market equilibrium a situation in which at the prevailing price, consumers can buy all of a good they wish to buy and producers can sell of a good they wish to sell. Equilibrium quantity the amount of a good bought and sold in the market at a prevailing equilibrium price.

MARKET EQUILIBRIUM(1) (2) S0Quantity Supplied Price Qs = 100 + 10P

(3) D0Quantity Demanded Qd = 1300 20P

(4) Excess Supply(+)/ Excess Demand(-) Demand((surplus/shortage)

(P) 0 10 20 30 40 50 60 65

Qs 100 200 300 400 500 600 700 750

Qd 1300 1100 900 700 500 300 100 0

Qs Qd -1200 -900 -600 -300 0 +300 +600 +750

MARKET EQUILIBRIUM Surplus (excess supply) exists when quantity supplied exceeds quantity demanded Shortage (excess demand) exists when quantity demanded exceeds quantity supplied

MARKET EQUILIBRIUM

Equilibrium price is sometimes called market clearing price because at equilibrium, the market clears in the sense that buyers can purchase all of the goods they want and sellers can sell all of the goods they want.

MARKET EQUILIBRIUMIllustration of Equilibrium (Qs = Qd) Qs = 100 + 10P Qs = 1300 20P Determine the equilibrium price by equating the two equations, Qs = Qd 100 + 10P = 1300 20P 1300 100 1200 40

10P + 20P = 30P P = =

MARKET EQUILIBRIUMNote that at P = 40, Qs = Qd Therefore, Pe = 40 Substitute P = 40 to either the supply or the demand equation to obtain the equilibrium quantity (Qe). Qd = 1300 20P Qd = 1300 20 ( 40 ) Qd = 500 or Qs = 100 = 10P Qs = 100 + 10 ( 40 ) Qs = 500

MARKET EQUILIBRIUMLets say P = 50, then Qd = 1300 20P Qs = 100 + 10P Qd = 1300 20 ( 50 ) Qs = 100 + 10 ( 50 ) Qd = 300 Qs = 600 Since Qs exceeds Qd (Qs>Qd), there is a surplus amounting to 300 (600 300) units.

MARKET EQUILIBRIUMPrice (P)

S0

50 40

B

D00

300

500 600

Quantity (Q)

MARKET EQUILIBRIUMThis graph shows that point B is the market equilibrium where Qs = Qd. At P = 40, Qs = 500 units and Qd = 500 units. At price lower than 40, say 20, suppliers are only willing to supply 300 units while consumers want to buy 900 units. There is a shortage of 600 units at this price level. Because of this, demands are not satisfied, so consumers bid the price up in order to meet their demands. At price higher than 40, say 50, suppliers are willing to sell 600 units because of a higher selling price while consumers are only willing to buy 300 units. There is a surplus of 300 units. Producers must lower the price in order to keep from accumulating inventories.

MARKET EQUILIBRIUMChanges in Market Equilibrium

Consequently, demand and supply curves shifts. Because of the changes in the variables affecting both supply and demand, equilibrium price (Pe) and equilibrium quantity (Qe) change. Using demand and supply, managers may take either a qualitative or a quantitative forecast.

MARKET EQUILIBRIUMQualitative forecast a forecast that predicts only the direction in which an economic variable will move, such as price and quantity. Quantitative forecast a forecast that predicts the direction and the magnitude of the change in an economic variable.

MARKET EQUILIBRIUMIf you forecast that P will rise and sales will fall, you may have a qualitative forecast about P and Q. You may have sufficient data on the exact nature of supply and demand to be able to predict that price will rise by P1.50 and sales will fall by 7,000 units. This now is a quantitative forecast. Obviously, a manager will get more information from a quantitative than a qualitative forecast. Thus, an important task of a manager is predicting the effect, especially the effect on market price, of specific changes in the variables that determine the position of demand and supply curves.

MARKET EQUILIBRIUMThe approach of this study is to discuss the process of adjustment when something causes demand to change while supply remains constant, then, the process when supply changes while demand remains constant.

MARKET EQUILIBRIUMPrice

S0

B 50 40 30 C A

D1 D2 D0 Quantity (Q)

0

200

400 500 600

800

MARKET EQUILIBRIUMChanges in the Demand (Supply is constant) The previous graph shows that equilibrium occurs at Pe = 40 and Qe = 500 at point A. D1 shows an increase in demand because of an increase in income from P15,000 to P20,000. Beginning at point A as equilibrium, demand increases from D0 to D1. At the original price 40, consumers now demand 800 units with the new demand curve. Since firms are only willing to supply 500 units, at price 40, a shortage of 300 units results. The shortage causes the price to rise to new equilibrium where Qd = Qs. This new equilibrium, where D1 intersects S0 occurs when P = 50 and Qe = 600 units (point B). Therefore, the increase in demand (supply constant) increases both the equilibrium price and quantity.

MARKET EQUILIBRIUMD2 shows the decrease in demand because of a decrease in income from P15,000 to P10,000. Again, beginning at point A as equilibrium, demand decreases from D0 to D2. At the original price of 40, firms wants to supply 500 units but consumers are only willing to buy 200 units. There is a surplus of 300 units at P = 40 and this causes price to fall. The market returns to equilibrium only when P = 30 and Qe = 400 (point C). Therefore, the decrease in demand (supply constant) decreases both equilibrium price and quantity.

MARKET EQUILIBRIUM

Principle: When demand increases and supply is constant, both equilibrium price (Pe) and quantity (Qe) rises. When demand decreases and supply is constant, both Pe and Qe falls.

MARKET EQUILIBRIUMChanges in Supply (Demand is constant) To illustrate the effect of changes, D0 and S0 are reproduced. S1 shows an increase in supply. The shift from S0 to S1 was caused by a decrease in the price of inputs from 50 to 31.25. S2 shows a decrease in supply. The shift from S0 to S2 was caused by a decrease in the number of firms in the industry from 90 firms to 30 firms.

MARKET EQUILIBRIUMBeginning in equilibrium at point R, let supply increases to S1. at the original price 40, consumers still want to purchase 500 units, but sellers now wishes to sell 650 units causing a surplus or an excess of supply of 150 units. The surplus causes price to fall, which induces suppliers to supply less and buyers to demand more. Price continue to fall until the new equilibrium is attained at Pe = 35 and Qe = 600 units (point S). at this point S, Qs = Qd. Thus, when supply increases and demand remain constant, Pe will fall and Qe = will increase.

MARKET EQUILIBRIUMLet now price decrease to S2. we now return to S0 where Pe = 40 and Qe = 500 units. At this point, Pi = 50. A decrease in the number of firms causes the supply curve (S0) to shift to the left (S2). At the original price, consumer still want to buy 500 units but sellers want now to sell only 200 units. This leads to a shortage or excess demand of 300 units. Shortages cause price to rise. The increase in price causes sellers to supply more and buyers to demand less, thereby reducing the shortage. Price will continue to increase until it attains the new equilibrium at a price of 50 and 300 units of output (point T). at the new equilibrium (T), S2 intersects D0 and Qs = Qd. Therefore, when supply decreases while demand remains constant, price will rise and quantity sold will decrease.

MARKET EQUILIBRIUMPrinciple : When supply increases and demand is constant, equilibrium price (Pe) falls and equilibrium quantity (Qe) rises. When supply decreases and demand is constant, Pe rises and Qe falls.

MARKET EQUILIBRIUMS2

P

S0 S1

50 40 35 D0

200 300 500 600 650

Q

MARKET EQUILIBRIUMSummary of simultaneous shift in the Demand and Supply : The four possible ways - Both Demand and Supply increase - Demand decreases and Supply increases - Demand increases and Supply decreases - Both Demand and Supply decrease

MARKET EQUILIBRIUMBoth Demand and Supply increaseS1 S0

Qe rises Pe may rise or fallS3

P

Pe Pe PeD2 D1

Qe

Qe

Qe

Q

MARKET EQUILIBRIUMDemand decreases and Supply increasesPS0 S1

Pe falls Qe may rise or fallS2

Pe Pe PeD0

D1

QeQe

Qe

Qe

MARKET EQUILIBRIUMDemand increases and Supply decreasesPS2 S1 S0

Pe rises Qe may rise or fall

Pe Pe

PeD0

D1

Qe Qe Qe

Q

MARKET EQUILIBRIUMBoth Demand and Supply decreasePeS2 S1

Qe falls Pe may rise or fallS0

Pe Pe Pe

D0

D1

Qe

Qe

Qe

Qe

MARKET EQUILIBRIUM

QUALITATIVE FORECASTING Predicting the direction of changes in Airfares: A Qualitative Analysis

MARKET EQUILIBRIUMCase You manage the travel department of a leading large corporation, and your sales force makes heavy use of air travel to call on customers. Because of this, the president of the corporation wants you to reduce expenditures for next year. The extent to which you will predict air travel for next year will depend upon what happen to the price of air travel. If airfares decrease next year, you can satisfy both the wants of the president, who wants expenditure cut, and the sales personnel, who would be hurt by travel restrictions.

MARKET EQUILIBRIUMYou have recently read in business magazine about the following two events that you expect will affect the airline industry next year. 1. A number of new, small airlines have recently entered the industry and others are ex