Market Equilibrium

MARKET EQUILIBRIUMMARKET EQUILIBRIUM

Price determination using Price determination using

Demand and SupplyDemand and Supply

PP = = f (f (Qd,Qs)Qd,Qs)

MARKET EQUILIBRIUMMARKET EQUILIBRIUMThe interaction of buyers and sellers in the The interaction of buyers and sellers in the

market leads to market equilibrium.market leads to market equilibrium.

Market equilibriumMarket equilibrium – a situation in which at – a situation in which at the prevailing price, consumers can buy all the prevailing price, consumers can buy all of a good they wish to buy and producers of a good they wish to buy and producers can sell of a good they wish to sell.can sell of a good they wish to sell.

Equilibrium quantityEquilibrium quantity – the amount of a – the amount of a good bought and sold in the market at a good bought and sold in the market at a prevailing equilibrium price.prevailing equilibrium price.


(1) (2) (3) (4) (1) (2) (3) (4) SS00 D D00 Excess Supply(+)/ Excess Supply(+)/ Quantity Supplied Quantity DemandedQuantity Supplied Quantity Demanded Excess Demand(-) Excess Demand(-)

Price Qs = 100 + 10P Qd = 1300 – 20P (surplus/shortage)Price Qs = 100 + 10P Qd = 1300 – 20P (surplus/shortage)

(P) Qs Qd Qs – Qd(P) Qs Qd Qs – Qd 0 100 1300 -12000 100 1300 -1200 10 200 1100 -90010 200 1100 -900 20 300 900 -60020 300 900 -600 30 400 700 -30030 400 700 -300 40 500 500 040 500 500 0 50 600 300 +30050 600 300 +300 60 700 100 +60060 700 100 +600 65 750 0 +75065 750 0 +750


Surplus Surplus (excess supply) – (excess supply) – exists when quantity supplied exists when quantity supplied exceeds quantity demandedexceeds quantity demanded

ShortageShortage (excess demand) – (excess demand) – exists when quantity exists when quantity demanded exceeds quantity demanded exceeds quantity suppliedsupplied


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


Illustration of Equilibrium (Qs = Qd)Illustration of Equilibrium (Qs = Qd)Qs = 100 + 10PQs = 100 + 10PQs = 1300 – 20PQs = 1300 – 20P

Determine the equilibrium price by equating the two Determine the equilibrium price by equating the two equations,equations,

Qs = QdQs = Qd

100 + 10P = 1300 – 20P100 + 10P = 1300 – 20P

10P + 20P = 1300 – 10010P + 20P = 1300 – 100 30P = 120030P = 1200 P = 40P = 40

MARKET EQUILIBRIUMMARKET EQUILIBRIUMNote that at P = 40, Qs = QdNote that at P = 40, Qs = Qd

Therefore, Pe = 40Therefore, Pe = 40Substitute P = 40 to either the supply or the demand Substitute P = 40 to either the supply or the demand

equation to obtain the equilibrium quantity (Qe).equation to obtain the equilibrium quantity (Qe).

Qd = 1300 – 20PQd = 1300 – 20PQd = 1300 – 20 ( 40 )Qd = 1300 – 20 ( 40 )Qd = 500Qd = 500

ororQs = 100 = 10PQs = 100 = 10PQs = 100 + 10 ( 40 )Qs = 100 + 10 ( 40 )Qs = 500Qs = 500

MARKET EQUILIBRIUMMARKET EQUILIBRIUMLets say P = 50, thenLets say P = 50, then

Qd = 1300 – 20PQd = 1300 – 20P

Qs = 100 + 10PQs = 100 + 10P Qd = 1300 – 20 ( 50 )Qd = 1300 – 20 ( 50 )

Qs = 100 + 10 ( 50 )Qs = 100 + 10 ( 50 )

Qd = 300Qd = 300 Qs = 600Qs = 600

Since Qs exceeds Qd (Qs>Qd), there is a Since Qs exceeds Qd (Qs>Qd), there is a surplus amounting to 300 (600 – 300) units.surplus amounting to 300 (600 – 300) units.


Price

(P)

50

40

0

300 500 600 Quantity (Q)

D0

S0

B


This graph shows that point B is the market This graph shows that point B is the market equilibrium where Qs = Qd. At P = 40, Qs = 500 units equilibrium where Qs = Qd. At P = 40, Qs = 500 units and Qd = 500 units.and Qd = 500 units.

At price lower than 40, say 20, suppliers are only At price lower than 40, say 20, suppliers are only willing to supply 300 units while consumers want to buy willing to supply 300 units while consumers want to buy 900 units. There is a shortage of 600 units at this price 900 units. There is a shortage of 600 units at this price level. Because of this, demands are not satisfied, so level. Because of this, demands are not satisfied, so consumers bid the price up in order to meet their consumers bid the price up in order to meet their demands.demands.

At price higher than 40, say 50, suppliers are At price higher than 40, say 50, suppliers are willing to sell 600 units because of a higher selling price willing to sell 600 units because of a higher selling price while consumers are only willing to buy 300 units. while consumers are only willing to buy 300 units. There is a surplus of 300 units. Producers must lower There is a surplus of 300 units. Producers must lower the price in order to keep from accumulating the price in order to keep from accumulating inventories.inventories.


Changes in Market EquilibriumChanges in Market Equilibrium

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


Qualitative forecastQualitative forecast – a – a forecast that predicts only the forecast that predicts only the direction in which an economic direction in which an economic variable will move, such as price and variable will move, such as price and quantity.quantity.

Quantitative forecastQuantitative forecast – a – a forecast that predicts the direction forecast that predicts the direction and the magnitude of the change in and the magnitude of the change in an economic variable.an economic variable.


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


The approach of this study is The approach of this study is to discuss the process of to discuss the process of

adjustment when something adjustment when something causes demand to change while causes demand to change while supply remains constant, then, supply remains constant, then,

the process when supply the process when supply changes while demand remains changes while demand remains

constant.constant.


S0

D0D2

D1

Price

50

40

30

0 200 400 500 600 800 Quantity (Q)

A

B

C

MARKET EQUILIBRIUMMARKET EQUILIBRIUMChanges in the Demand (Supply is constant)Changes in the Demand (Supply is constant)

The previous graph shows that equilibrium occurs The previous graph shows that equilibrium occurs at Pe = 40 and Qe = 500 at point A. Dat Pe = 40 and Qe = 500 at point A. D11 shows an shows an increase in demand because of an increase in income increase in demand because of an increase in income from P15,000 to P20,000. Beginning at point A as from P15,000 to P20,000. Beginning at point A as equilibrium, demand increases from Dequilibrium, demand increases from D00 to D to D11. At the . At the original price 40, consumers now demand 800 units original price 40, consumers now demand 800 units with the new demand curve. Since firms are only willing with the new demand curve. Since firms are only willing to supply 500 units, at price 40, a shortage of 300 units to supply 500 units, at price 40, a shortage of 300 units results. The shortage causes the price to rise to new results. The shortage causes the price to rise to new equilibrium where Qd = Qs. This new equilibrium, equilibrium where Qd = Qs. This new equilibrium, where Dwhere D11 intersects S0 occurs when P = 50 and Qe = intersects S0 occurs when P = 50 and Qe = 600 units (point B). Therefore, the increase in demand 600 units (point B). Therefore, the increase in demand (supply constant) increases both the equilibrium price (supply constant) increases both the equilibrium price and quantity.and quantity.


DD22 shows the decrease in demand because shows the decrease in demand because of a decrease in income from P15,000 to of a decrease in income from P15,000 to P10,000. Again, beginning at point A as P10,000. Again, beginning at point A as equilibrium, demand decreases from Dequilibrium, demand decreases from D00 to D to D22. . AAt the original price of 40, firms wants to supply t the original price of 40, firms wants to supply 500 units but consumers are only willing to buy 500 units but consumers are only willing to buy 200 units. There is a surplus of 300 units at P = 200 units. There is a surplus of 300 units at P = 40 and this causes price to fall. The market 40 and this causes price to fall. The market returns to equilibrium only when P = 30 and returns to equilibrium only when P = 30 and Qe = 400 (point C). Therefore, the decrease in Qe = 400 (point C). Therefore, the decrease in demand (supply constant) decreases both demand (supply constant) decreases both equilibrium price and quantity.equilibrium price and quantity.


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


Changes in Supply (Demand is constant)Changes in Supply (Demand is constant)

To illustrate the effect of changes, DTo illustrate the effect of changes, D00 and Sand S00 are reproduced. S are reproduced. S11 shows an increase shows an increase in supply. The shift from Sin supply. The shift from S00 to S to S11 was caused was caused by a decrease in the price of inputs from 50 by a decrease in the price of inputs from 50 to 31.25. Sto 31.25. S22 shows a decrease in supply. The shows a decrease in supply. The shift from Sshift from S00 to S to S22 was caused by a decrease was caused by a decrease in the number of firms in the industry from in the number of firms in the industry from 90 firms to 30 firms.90 firms to 30 firms.


Beginning in equilibrium at point R, let Beginning in equilibrium at point R, let supply increases to Ssupply increases to S11. at the original price . at the original price 40, consumers still want to purchase 500 40, consumers still want to purchase 500 units, but sellers now wishes to sell 650 units units, but sellers now wishes to sell 650 units causing a surplus or an excess of supply of causing a surplus or an excess of supply of 150 units. The surplus causes price to fall, 150 units. The surplus causes price to fall, which induces suppliers to supply less and which induces suppliers to supply less and buyers to demand more. Price continue to fall buyers to demand more. Price continue to fall until the new equilibrium is attained at Pe = until the new equilibrium is attained at Pe = 35 and Qe = 600 units (point S). at this point 35 and Qe = 600 units (point S). at this point S, Qs = Qd. Thus, when supply increases and S, Qs = Qd. Thus, when supply increases and demand remain constant, Pe will fall and Qe = demand remain constant, Pe will fall and Qe = will increase.will increase.

MARKET EQUILIBRIUMMARKET EQUILIBRIUMLet now price decrease to SLet now price decrease to S22. we now return to S. we now return to S00

where Pe = 40 and Qe = 500 units. At this point, Pi = where Pe = 40 and Qe = 500 units. At this point, Pi = 50. A decrease in the number of firms causes the 50. A decrease in the number of firms causes the supply curve (Ssupply curve (S00) to shift to the left (S) to shift to the left (S22). At the original ). At the original price, consumer still want to buy 500 units but sellers price, consumer still want to buy 500 units but sellers want now to sell only 200 units. This leads to a want now to sell only 200 units. This leads to a shortage or excess demand of 300 units. Shortages shortage or excess demand of 300 units. Shortages cause price to rise. The increase in price causes sellers cause price to rise. The increase in price causes sellers to supply more and buyers to demand less, thereby to supply more and buyers to demand less, thereby reducing the shortage. Price will continue to increase reducing the shortage. Price will continue to increase until it attains the new equilibrium at a price of 50 and until it attains the new equilibrium at a price of 50 and 300 units of output (point T). at the new equilibrium (T), 300 units of output (point T). at the new equilibrium (T), S2 intersects D0 and Qs = Qd. Therefore, when supply S2 intersects D0 and Qs = Qd. Therefore, when supply decreases while demand remains constant, price will decreases while demand remains constant, price will rise and quantity sold will decrease.rise and quantity sold will decrease.


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


S2

S0

S1

D0

P

50 40

35

200 300 500 600 650 Q


Summary of simultaneous shift in the Summary of simultaneous shift in the Demand and Supply : The four Demand and Supply : The four possible wayspossible ways

- Both Demand and Supply increase- Both Demand and Supply increase

- Demand decreases and Supply - Demand decreases and Supply increasesincreases

- Demand increases and Supply - Demand increases and Supply decreasesdecreases

- Both Demand and Supply decrease- Both Demand and Supply decrease


Both Demand and Supply increaseBoth Demand and Supply increase

Qe risesPe may rise or fall S0

S1

S3

D1

D2

P

Pe’Pe

Pe”

Qe Qe’ Qe” Q


Demand decreases and Supply increasesDemand decreases and Supply increasesP

Pe

Pe’

Pe”

Qe’Qe Qe” Qe

S0

S1

S2

D0

D1

Pe fallsQe may rise or fall

MARKET EQUILIBRIUMMARKET EQUILIBRIUMDemand increases and Supply decreasesDemand increases and Supply decreases

P

Pe”Pe’

Pe

Qe” Qe Qe’ Q

S2

S1

S0

D0

D1

Pe risesQe may rise or fall


Both Demand and Supply decreaseBoth Demand and Supply decrease

Pe

Pe”

PePe’

Qe” Qe’ Qe Qe

S2 S1

S0

D1

D0

Qe fallsPe may rise or fall


QUALITATIVE FORECASTINGPredicting the direction of changes in Airfares: A Qualitative Analysis

MARKET EQUILIBRIUMMARKET EQUILIBRIUMCaseCase

You manage the travel department of a You manage the travel department of a leading large corporation, and your sales force leading large corporation, and your sales force makes heavy use of air travel to call on makes heavy use of air travel to call on customers. Because of this, the president of the customers. Because of this, the president of the corporation wants you to reduce expenditures corporation wants you to reduce expenditures for next year.for next year.

The extent to which you will predict air The extent to which you will predict air travel for next year will depend upon what travel for next year will depend upon what happen to the price of air travel.happen to the price of air travel.

If airfares decrease next year, you can If airfares decrease next year, you can satisfy both the wants of the president, who satisfy both the wants of the president, who wants expenditure cut, and the sales personnel, wants expenditure cut, and the sales personnel, who would be hurt by travel restrictions.who would be hurt by travel restrictions.

MARKET EQUILIBRIUMMARKET EQUILIBRIUMYou have recently read in business magazine You have recently read in business magazine about the following two events that you expect about the following two events that you expect will affect the airline industry next year.will affect the airline industry next year.1. A number of new, small airlines have 1. A number of new, small airlines have recently entered the industry and others are recently entered the industry and others are expected will affect the airline industry next expected will affect the airline industry next year.year.2. Teleconferencing is being a popular, cost-2. Teleconferencing is being a popular, cost-effective alternative to business travel for effective alternative to business travel for many Philippine corporations this year. The many Philippine corporations this year. The trend is expected to accelerate next year as trend is expected to accelerate next year as telecommunication firms begin cutting process telecommunication firms begin cutting process on teleconferencing rates.on teleconferencing rates.Using the data above, make a qualitative Using the data above, make a qualitative forecast on the prices of airfares.forecast on the prices of airfares.

MARKET EQUILIBRIUMMARKET EQUILIBRIUMAn increase in the number of airlines causes An increase in the number of airlines causes

supply to increase. The increase in supply is shown supply to increase. The increase in supply is shown by the shift of S to S’. Since teleconferencing and by the shift of S to S’. Since teleconferencing and air travel are substitute, a reduction in the price of air travel are substitute, a reduction in the price of teleconferencing causes a decrease in demand for teleconferencing causes a decrease in demand for air travel. The decrease in demand is shown by the air travel. The decrease in demand is shown by the shift of Dshift of D00 to D to D11. Thus, you must analyze a . Thus, you must analyze a situation in which Dsituation in which D00 and S and S00 shift simultaneously. shift simultaneously. The decrease in demand combined with the The decrease in demand combined with the increase in supply leads you to predict a fall in increase in supply leads you to predict a fall in airfares next year (point B). While you can predict airfares next year (point B). While you can predict that airfares will definitely fall when D decreases that airfares will definitely fall when D decreases and S increases, you cannot predict whether Qe and S increases, you cannot predict whether Qe will rose or fall in the situation (as shown by Swill rose or fall in the situation (as shown by S11). ). The change in Qe is indeterminate. The predicted The change in Qe is indeterminate. The predicted fall in airfares is good for you, but bad news for the fall in airfares is good for you, but bad news for the financially troubled airline industry.financially troubled airline industry.


D0

D1

S0S1

S2

PA

PB

PC

QBQA QC Q

A

B

C


END OF THE SLIDE PRESENTATIONEND OF THE SLIDE PRESENTATION

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Market Equilibrium