Market Equilibrium

Price

Quantity

S

D

Pm

Qm

At a Price Above Equilibrium

Price

Quantity

S

D

Pm

Qm

P1

QsQd

•Qs > QD

•Surplus

•Too many goods and services

•Producers cut price

•Qd increases

•Qs decreases

•Return to equilibrium

A surplus is where price is set above equilibrium causing QS>QD

At a Price Below Equilibrium

Price

Quantity

S

D

Pm

Qm

P1

QdQs

•Qd > Qs

•Shortage

•Not enough goods and services

•Consumers bid up price

•Qd decreases

•Qs increases

•Return to equilibrium

A shortage is where the price is set below equilibrium causing QD>QS

CONCLUSION

A market will tend toward equilibrium

If the price is not at equilibrium then market forces will work to move the market back toward equilibrium.

CONSUMER SURPLUSDEFINITION:

MEASURED BY:

The difference between what consumers are willing to pay and the actual price paid for a commodity

The area below the demand curve and above the price line

Consumer Surplus

Price

Quantity

S

D

Pm

Qm

Consumer

Surplus

Producer SurplusProducer SurplusDefinitionDefinition::

Measured byMeasured by::

The difference between the revenue received by a producer and the the cost necessary to produce the good

The area below the demand curve and above the price line

Producer Surplus

Price

Quantity

S

D

Pm

Qm

Producer

Surplus

WHY IS EQUILIBRIUM BEST?Equilibrium represents the

allocatively efficient point.This is where Consumer Surplus

and Producer Surplus are maximised

ie benefits to consumers and producers are at their greatest

WHICH IS THE ALLOCATIVELY EFFICIENT POINT?

cars

television

A

B

100

60

100 200

Which is the allocatively efficient Which is the allocatively efficient point?point?

cars

television

A

B

100

60

100 200 quantity

price

Market for Cars

S

D

100

Which is the allocatively efficent Which is the allocatively efficent point?point?

cars

television

A

B

100

60

100 200 quantity

price

Market for Cars

S

D

100

Net Welfare Benefit

The combined values of the consumer and producer surpluses is referred to as the net welfare benefit.

S

D

Pm

Qm

Net welfare benefit.

Allocative Efficiency and Market Equilibrium

Markets allocate resources to the production of goods and services that satisfy consumers needs and wants.

To be allocatively efficient a market must price and produce at equilibrium .

Price

Quantity

S

D

200 400 600 800

1.80

1.50

1.20

0.90

0.60

0.30

Any price other than $1.20 and any output level other than 400

units will result in a loss of

allocative efficiency

Resources would be either over or under allocated to

production and net welfare

benefit would be reduced.

To maintain allocative

efficiency a market must be able to

move freely to any new equilibrium

Any changes in the market where the forces of demand and supply are able to freely adjust to market conditions will still result in allocative efficiency.

A loss of Allocative EfficiencyA loss of allocative efficiency occurs when a market is not allowed to price and produce at equilibrium this will result from :

Price Controls(setting either a minimum or maximum price)Imposition of a sales tax or subsidyImposition of a tariff or a quota (normally relates to internationally traded products)

All of these regulations set by the government will result in a dead weight loss and thus causing net social welfare to fall.

DEADWEIGHT LOSSWhen a market does not achieve

equilibrium producer and consumer surplus will not be maximised

The loss in allocative efficiency is DWLIt is measured by the loss of CS and PS

not offset by gains to other groups (eg government)

Deadweight LossDeadweight LossDeadweight loss can be caused by:• Quotas• Price controls• Indirect Taxes• Subsidies

A Subsidy

Price

Quantity

S

D

Pm

Qm

A Subsidy

Price

Quantity

S

D

Pm

Qm

Subsidies reduce costs and increase Supply

S+Subsidy

A Subsidy

Price

Quantity

S

D

Pm

Qm

Consumers pay the new equilibrium price - Pc

S+Subsidy

Q’

Pc

A Subsidy

Price

Quantity

S

D

Pm

Qm

The per unit subsidy is represented by the vertical distance between the two supply curves

S+Subsidy

Q’

Pc

A Subsidy

Price

Quantity

S

D

Pm

Qm

Producers receive higher price -Pp

S+Subsidy

Q’

Pc

Pp

A Subsidy

Price

Quantity

S

D

Pm

Qm

The total cost to the government is represented by the shaded area

S+Subsidy

Q’

Pc

Pp

A Subsidy

Price

Quantity

S

D

Pm

Qm

S+Subsidy

Q’

Pc

Pp Original CS

A Subsidy

Price

Quantity

S

D

Pm

Qm

S+Subsidy

Q’

Pc

Pp New CS

The gain in CS represents the incidence of a

subsidy on consumers

A Subsidy

Price

Quantity

S

D

Pm

Qm

S+Subsidy

Q’

Pc

Pp Old PS

A Subsidy

Price

Quantity

S

D

Pm

Qm

S+Subsidy

Q’

Pc

Pp New PS

The gain in PS represents the incidence of a

subsidy on producers

A Subsidy

Price

Quantity

S

D

Pm

Qm

S+Subsidy

Q’

Pc

Pp DWL

An Indirect Tax – Sales Tax

Price

Quantity

S

D

Pm

Qm

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

Indirect taxes increase costs and shift the supply curve to the left

S+tax

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

Consumers pay the new equilibrium price - Pc

S+tax

Pc

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

The per unit tax is measured by the vertical distance between the two supply curves

S+tax

Q’

Pc

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

The producer recieves the lower price - Pp

S+tax

Q’

Pc

Pp

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

The government receives the shaded area as tax revenue

S+tax

Q’

Pc

Pp

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

S+tax

Q’

Pc

Pp

Original CS

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

S+tax

Q’

Pc

Pp

New CS

The area of tax which was previously CS

represents the incidence of the tax on

consumers

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

S+tax

Q’

Pc

Pp

Original PS

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

S+tax

Q’

Pc

Pp

New PS

The area of tax which was previously PS

represents the incidence of the tax on

producers

An Indirect Tax

Price

Quantity

S

D

Pm

Qm

S+tax

Q’

Pc

Pp

DWL

A Quota

Price

Quantity

S

D

Pm

Qm

A Quota

Price

Quantity

S

D

Pm

Qm

In this example we assume there is no domestic production

Q’

A Quota

Price

Quantity

S

D

Pm

Qm

A quota is a limit on the number of imports into a country

The supply curve becomes vertical at the quota level

Q’

A Quota

Price

Quantity

S’

D

Pm

Qm

A quota is a limit on the number of imports into a country

The supply curve becomes vertical at the quota level

Q’

S

A Quota

Price

Quantity

S’

D

Pm

Qm

The new price is determined at the intersection of the new Supply curve and the original Demand curve - P’

Q’

S

P’

A Quota

Price

Quantity

S

D

Pm

Qm

Original CS

Q’

P’

A Quota

Price

Quantity

S

D

Pm

Qm

New CS

Q’

P’

A Quota

Price

Quantity

S

D

Pm

Qm

Old PS

Q’

P’

A Quota

Price

Quantity

S

D

Pm

Qm

New PS

Q’

P’

A Quota

Price

Quantity

S

D

Pm

Qm

DWL

Q’

P’

A Maximum Price

Price

Quantity

S

D

Pm

Qm

A Maximum Price

Price

Quantity

S

D

Pm

Qm

A maximum price is only effective when set below equilibrium price

Pmax

A Maximum Price

Price

Quantity

S

D

Pm

Qm

•Qs decreases

•Although consumers would like to buy more producers only supply Qs

•There is a shortage

Pmax

Qs Qd

A Maximum Price

Price

Quantity

S

D

Pm

Qm

Pmax

Original CS

Qs

A Maximum Price

Price

Quantity

S

D

Pm

Qm

Pmax

New CS

Qs

A Maximum Price

Price

Quantity

S

D

Pm

Qm

Pmax

Original PS

Qs

A Maximum Price

Price

Quantity

S

D

Pm

Qm

Pmax

New PS

Qs

A Maximum Price

Price

Quantity

S

D

Pm

Qm

DWL

Pmax

Qs

A Minimum Price

Price

Quantity

S

D

Pm

Qm

A Minimum Price

Price

Quantity

S

D

Pmin

Qm

Pm

A minimum price is only effective when set above equilibrium price

A Minimum Price

Price

Quantity

S

D

Pmin

Qm

Pm

Qd

•Qd decreases

•Although producers would like to sell more they are unable to at this high price

A Minimum Price

Price

Quantity

S

D

Pmin

Qm

Pm

Original CS

Qd

A Minimum Price

Price

Quantity

S

D

Pmin

Qm

Pm

New CS

Qd

A Minimum Price

Price

Quantity

S

D

Pmin

Qm

Pm

Original PS

Qd

A Minimum Price

Price

Quantity

S

D

Pmin

Qm

Pm

New PS

Qd

A Minimum Price

Price

Quantity

S

D

Pmin

Qm

Pm

DWL

Qd

Net Welfare Benefit

The combined values of the consumer and producer surpluses is referred to as the net welfare benefit.

S

D

Pm

Qm

Net welfare benefit.

Allocative Efficiency and Market Equilibrium

Markets allocate resources to the production of goods and services that satisfy consumers needs and wants.

To be allocatively efficient a market must price and produce at equilibrium .

Price

Quantity

S

D

200 400 600 800

1.80

1.50

1.20

0.90

0.60

0.30

Any price other than $1.20 and any output level other than 400

units will result in a loss of

allocative efficiency

Resources would be either over or under allocated to

production and net welfare

benefit would be reduced.

To maintain allocative

efficiency a market must be able to

move freely to any new equilibrium

Any changes in the market where the forces of demand and supply are able to freely adjust to market conditions will still result in allocative efficiency.

A loss of Allocative EfficiencyA loss of allocative efficiency occurs when a market is not allowed to price and produce at equilibrium this will result from :

Price Controls(setting either a minimum or maximum price)Imposition of a sales tax or subsidyImposition of a tariff or a quota (normally relates to internationally traded products)

All of these regulations set by the government will result in a dead weight loss and thus causing net social welfare to fall.