Market Equilibrium Price

8/8/2019 Market Equilibrium Price

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Market Equilibrium Price

In this note we bring the forces of supply and demand together to consider the determination of equilibrium prices.

The Concept of Market Equilibrium

Equilibrium means a state of equality or a state of balancebetween market demand and supply . Without a shift indemand and/or supply there will be no change in market price.


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In the diagram above, the quantity demanded and supplied at price P1 are equal. At any price above P1, supply exceedsdemand and at a price below P1, demand exceeds supply. In

other words, prices where demand and supply are out of balanceare termed points of disequilibrium.

Changes in the conditions of demand or supply will shift thedemand or supply curves. This will cause changes in theequilibrium price and quantity in the market.

Demand and supply schedules can be represented in a table. The

example below provides an illustration of the concept of equilibrium. The weekly demand and supply schedules for T-shirts (in thousands) in a city are shown in the next table:

Price perunit ()

8 7 6 5 4 3 2 1

Demand(000s)

6 8 10 12 14 16 18 20

Supply (000s)18 16 14 12 10 8 6 4 New Demand(000s)

10 12 14 16 18 20 22 24

New Supply(000s)

26 24 22 20 18 16 14 12

1. The equilibrium price is 5 where demand and supply are

equal at 12,000 units2. If the current market price was 3 there would be excess

demand for 8,000 units3. If the current market price was 8 there would be excess

supply of 12,000 units


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4. A change in fashion causes the demand for T-shirts to rise by 4,000 at each price. The next row of the table shows thehigher level of demand. Assuming that the supply schedule

remains unchanged, the new equilibrium price is 6 per teeshirt with an equilibrium quantity of 14,000 units5. The entry of new producers into the market causes a rise in

supply of 8,000 T-shirts at each price. The new equilibrium price becomes 4 with 18,000 units bought and sold

Changes in Market Demand and Equilibrium Price

The demand curve may shift to the right (increase) for severalreasons:

1. A rise in the price of a substitute or a fall in the price of acomplement

2. An increase in consumers income or their wealth


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3. Changing consumer tastes and preferences in favour of the product

4. A fall in interest rates (i.e. borrowing rates on bank loans or

mortgage interest rates)5. A general rise in consumer confidence and optimism

The outward shift in the demand curve causes a movement(expansion) along the supply curve and a rise in the equilibrium

price and quantity. Firms in the market will sell more at ahigher price and therefore receive more in total revenue.

The reverse effects will occur when there is an inward shift of demand. A shift in the demand curve does not cause a shift inthe supply curve! Demand and supply factors are assumed to beindependent of each other although some economists claim thisassumption is no longer valid!


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Changes in Market Supply and Equilibrium Price

The supply curve may shift outwards if there is

1. A fall in the costs of production (e.g. a fall in labour or rawmaterial costs)

2. A government subsidy to producers that reduces their costsfor each unit supplied

3. Favourable climatic conditions causing higher than

expected yields for agricultural commodities4. A fall in the price of a substitute in production5. An improvement in production technology leading to

higher productivity and efficiency in the production processand lower costs for businesses


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6. The entry of new suppliers (firms) into the market whichleads to an increase in total market supply available toconsumers

The outward shift of the supply curve increases the supplyavailable in the market at each price and with a given demandcurve, there is a fall in the market equilibrium price from P1 toP3 and a rise in the quantity of output bought and sold from Q1to Q3. The shift in supply causes an expansion along the demandcurve.

Important note for the exams:A shift in the supply curve does not cause a shift in the demandcurve. Instead we move along (up or down) the demand curve tothe new equilibrium position.

A fall in supply might also be caused by the exit of firms froman industry perhaps because they are not making a sufficiently

high rate of return by operating in a particular market.The equilibrium price and quantity in a market will change whenthere shifts in both market supply and demand. Two examples of this are shown in the next diagram:


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In the left-hand diagram above, we see an inward shift of supply(caused perhaps by rising costs or a decision by producers to cut

back on output at each price level) together with a fall (inwardshift) in demand (perhaps the result of a decline in consumer confidence and incomes). Both factors lead to a fall in quantitytraded, but the rise in costs forces up the market price.

The second example on the right shows a rise in demand fromD1 to D3 but a much bigger increase in supply from S1 to S2.The net result is a fall in equilibrium price (from P1 to P3) and

an increase in the equilibrium quantity traded in the market.Moving from one market equilibrium to another

Changes in equilibrium prices and quantities do not happeninstantaneously ! The shifts in supply and demand outlined in


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the diagrams in previous pages are reflective of changes inconditions in the market. So an outward shift of demand(depending upon supply conditions) leads to a short term rise in

price and a fall in available stocks. The higher price then acts asan incentive for suppliers to raise their output (termed as anexpansion of supply) causing a movement up the short termsupply curve towards the new equilibrium point.

We tend to use these diagrams to illustrate movements in market prices and quantities this is known as comparative staticanalysis . The reality in most markets and industries is much

more complex. For a start, many firms have imperfectknowledge about their demand curves they do not know

precisely how demand reacts to changes in price or the true levelof demand at each and every price level. Likewise, constructingaccurate supply curves requires detailed information on

production costs and these may not be available.

The importance of price elasticity of demand

The price elasticity of demand will influence the effects of shiftsin supply on the equilibrium price and quantity in a market. Thisis illustrated in the next two diagrams. In the left hand diagram

below we have drawn a highly elastic demand curve. We see anoutward shift of supply which leads to a large rise inequilibrium price and quantity and only a relatively smallchange in the market price. In the right hand diagram, a similar increase in supply is drawn together with an inelastic demandcurve. Here the effect is more on the price. There is a sharp fallin the price and only a relatively small expansion in theequilibrium quantity.


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Author: Geoff Riley, Eton College, September 2006

Equilibrium

Equilibrium is a term relating to a 'state of rest', a situationwhere there is no tendency to change. In economics, equilibrium


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is an important concept. Equilibrium analysis enables us to look at what factors might bring about change and what the possibleconsequences of those changes might be. Remember, that

models are used in economics to help us to analyse andunderstand how things in reality might work. Equilibriumanalysis is one aspect of that process in that we can look at causeand effect and assess the possible impact of such changes.

For the purposes of this resource we are going to look at marketequilibrium . Market equilibrium occurs where the amountconsumers wish to purchase at a particular price is the same as

the amount producers are willing to offer for sale at that price. Itis the point at which there is no incentive for producers or consumers to change their behaviour. Graphically, theequilibrium price and output are found where the demand curveintersects (crosses) the supply curve.

Mathematically, what we are looking to find is the point wherethe quantity demanded (Qd) is equal to the quantity supplied(Qs). Let's take our example from above:


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Assume the demand is Qd = 150 - 5P and that supply is given by Qs = 90 + 10P . What we now have is a task that involvesunderstanding how to do simultaneous equations .

In equilibrium we know that Qs = Qd. Remember that Qs = 90 +10P and that Qd = 150 - 5P. Given that we know that anequation means that whatever is on the left hand side must bethe same as that on the right hand side we can re-write our simultaneous equation as follows:

90 + 10P = 150 - 5P

We can now go about collecting all the like terms onto each side(by doing the same to both sides) and solving the equation tofind P. Explanation 1 shows the long route and Explanation 2the route you might normally see in a textbook.

Explanation 1

(90 - 90) + (10P + 5P) = (150 - 90) - (5P + 5P)We have added 5P to both sides and taken away 90 fromboth sides. This gives us:15P = 60Now divide both sides by 15 to get P on its own.15P / 15 = 60 / 15The 15P term will now cancel down. How many times does 15go into 15P? Once.

60 / 15 = 4P = 4


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Explanation 2

10P + 5P = 150 - 9015P = 60P = 4

We now know the equilibrium price is 4 so we can substitutethis into the equations to get the Qd and Qs.

Qd = 150 - 5PQd = 150 - 5(4)Qd = 150 - 20Qd = 130

Doing the same thing to the supply:Qs = 90 + 10PQs = 90 + 10(4)Qs = 90 + 40Qs = 130

So, the equilibrium price is 4 and the equilibrium quantitybought and sold is 130.

Other examples of where this technique might be used includefinding equilibrium national income in a two sector economy(for example, if just consumption and investment areconsidered), in IS/LM analysis, in finding the break even point,

in prodcution calculations and many other areas.Sometimes, you will also see demand and supply equationswritten differently; don't panic. The principles are exactly thesame. Take the examples below:


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Some examples to work through:

1.Q = 3P + 2, Qs = 2 - P2.3P + 7Q = 10, 4P - Q = 33.5P + 10Q = 10, 2P - Q = 14.2P + Q = 7, 3P + Q = 105.5P + 3Y = 7, 4P - 5Y = 36.4P + 6Q = -13, 3P - 5Q = 147.6P + 3Q = 1, 4P - 2Q = 28.3P + 5Q = 12, 6P - 4Q = 39.6P + 3Q = 2P + Q = 110. 2P + Q = 7, 4P + Q = 1111. 5P + 7Q = 12, 6P - 3Q = 312. 2P + 3Z = 2, 6P - 12Z = 13

Linear Regression Trendline

Posted by admin on November 11, 2009 - Write Your Review

A Linear Regression Trendline is a straight line drawnthrough a chart of a securitys prices using the least squaresmethod, and it is used to forecast future trends.A Linear Regression trendline uses the least squares method to

plot a straight line through prices so as to minimize the distances between the prices and the resulting trendline.A Linear Regression trendline is simply a trendline drawn between two

points using the least squares fit method. The trendline isdisplayed in the exact middle of the prices. If you think of this
http://www.niftylivecharts.com/blog/author/admin/http://www.niftylivecharts.com/blog/linear-regression-trendline/#respondhttp://www.niftylivecharts.com/blog/linear-regression-trendline/#respondhttp://www.niftylivecharts.com/blog/author/admin/


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trendline as the equilibrium price, any move above or belowthe trendline indicates overzealous buyers or sellers.

A Linear Regression trendline shows where equilibrium exists.Raff Regression Channels show the range prices can beexpected to deviate from a Linear Regression trendline.
http://www.niftylivecharts.com/blog/wp-content/uploads/2009/11/trendline.gif

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Market Equilibrium Price