4 chapter d ynamic p ower p oint ™ s lides by s olina l indahl equilibrium: how supply and demand...

44CHAPTE

R

DYNAMIC POWERPOINT™ SLIDES BY SOLINA LINDAHL

Equilibrium: How Supply Equilibrium: How Supply and Demand Determine and Demand Determine

PricesPrices

CHAPTER OUTLINE

To Try it! To Try it! questionsquestions

To To VideoVideo

Some good blogs and other sites to get the juices flowing:

Food for Food for Thought….Thought….

Try it!Try it!

Would you prefer an economic system where goods were rationed by:a)Needb)Equality/fairnessc)Who can pay the most

To next To next Try it! Try it!

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Market Equilibrium

When Qs = Qd at a certain price, the market is in equilibrium, the amount consumers would purchase at this price is matched exactly by the amount producers wish to sell.

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Market Equilibrium

There is ONLY ONE PRICE where Qs = QdThis is “equilibrium price “equilibrium price and quantity”and quantity”

No shortagesNo surpluses

FREE MARKETS ALWAYS MOVE TOWARD EQUILIBRIUM PRICE

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Equilibrium and the Adjustment Process

65

$30Equilibrium Price

Equilibrium Quantity

Quantity of Oil (MBD)

Price of Oil per Barrel

Price is Determined by Supply and Demand

Supply Curve

Demand Curve

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How Markets Find Equilibrium When Price is Too High

$5.00

4.00

3.00

2.00

1.00

0

5 10 15 20 25

Q

S

P

D

Energy Drinks

..

At P = $5.00:

Qs = 25, Qd = Qs = 25, Qd = 1515

Price will fall to equilibrium ($4.00) and Qd will rise to 20, Qs will fall to 20 and

Qd = QsQd = Qs

At a price of $5.00, a SURPLUS of 10 energy drinks (25-15) exists… suppliers are left with stock on the shelves- they take action to get the surplus sold and raise revenue.

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How Markets Find Equilibrium When Price is Too Low

Price will rise to equilibrium ($4.00) and Qd will fall to 20, Qs will

rise to 20 and QQdd = Q= Qss

$5.00

4.00

3.00

2.00

1.00

05 10 15 20 25

Q

S

P

D

..

At P = $3.00:

QQss = 15, Q = 15, Qdd = 25 = 25

At a price of $3.00, a SHORTAGE of 10 energy drinks (25-15) exists… buyers compete with each other for purchases- sellers see their chance to raise price and revenue

Energy Drinks

Take a look…Take a look…

For a look at a real-world equilibrium pricing mechanism, click the picture below to see the Aalsmeer Dutch Tulip auction in action. (3 minutes)

http://video.kera.org/video/1283843915/

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D1

Shifting Demand and Supply Curves

Q0

P0

S

D0

Price of energy drinks

Quantity of energy drinks

Q1

P1

Causes the equilibrium to change to a higher P and higher P and QQ

An increase in demand

BACK TO

D0


S



Q0

P0

D1

Q1

P1

Causes the equilibrium to change to a lower P and lower P and QQ

A decrease in demand

BACK TO

S1

D0


S0



Q0

P0

Q1

P1

Causes the equilibrium to change to a lower P and higher Q

An increase in supply

BACK TO

S1

D0


S0



Q0

P0

Q1

P1

Causes the equilibrium to change to a higher P and lower Q

A decrease in supply

Try it!Try it!

Economists often say that prices are a “rationing mechanism.” If the supply of a good falls, how do prices “ration” these now-scarce goods in a competitive market?

a) Prices allocate goods to the people with the highest willingness to pay.

b) Prices allocate goods to the people with the lowest willingness to pay.

c) Prices allocate goods to those with the lowest value of their own time.

d) Prices allocate goods to the people who deserve them the most.


Try it!Try it!


Try it!Try it!#1: New machine is invented that lowers the cost of harvesting oranges.

Try it!Try it!#2: The FDA announces health benefits to eating oranges.

Try it!Try it!#2: The income of consumers falls and some orange growers quit the business and turn their orange groves into housing developments..

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Gains from Trade Are Maximized at Equilibrium Price and Quantity

Unexploited Gains from Trade Exist when Quantity is Below the Equilibrium Quantity



Unsatisfied Wants

Unexploited Gains from Trade

$15

$57

Satisfied Wants

24

Demand Curve

Supply Curve

$30

65

Equilibrium Price

Equilibrium Quantity

At Q=24, there are buyers who value buying the good

more than sellers value selling the good (there are

unexploited gains from trade up until 65 units)

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95

Value of Wasted Resources

$15

$50

Demand Curve

Supply Curve

$30

65

Equilibrium Price

Equilibrium

Quantity

Wasteful Trades Exist when Quantity is Above the Equilibrium Quantity

But at the Equilibrium Quantity

There Are No Unexploited Gains from Trade nor Any Wasteful Trades!

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Sellers

Consumer Surplus

Producer Surplus

Non-Buyers

Non-SellersBuyers



A Free Market Maximizes Producer plus Consumer Surplus (the gains from trade)

Demand Curve

Supply Curve

$30

65Equilibrium Quantity

Equilibrium Price

Try it!Try it!

If this market is in equilibrium, what is the total producer surplus? The total consumer surplus? What are the total gains from trade?a)Consumer Surplus=$6; Producer Surplus=$4; Total Gains from Trade=$10b)CS=$11; PS=$1; Total Gains from Trade=$12c)CS=$250; PS=$200; Total Gains from Trade=$450d)CS=$150; PS=$100; Total Gains from Trade=$250


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Equilibrium and Total Surplus

Equilibrium in a free market yields two important results:

Goods must be produced at the lowest possible cost.Goods must satisfy the highest valued demands.

These results indicate that total total surplus (both of the consumer and surplus (both of the consumer and producer) is maximized in free producer) is maximized in free markets. markets.

SEE THE SEE THE INVISIBLEINVISIBLE HANDHAND

SEE THE SEE THE INVISIBLEINVISIBLE HANDHANDWho is made better off and who is made

worse off by a legal doctrine that says tenants must have hot water?

If tenants benefit from a law that says apartments must have hot water then surely a law that says tenants must have hot water and a dishwasher benefits them even more, right? What about a law that says tenants must have hot water, a dishwasher and cable tv?

For a thought experiment that suggests BOTH parties are harmed when the market is tampered with, see this post on Worth’s STIH resource bank.

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Vernon Smith proved the invisible hand was there.

“I am still recovering from the shock of the experimental results. The outcome was unbelievably consistent with competitive price theory. ”

Vernon Smith, winner of 2002 Nobel Prize in Economics, on his 1956 experiments designed to disprove the supply and demand model.

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The Price of Oil, 1960-2005

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Terminology: Shifts vs. Movement along Supply and Demand curves

A shift in a demand (supply) curve is called a “Change in Demand (Supply)”

Not to be confused with:

Movement ALONG a demand (supply) curve is called “Change in Quantity Demanded (Supplied)

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Changes in Demand vs. Change in Quantity Demanded

Quantity (computer games)Quantity (computer games)

Pri

ce (

$)

Pri

ce (

$)

Change in Demand Change in Quantity Demanded

D0

D1

80

40

20 40

D0

80

20 40

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Changes in Supply vs. Change in Quantity Supplied

Quantity (computer games)Quantity (computer games)

Pri

ce (

$)

Pri

ce (

$)

Change in Supply Change in Quantity SuppliedS0

S1

40

20

S0

80

40

80

4020

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D1

Shifting Demand and Moving along Supply Curve

Q0

P0

S

D0



Q1

P1

causes a movement along the Supply curve… a “Change in Quantity Supplied”

An increase in demand

BACK TO

S1

D0

Shifting Supply and Moving along Demand Curve

S0



Q0

P0

Q1

P1

causes a movement along the Demand curve… a “Change in Quantity Demanded”

A decrease in supply

Try it!Try it!At a price of $3, quantity supplied is ______ and quantity demanded is ______, leading to a _______.a) 6; 2; surplus of 4 unitsb) 2; 4; surplus of 2 unitsc) 2; 6; shortage of 8 unitsd) 4; 2; shortage of 2 units


Try it!Try it!If garden gnomes regain

widespread popularity, what will happen?

a)Equilibrium Price and Quantity both fall.

b)Equilibrium Price and Quantity both rise.

c) Equilibrium Price falls and Quantity rises.

d)Equilibrium Price rises and Quantity falls.


Try it!Try it!If the cost of wood falls,

what will happen in the violin market?

a) Equilibrium Price and Quantity both fall.

b) Equilibrium Price and Quantity both rise.

c) Equilibrium Price falls and Quantity rises.

d) Equilibrium Price rises and Quantity falls.

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4 chapter d ynamic p ower p oint ™ s lides by s olina l indahl equilibrium: how supply and demand...

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