The Market EquilibriumThe Market Equilibrium(One More Time)

■ ■ Market demand and supplyMarket demand and supply

■ ■ Bring together suppliers and Bring together suppliers and demandersdemanders

■ ■ EquilibriumEquilibrium

Market Demand Is the Sum Market Demand Is the Sum of All Individual Demandsof All Individual Demands

At each price, sum the individual quantities At each price, sum the individual quantities demanded, Da, Db … Dn, to get market quantity demanded, Da, Db … Dn, to get market quantity demanded (Dm)demanded (Dm)

+ =Dm = ∑ Da + Db + . . . Dn

DbDa Dm

Market Supply Is the Sum of Market Supply Is the Sum of All Individual SuppliersAll Individual Suppliers

At each price, sum the individual quantities supplied At each price, sum the individual quantities supplied to get market quantity supplied (Sm)to get market quantity supplied (Sm)

Sa Sb Sm = ∑ Sa + Sb … Sn

+ =Sm

CompetitionCompetition■ ■ Demanders compete with each other to get Demanders compete with each other to get

goods.goods.Their efforts push price up, enriching suppliers.Their efforts push price up, enriching suppliers.

■ ■ Suppliers compete with each other to attract Suppliers compete with each other to attract customers.customers.

Their efforts push price down, enriching Their efforts push price down, enriching demanders.demanders.

■ ■ Demanders do NOT compete with suppliers, Demanders do NOT compete with suppliers, even thought it sometimes seems that way!even thought it sometimes seems that way!

They are bargaining: They are bargaining: Each party tries to convince the other of the Each party tries to convince the other of the

powerful competition faced by alternatives.powerful competition faced by alternatives.

Equilibrium: Competition Equilibrium: Competition means mutually beneficial means mutually beneficial cooperationcooperation

At At ““equilibriumequilibrium”” no one has an incentive to change behavior: no one has an incentive to change behavior:

P*

Q*

PriceS

D

Q/time

Adjustments to Adjustments to equilibriumequilibrium■ ■ Price above P*Price above P*

► ► Quantity supplied exceeds quantity demanded: excess Quantity supplied exceeds quantity demanded: excess supply, or supply, or ““surplussurplus”” ► ► Frustrated suppliers compete for business, lowering prices Frustrated suppliers compete for business, lowering prices ((““buyersbuyers’’ market market””)) ► ► Price falls until market clearsPrice falls until market clears

■■ Price below P*Price below P* ► ► Quantity demanded exceeds quantity supplied: excess Quantity demanded exceeds quantity supplied: excess demand, or demand, or ““shortageshortage”” ► ► Frustrated demanders compete for product, raising prices Frustrated demanders compete for product, raising prices ((““sellerssellers’’ market market””)) ► ► Price rises until market clearsPrice rises until market clears

Adjustment processAdjustment processWhat if the price is NOT right?What if the price is NOT right?■■Competition forces push price toward equilibrium:Competition forces push price toward equilibrium:

Excess Supply

Excess Demand

P high

P low

PriceS

D

Q/time

Minimum Wage: A Price Minimum Wage: A Price FloorFloor

Legal minimum on wage: WmLegal minimum on wage: Wm– If greater than W*If greater than W*

excess supply of laborexcess supply of labor

Winners:Winners:– Those who keep their jobsThose who keep their jobs

LosersLosers– Firms (& their customers) who payFirms (& their customers) who pay– Those who lose their jobsThose who lose their jobs

S

D

$

Labor0 Ld LsL*

W*

Wm

Data Confirming Theory

Rent Controls: Rent Controls: A Price Ceiling on A Price Ceiling on ApartmentsApartments

Legal maximum on allowable rent:Legal maximum on allowable rent:Pm less than P*Pm less than P*

excess demand for spaceexcess demand for space Winners:Winners:

– Those who keep apartmentsThose who keep apartments LosersLosers

– LandlordsLandlords– Those who canThose who can’’t get int get in

$ S

D

Quantity0 Qs Q* Qd

P*Pm

QuestionsQuestions How do each of these events How do each of these events

influence the equilibrium influence the equilibrium (i) price of airline tickets and (i) price of airline tickets and (ii) quantity of airline trips taken(ii) quantity of airline trips taken

1. Rise in price of jet fuel1. Rise in price of jet fuel2. Depression in the economy2. Depression in the economy3. Threat of war3. Threat of war4. Government regulations making air 4. Government regulations making air

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