Topic 4 Market Equilibrium

When demand and supply changes in the same direction

we are certain what happens to the eq qty but the eq price can increase, decrease or remain unchanged.

When the demand and supply changes in opposite directions

we know what happens to the eq price but eq qty can increase, decrease and remain unchanged

Price Ceiling

A legally established maximum price a seller can charge for a good or service Eg. rent control, maximum price on petrol

What is market equilibrium?

A market situation that occurs at any price and quantity where the quantity demanded and the quantity supplied are equal.

When demand and supply goes in the same direction:

(a.) we are certain what happens to equilibrium quantity but (b.) equilibrium price is indeterminate

When ONLY demand changes: (no change in supply)

(a.) we can predict what will happen to both eq price and eq quantity (b.) ↑ demand → both eq price and eq quantity ↑ ↓ demand → both eq price and eq quantity ↓

When ONLY supply changes: (no change in demand)

(a.) we can predict what will happen to the equilibrium price and quantity (b.) ↑ supply → ↓ equilibrium price but quantity ↑ ↓ supply → ↑ equilibrium price but quantity ↓

Why impose a price ceiling?

Price ceiling is imposed when the current equilibrium price is considered too high. So for price ceiling to be effective, it must be set below the market equilibrium price

Why implement a price floor?

Price floors are imposed when the current equilibrium price is considered to be too low So for the price floor to be effective, it must be set above the market equilibrium price.

Price Floor

a legally established minimum price a seller can be paid

Government Intervention

PRICE CEILING (if govnt believes people are paying too much) PRICE FLOOR (if govnt believes sellers are receiving too little)

Changes in Market Equilibrium

equilibrium price and equilibrium quantity will change whenever - demand changes - supply changes - demand and supply changes

What happens when the market is not in equilibrium?

#1 If the price is above the equilibrium price.... Example: the price is at $2 the quantity supplied (13) > quantity demanded (7) → the market is in surplus (6) → to get rid of the excess supply, firms will lower the price of the good (price continues to fall until equilibrium is attained) #2 If the price is below the equilibrium price... Example: the price is $1 the quantity demanded (15) > quantity supplied (6) → a shortage exists → to reduce the shortage, the firm will increase the price of the good until equilibrium is attained.

Decrease in BOTH demand and supply explanation

A decrease in demand or in supply decreases the equilibrium quantity. When demand and supply decrease together, the quantity decreases. Price falls when demand decreases and rises when supply decreases. Must know magnitude of the changes to determine the effect on the price: If demand decreases by more than supply decreases, the price falls. If supply decreases by more than demand decreases, the price rises. If supply decreases by the same amount as demand decreases, the price remains unchanged.

Changes in supply on equilibrium price and quantity

#1 Increase in Supply Assume that demand is constant and some non-price determinant of supply shifts the supply curve → supply curve shifts rightward Example: ↓ in price of milk to produce choco bars → ↓ cost of producing choco bars → supply curve shift rightwards from S to S₁ #2 Decrease in Supply → Supply curve shift leftward Example: ↓ in choco bars producers → supply curve shift leftwards from S to S₁. Equilibrium price ↑ and equilibrium price ↓

Changes in demand on equilibrium price and quantity

#1 Increase in demand Example: market for chocolate bars Assume that its market supply, S is constant and market demand increases from D to D₁ → A change in any one of the non-price determinants would have caused the demand curve to shift rightward → This particular brand of choco was eaten by a popular actress, so now the demand curve shifts rightward and equilibrium price ↑ and equilibrium quantity ↑ #2 Decrease in demand Example: chocolate bars were mentioned in an article about diabetes → demand curve shifts leftward from D to D₁ → Equilibrium price ↓ and equilibrium quantity ↓

Demand increases and supply decreases

#1 ↑Dd > ↓ Ss Large increase in demand is more than the slight decrease in supply. Hence, both the eq quantity and price increase #2 ↑Dd < ↓ Ss Increase in demand is lesser than the decrease in supply so the eq price increase and eq quantity falls #3 ↑Dd = ↓ Ss when there is an equal increase in demand and decrease in supply, the shift in supply and demand graphs are the same so the eq price rises and eq qty remains unchanged . . . . . . . . . . . . . . . . . . . . . . . .

Supply increases and demand decreases

#1 ↑Dd > ↓ Ss The increase is demand is greater than the slight decrease in supply so both the eq price and eq qty falls. #2 ↓ Dd < ↑Ss The increase in supply is larger than the decrease in supply. hence the eq price falls and eq qty rises #3 ↓ Dd = ↑Ss When there is an equal decrease in demand and increase in supply, the eq price falls and eq qty remains unchanged. . . . . . . . . . . . . . . . . . . . . . . . .

Increase in BOTH demand and supply explanation

An increase in demand or in supply increases the equilibrium quantity. When demand and supply increase together, the quantity increases. The prices rises when demand increases and falls when supply increases. Must know magnitude of the changes to determine the effect on the price: If demand increases by more than supply increases, the prices rises. If supply increases by more than demand increases, the price falls. When supply increases the same amount as demand increases, so the price remains unchanged.

What happens to the equilibrium price and quantity when both demand and supply curve change simultaneously?

As long as only one curve shifts at a time, we can tell what will happen to the equilibrium price and quantity. However if both demand and supply curves shift at the same time, the outcome is less obvious.

* Decrease in BOTH demand and supply

Decreases the equilibrium quantity. The change in the equilibrium price is ambiguous because the: Decrease in demand lowers the price Decrease in supply raises the price. #1 When the ↓ Dd >↓ Ss equilibrium price will decrease → large decrease in buyers and at the same time a slight increase in the cost of production for cars #2 When the ↓ Dd < ↓ Ss equilibrium price will increase → slight decrease is number of buyers and the large increase in cost of production of cars #3 When the ↓ Dd = ↓ Ss equilibrium price will remain unchanged → no. of buyers and at the same time a proportionate decrease in the supply of cars . . . . . . . . . . . . . . . . . . . . . . .

Result of price ceiling

quantity demanded > quantity supplied a shortage is created *price cannot rise to bring market back to equilibrium

Result of price floor

quantity supplied > quantity demanded a surplus is created *price cannot fall to bring market back to equilibrium

* Increase in BOTH demand and supply

•Increases the equilibrium quantity. •The change in the equilibrium price is unchanged because the: Increase in demand raises the price. Increase in supply lowers the price. #1 When the ↑ Dd > ↓ Ss equilibrium price will increase → large increase in buyers, slight decrease in cost of production #2 When the ↑ Dd < ↑ Ss equilibrium price will decrease → slight increase in buyers and large increase in improvement of technology for car production #3 When the ↑ Dd = ↑ Ss equilibrium price will remain unchanged → increase in no. of buyers and at the same time a proportionate increase in the supply of cars . . . . . . . . . . . . . . . . . . . . . . . .