Supply and demand schedule
Equilibrium (price and quantity) a state that occurs in a market when the price is such that the quantity that consumers wish to buy is exactly balanced by the quantity that firms wish to supply.
• Competitive markets-numerous sellers in a market and so one firm does not have any influence in the price of a good or service.
• Can also be called: market clearing price or market clearing quantity .
• The equilibrium price and quantity would not change unless there was a change in the conditions of demand or supply.
Comments on the Equilibrium
The equilibrium is unique
Prices where demand does not equal supply are known as points of disequilibria
Market forces should push markets from disequilibrium towards equilibrium.
– The market price and market quantity represent a stable equilibrium such that market forces always push the price and quantity back to these equilibrium values.
Market Equilibrium: Simultaneous Equations
A Shift in Demand
Shift in demand to the left
Shift in demand to the right
A Shift in Supply
Shift in supply to the right
Shift in supply to the left
Inelastic supply
Under inelastic supply we should expect that supply will not react strongly to a change in the price.
Inelastic supply can result from an inability to react to prices, or indeed a desire to control supply (e.g., lawyers have to take professional exams restricting the supply of lawyers).
Elastic supply
Elasticity of Demand and Changes in the Equilibrium
Disequilibrium Analysis: a Market Surplus
At a price of £10 consumers are willing to demand 1,000 units, but firms are willing to supply 2,000 units.
This is clearly not an equilibrium position.
With supply exceeding demand by
2,000 − 1,000 = 1,000 units, the market is said to be running a surplus.
In effect, firms will be left with excess stock in their warehouses.
What could a firm do with their excess stock?
This will cause an extension of demand.
Moving prices and quantity back to the equilibrium
Disequilibrium Analysis: a Shortage
This time we have the market price of £8, which is below the market equilibrium price of £10.
At £8, we can see that consumers are willing to demand 2,000 units, but firms are only willing to supply 1,000 units.
We now have a shortage of
2,000 − 1,000 = 1,000 units
What could happen in this case?
Two responses are likely:
• Firms may raise their prices causing an extension of supply.
• Or consumers can bid prices up in order to consume a good or service.
Price Floor
To address the excess consumption of alcohol, the government may consider imposing a minimum price .
The minimum price then acts as a floor below which it is illegal to
set a price.
To be effective in reducing consumption, the minimum price must be higher than the market equilibrium price.
A minimum price above the market equilibrium results in supply exceeding demand and a surplus of output on the market.
What is a business example of price floors?
MINIMUM WAGES
Price Ceiling
A government may also be concerned when prices, especially for important items, such as fuel and energy can ecome too high .
In such circumstances, the government may impose maximum prices . A maximum price acts as a price ceiling bove which it is illegal to set prices.
The market is likely to be in disequilibrium and be characterized by a significant shortage of supply.
Pooling and Separating Equilibria
Separating equilibrium:
“Good” and “bad” products are sold in separate markets.
Pooling equilibrium:
“Good” and “bad” products are sold in the same (pooled)
Uses a separating equilibrium
Dealer 1 Good quality car £5,000
Dealer 2 Bad quality car £2,500
You would be willing to pay £5,000 if
you wanted a good car, or £2,500 if
you wanted a bad car.
Uses a separating equilibrium
Good quality car & Bad quality car
Same price
Consumers find it difficult to
differentiate.
What issue occurs with this for businesses?
This is known as Gresham’s Law an increasing supply of bad products will drive out good products from the market.
Suppliers of good quality cars under a pooling equilibrium are disadvantaged because consumers are unable to differentiate their products from the bad offerings.
In order to solve this problem, they need to find a way of creating a separating equilibrium. The way to achieve this is to do something that the bad suppliers would be unwilling to copy.
