W&L ECON 101 - Homework (7 pages)

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Homework

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Pages:
7
School:
Washington and Lee University
Course:
Econ 101 - Principles of Microeconomics
Principles of Microeconomics Documents

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Homework 2 Market Equilibrium and Shocks Econ 101 Professor Guse 1 This question is taken verbatum from the study guide accompanying the 1967 edition of the classic Economics textbook by Paul Samuelson We say that in a competitive market there is an equilibrium price at which demand and supply curves intersect a Why do we single out this intersection and call the price there equilibrium price What makes this price different from other prices and what do we mean by equilibrium ANSWER This special price at the intersection is the market clearing price It is usually the only price at which the quantity demanded of the good is equal to the quantity supplied We economists tend to believe that market forces will push the price for a good toward this clearing price in equilibrium Why When an economic system is in equilibrium it means that none of the participants have an incentive to change their behavior In the type of market environments we are talking about this means that buyers demand have no incentive to change the quantity the buy each period and suppliers have no incentive to change the quantity they produce and sell each period Our claim is that the market clearing price is the equilibrium price To see why imagine that the price is above the market clearing price Then the quantity suppliers are willing to bring to market exceeds the quantity demanders are willing to purchase Suppliers will be left with unsold goods at the end of the trading period Do they have incentive to change their behavior Yes Unless they want to pay the cost of keeping large inventories at the very least they will have incentive to produce less output in the next period Alternatively they could continue to produce the same amount and lower the post a lower price so that they sell more Or they may pursue some blend of these tactics Either way the price and quantity in the next period would move in the direction of the market clearing price and associated quantity b Is there any reason to



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