Slide 1Knowledge RecapKnowledge RecapMarket EquilibriumMarket EquilibriumMarket EquilibriumMarket EquilibriumChanges to Market EquilibriumChanges to Market EquilibriumChanges to Market EquilibriumChanges to Market EquilibriumECON 203: Principles of MicroeconomicsClass 5: Market Equilibrium1Knowledge Recap•Demand curve.–A graph of the relationship between price and quantity demanded. –Shows how the quantity demanded changes in response to a change in the price of that good holding all else constant.•Changes in price result in movements along the demand curve and change in quantity demanded.•Changes in factors other than price result in a shift of the demand curve. 2Knowledge Recap•Supply curve.–A graph of the relationship between price and quantity supplied. –Shows how the quantity supplied changes in response to a change in the price of that good holding all else constant.•Changes in price result in movements along the supply curve and change in quantity supplied.•Changes in factors other than price result in a shift of the supply curve. 3Market Equilibrium•Market equilibrium: a situation in which the price is at a level where quantity supplied equals quantity demanded.–Equilibrium price: the price where quantity supplied equals quantity demanded.–Equilibrium quantity: the quantity supplied and quantity demanded at equilibrium price.4Market Equilibrium•Market for downloads of music albums.5Price Quantity demandedQuantity supplied$0.00 19 million 0$0.50 16 million 0$1.00 13 million 1 million$1.50 10 million 4 million$2.00 7 million 7 million$2.50 4 million 10 million$3.00 1 million 13 millionMarket Equilibrium•Surplus: a situation in which quantity supplied is greater than quantity demanded.–Example: at price of $2.00 there is a surplus of 12 million.•Shortage: a situation in which quantity demanded is greater than quantity supplied.– Example: at price of $1.00 there is a shortage of 12 million.•Law of supply and demand: the price of any good adjusts to bring the quantity supplied and quantity demanded for that good into balance.6Market Equilibrium•The actions of buyers and sellers naturally move markets towards the equilibrium.•Surplus.–Producers accumulate stock (have more than they can sell).–Drop prices to sell the extra units.–As price drops, quantity demanded increases and quantity supplied drops along the demand and supply curves.•Shortage.–Some buyers in the market are willing to spend more.–Producers can increase prices without loosing sales.–As prices increase, quantity demanded drops and quantity supplied increases along the demand and supply curves.7Changes to Market Equilibrium•A shift in the demand and/or supply curves affects the market equilibrium.–The government begins a strict campaign against file-sharing, decreasing buyers’ demand for free music and increasing their demand for legal music downloads.–The change in preferences causes a shift of the demand curve to the right creating a shortage at the current price.–iTunes, TunesGo and others increase prices along the supply curve.–As prices increase, demand drops along the demand curve.–The adjustment continues until reaching new equilibrium.8Changes to Market Equilibrium•Changes in demand:–An increase in demand leads to an increase in equilibrium price and quantity.–A decrease in demand leads to a decrease in equilibrium price and quantity.•Changes in supply:–An increase in supply leads to a decrease in equilibrium price and an increase in equilibrium quantity.–An decrease in supply leads to an increase in equilibrium price and a decrease in equilibrium quantity.9Changes to Market Equilibrium•Changes in both demand and supply:–An increase in both demand and supply lead to an increase in equilibrium quantity and an ambiguous effect on equilibrium price.–A decrease in both demand and supply lead to a decrease in equilibrium quantity and an ambiguous effect on equilibrium price.–An increase in demand with a decrease in supply will lead to an increase in equilibrium price and an ambiguous effect on equilibrium quantity.–A decrease in demand with an increase in supply will lead to a decrease in equilibrium price and an ambiguous effect on equilibrium quantity.10Changes to Market Equilibrium•Example of an event affecting supply and demand. –U.S. oil producers start fracking, which gives them access to new wells. At the same time Tesla and Ford make available cheap electric cars.•Increase in supply – shifts of supply curve to right.•Decrease in demand – shift of demand curve to left.•Decrease in prices.•Effect on quantity depends on the relative magnitude of the shifts and the slope of the demand and supply