Chapter 4 Market Equilibrium This division of labor from which so many advantages are derived is not originally the effect of any human wisdom which foresees and intends that general opulence to which it gives occasion It is the necessary though very slow and gradual consequence of a certain propensity in human nature which has in view no such extensive utility the propensity to truck barter and exchange one thing for another Adam Smith Wealth of Nations 2 Overview Equilibrium P and Q How equilibrium P and Q are affected by factors that change shift supply and demand Comparative Statics 3 Equilibrium No tendency to change unless an outside force acts on system Equi equal Libra balance Equilibrium Price P Equilibrium Quantity Q If the system is in equilibrium then there is no tendency for P or Q to change If the system is not in equilibrium there is a tendency for P and Q to move toward the equilibrium values 4 P P It takes two to tango P Q are equilibrium price and quantity S Only when P P does Qs QD Q D Q 5 Suppose P P Excess supply or surplus What happens to P Why P P1 P QD Q QS S Qs QD D Q 6 P Suppose P P P P1 What happens to P Why Excess demand or shortage Qs QD S Qs QD D Q 7 If there are no impediments to price adjustment e g government price controls a business cartel then price will adjust to equate QS and QD Price will adjust to clear the market iClicker Time 8 What is the equilibrium price in this market At a price of 80 does the market face a surplus or a shortage A Shortage B Surplus Gains from Trade P P CS PS Gains from Trade PS CS Gain in welfare measured in for consumers and producers from market trades S D Q 11 P 30 3 1 CS PS Gains from Trade Market for Tofu CS 0 5 x 27 x 5000 67 500 PS 0 5 x 2 x 5000 5 000 GT 67 500 5 000 72 500 S D Q 12 5 000 lbs Gains from Trade P P CS PS Gains from trade welfare maximized when Q Q Willingness to pay for the last unit D Marginal Cost S S D Q 13 Q Gains from Trade Suppose Q Q Unrealized gains from trade Deadweight Loss S P P CS PS Marginal units cost less to produce than they are worth to consumers Q is under produced and consumed Welfare is reduced D Q 14 Q Q P Gains from Trade Thinking at the margin S CS PS P At quantities beyond Q the resources used to produce the good would be more highly valued in other uses Value of wasted resources DWL Q Q D Q 15 Suppose Q Q Marginal units cost more to produce than they are worth to consumers Q is overproduced and consumed Welfare is reduced P P leads to the efficient level of production Q Q Gains from trade welfare are maximized This is the Invisible Hand at work If Q is above or below Q gains from trade are smaller and there is a welfare loss relative to Q At equilibrium All buyers are willing to pay more than non buyers All sellers are willing to sell for less than non sellers There are no remaining profitable deals between non buyers and non sellers i e all non sellers have higher costs than non buyers value the good 16 P P CS PS Gains from Trade B u y ers N o n S ellers S ellers N o n B u y ers Q No Mutually Beneficial Trades S Between Gains from trade welfare maximized when Q Q Willingness to pay for the last unit D Marginal Cost S D Q 17 P P leads to the efficient level of production Q Q Gains from trade welfare are maximized This is the Invisible Hand at work If Q is above or below Q gains from trade are smaller and there is a welfare loss relative to Q At equilibrium All buyers are willing to pay more than non buyers All sellers are willing to sell for less than non sellers There are no remaining profitable deals between non buyers and non sellers i e all non sellers have higher costs than non buyers value the good iClicker Time 18 At a price of 20 producers are only willing to sell 20 units of the product Point to the area that represents the lost gains from trade resulting from this situation Shifts in Supply and Demand and Effects on Equilibrium P and Q KEY RULE ONE EVENT ONE CURVE Market for tofu P P2 P1 S S D Q2 Q1 Q Drought in the Midwest raises the price of soybeans What is the effect on equilibrium P and Q of tofu And through which mechanism Which curve shifts Equilibrium P rises and equilibrium Q falls 20 Shifts in Supply and Demand and Effects on Equilibrium P and Q KEY RULE ONE EVENT ONE CURVE Market for Sport Utility Vehicles SUVs P P1 P2 S D D Q2 Q1 Q Turmoil in the Middle East causes the price of oil to increase sharply raising the price of gasoline What is the effect on equilibrium P and Q of SUVs Which curve shifts Equilibrium P falls and equilibrium Q falls 21 Now we introduce a key acronym for Econ 1014 TWAG Think With A Graph Write down a S D graph on a piece of paper and reason through the problem using the graph 22 Shifts in Supply and Demand and Effects on Equilibrium P and Q Market for tofu P P2 P1 Expanded ethanol corn subsidies restrict the supply of soybeans raising the price of soybeans What is the effect on equilibrium P and Q of tofu Which curve shifts Equilibrium P rises and equilibrium Q falls S S D Q2 Q1 Q 23 Footnote on terminology In this case there was a decrease in supply leading to a decrease in quantity demanded Shift in the supply curve and a movement along a given demand curve DO NOT SAY Supply goes down so price goes up so demand falls It seems like semantics and somewhat is but sloppy use of vocabulary will impact your understanding and hurt you later on in the course 24 Shifts in Supply and Demand and Effects on Equilibrium P and Q Market for tofu P P2 P1 S S D Q2 Q1 Q Decrease shift in supply Led to a decrease in quantity demanded movement along the demand curve 25 Shifts in Supply and Demand and Effects on Equilibrium P and Q P P1 P2 Market for Sport Utility Vehicles SUVs Turmoil in the Middle East causes the price of oil to increase sharply raising the price of gas What is the effect on equilibrium P and Q of SUVs Equilibrium P falls and equilibrium Q falls This is a decrease in demand that leads to a decrease in quantity supplied S D D 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