Price Determination and

Market Equilibrium
 Market Equilibrium
Price per unit of
hamburger
5
Equilibrium S

1
D
4 10 Quantity (millions) per day

Market equilibrium: If sellers are free to sell their goods

at any price, trial and error will ensure that the price and
quantity combination that occurs will be an equilibrium
 D & S: A more formal treatment
The Demand side

 Qd=f(P)
 An example of a demand function is:

Qd 100 2 P
 If P = P0 then Qd = 100
 If P = P50 then Qd = 0

P = 50 is the choke price

 The Market for Beef
Price per ton

vertical
intercept Inverse relationship between
50 price and quantity

horizontal
intercept

100

Quantity (1000‟s tons) per day

 The Demand Side
 Qd = 100 - 2P
 The number (coefficient) “-2” attached to the price
variable, P, is the slope of the curve
 This number shows how much the quantity of beef
demanded changes in response to a unit change in the price
of beef:
If P 10 , then Qd 100 (2 10 ) 80
If P 11, then Qd 100 (2 11) 78
 For every increase in P by a peso, Qd goes down by 2 units
(= 2000 tons of beef).
 The Supply Side
 Qs=f(P)
 An example of a supply function is:

Qs 10 0.5 P
If Qs = 0, then P = 20

P = 20 thus represents the vertical intercept for the

supply curve
 The Supply Side
 Qs = -10 + 0.5P
 The number (coefficient) “0.5” attached to the price
variable, P, is the slope of the curve
 This number shows how the quantity supplied changes in
response to a unit change in price

If P 30 , then Qs 10 (0.5 30 ) 5
If P 31, then Qs 10 (0.5 31) 5.5
 If the price of beef rises by one unit the supply of beef
rises by 0.5 of a unit per day.
 Finding the Market Equilibrium

 Two equations: demand & supply

Qd = 100 - 2P & Qs = -10 + 0.5P

 Two unknowns: price & quantity

 Equilibrium condition: Qd = Qs

Therefore …..
Finding the Market Equilibrium

100 (2 P) 10 (0.5 P)
110 2.5 P
110
P
2.5

44 P
 Equilibrium price, p* per ton is 44
 So: how do we get q*?
 We have to substitute p*=44 either:
in the demand function:
 Qd = 100 - 2P  Qd=100 - 2 x 44 Qd= 12
or in the supply function:
 Qs = -10 + 0.5p Qs=-10+0.5 x 44Qs=12

 q*= 12 units, or 12,000 tons of beef per day

 The Market for Beef
Price per ton
S

50
44
40
30

20

10 D

12 100

Quantity (1000‟s tons) per day

 Exercises on the Demand Curve

 Increase income  Shift to the right

 Decrease in income  Shift to the left
 Greater taste/preference  Shift to the right
 Less taste /preference  Shift to the left
 Increase in population  Shift to the right
 Greater speculation  Shift to the right
 Exercises on the Supply Curve

 Increase # of sellers  Shift to the right

 Decrease # of sellers  Shift to the left
 Better technology  Shift to the right
 Increase in cost of prod  Shift to the left
 Decrease in cost of prod  Shift to the right
 Some Comparative Static Analysis:
The effect of an income increase
Price per unit of
hamburger

5 S
B

A C
3

1
D D‟
4 5 6 10 Quantity (millions) per day
 Some Comparative Static Analysis:
The effect of a health scare
Price per unit of
hamburger
S
5
A
C
3
Quantity (millions) per day
2.5 B

1 D
D‟
2 3 4 10
 Some Comparative Static Analysis:
The effect of an import ban

Price per unit of

hamburger
S‟
5 S

B
C
3 A
D
1

10
2 3 4 Quantity (millions) per day
 Consumer & Producer Surplus

Price per litre

Consumer S
Surplus

p* A

Producer E D
Surplus
q* litres (millions) per day
 Markets in Action

 Free markets allow prices to be determined by the

forces of supply and demand

 Price controls are government rules setting price

floors or ceilings that forbid the adjustment of
prices to clear markets

 Price controls will generally generate losses in

consumer surplus  losses in welfare, and end up
with black markets
 Markets in Action
Effect of a (Low) Price Ceiling
 An example: think of the market for loans
 Banks lend money and charge an interest rate „i‟, which will
be considered the price of money
S
Interest rate

A
i*

ic
excess of demand
D
q* (millions) per day
 Markets in Action
Effect of a (high) Price Floor
 An example: think of the market for sugar in Uruguay
 The government sets a higher price floor than the equilibrium
Price per kilo excess of supply
S
pf

p*

D
qd q* qs kilos (millions) per day