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Outline
I. Changes in Equilibrium
A. Change in Demand B. Change in Supply C. Change in Both Demand and Supply
Market Dynamics
Equilibrium - where quantity demanded equals quantity supplied Equilibrium Price (P*) - price where equilibrium occurs. If price above equilibrium, then surplus occurs If price below equilibrium, then shortage arises
Equilibrium/Surplus/Shortage
P P1 P* P2
Shortage Surplus
Q*
Changes in Equilibrium
Remember that Supply and Demand are drawn under the ceteris paribus assumption. Any factors which cause Supply and/or Demand to change will affect equilibrium price and quantity.
Change in Demand
Demand will change for any of the non-price determinants examined previously:
Tastes/Preferences Income Price of Substitute & Complementary goods Expectations Population
Ceteris paribus, lets say the demand for CDs increased due to an increase in income. How would this affect market equilibrium price & quantity of CDs?
Increase in Demand
P SCDs
DCDs 0
Increase in Demand
P P* P* E E SCDs
D
DCDs 0 Q* Q* Q
Change in Supply
Supply will change for any of the the nonprice determinants examined previously:
- Costs of Production Input costs / taxes & subsidies - Technology - Nature and the environment - Number of producers - Complements & substitutes in production
Ceteris paribus, lets say that the government lowers taxes on CDs. How would this affect the market equilibrium price & quantity of CDs?
Increase in Supply
P SCDs
DCDs 0
Increase in Supply
P
SCDs
S
P* P*
E E DCDs Q* Q* Q
P*
P ?
E2 D DSteak Q
Q* Q1 Q2
Final Equilibrium Quantity & Price when Demand & Supply move in the Same Direction
Since it is barbecue season, consumer preference for steak has increased, thus causing demand to increase from D to D. This temporarily pulls up price and increases quantity demanded to P1 and Q1 respectively.
At the intermediate equilibrium level, E1, supply then increases from S to S as a result of lower cattle prices (a fall in the price of an input) which pushes the final market equilibrium quantity to E2 where the final equilibrium quantity is Q2 and equilibrium price is indeterminate.
S E2 SSpinach
E1
D
DSpinach Q
Q* Q1
Final Equilibrium Quantity & Price when Demand & Supply move in Opposite Directions
As a result of the price of lemons falling (a complimentary good) the demand for spinach increases from D to D and temporarily raises the price from P* to P1 and quantity from Q* to Q1.
At the intermediate equilibrium level, E1, supply then decreases from S to S because there are fewer farmers growing spinach which pushes the final market equilibrium quantity to E2 where the final equilibrium price is P2 and equilibrium quantity is indeterminate.
Rationiong device
The price is what determines who can have the good
Market Disequilibrium
Is it possible for the price and quantity to NOT be in equilibrium? Yes - While the invisible hand may move price towards equilibrium, price controls tend to generate disequilibrium in the marketplace
Price Controls
There are two types of price controls: 1) Price Ceilings 2) Price Floors
Price Ceilings
Price Ceiling - sets a maximum price that is allowed by law. Result of Price Ceiling:
Stay at a permanent shortage situation
Note that a price ceiling can be any price the government chooses. It is, however only effective if it is below the equilibrium price
Price Ceiling
Example of Price Ceiling
Rent controlled apartments
In New York City, San Francisco, Boston, and other cities the city or state determines the maximum amount that can be charged for rent on many apartments. A maximum price is a price ceiling
D 0 Q
P* D 0 Q* Q
P*
Pceiling
D 0 Qs
Amount of Shortage
Q* Qd
Price Floors
Price Floor - sets a minimum price that is allowed by law. Result of Price Floor
Stay at a permanent surplus situation
Note that a price floor can be set at any price, but is only effective if it is above the equilibrium price
Price Floors
Example of Price Floor
Minimum Wage Legislation
The minimum wage is a lowest price the government will allow firms to pay for labor. A minimum price is a price floor
Price Floors
When we look at the labor market it is similar to other supply and demand diagrams except for the labels.
L - quantity of workers w - wages (the price we pay workers)
It is also different because the suppliers of labor are households, not firms, and the demanders of labor are firms, not households
D 0 # of Workers
w* D 0 L* # of Workers
wfloor
w* D 0 Ld L*
Ls
# of Workers
Commodity Agreements
Market instability may arise due to:
Fluctuating prices due to changing market conditions Changing prices due to changes in exchange rates Changes in foreign government protectionist measures
Producers of commodities (eg. coffee, sugar, grains, tin) may cooperate to stabilize the market
eg. prices kept from falling below certain level
S1
P2 P1
D
Q2 Q1
S1 S2
S3
S4 S5
Shortage
Target Band
P2 P1 Q1 Q2 Q3
Surplus
D
Q4 Q5
Destruction of commodity
If food, normative issue arises in light of global poverty & hunger
Further Practice
Use the last question page to complete the following. For each question indicate whether: - price increased, decreased or it was indeterminate (impossible to determine) - quantity increased, decreased or it was indeterminate (impossible to determine)
Practice Test