Dr. Duffy Microeconomics

The end of CHAPTER 3 Frank and BernankeWith supplemental material

Market Equilibrium

A market equilibrium comes at the placewhere quantity demanded equals quantitysupplied.

Equilibrium takes place at the intersectionof the supply and demand curves.

Market Equilibrium

• Equilibrium• A system is in equilibrium when there is

no tendency for it to change

• Market Equilibrium• Occurs in a market when all buyers and

sellers are satisfied with their respective quantities at the market price

Market Equilibrium

• What Do You Think?• Is the market equilibrium always an

ideal outcome for all market participants?

• Would buyers prefer a lower price than the equilibrium price?

• Would sellers prefer a higher price than the equilibrium price?

Movements of Curves

• An increase moves demand (or supply) to the right.

• A decrease moves demand (or supply) to the left.

• Think in terms of right and left, not up and down, when shifting curves.

Predicting and Explaining Changes In Prices and Quantities

• Distinguishing Between:• A change in the quantity demanded

• A movement along the demand curve that occurs in response to a change in price

• A change in demand• A shift of the entire demand curve

An Increase In Quantity Demanded vs. An Increase In Demand

Price($/can)

Quantity(1000s of cans/day)

5

2

3

4

1

4

122

6

0 106 8

Increase in quantity

demanded

D

An Increase In Quantity Demanded vs. An Increase In Demand

Price($/can)

Quantity(1000s of cans/day)

5

2

3

1

4

12

6

0

Increase in demand

D

D

D’

D’

Predicting and Explaining Changes In Prices and Quantities

• Change in the quantity supplied• A movement along the supply curve

that occurs in response to a change in price

• Change in supply• A shift of the entire supply curve

An Increase In Quantity Supplied vs. An Increase In Supply

Price($/can)

Quantity(1000s of cans/day)

5

2

3

4

1

4

102

6

0 6 8

S

S

Increase in quantity supplied

An Increase In Quantity Supplied vs. An Increase In Supply

Price($/can)

Quantity(1000s of cans/day)

5

2

3

4

1

4

102

6 S

0 6 8

S

S’

S’

Increase in supply

Predicting and Explaining Changes In Prices and Quantities

• Economic Naturalist• When the Federal Government

implements a large pay increase for its employees, why do rents for apartments near Washington Metro stations go up relative to rents for apartments located far away from Metro stations?

The Effect of a Federal Pay Raise on the Rent for Conveniently Located Apartments in Washington D.C.

Rent(dollars per

month)

Conveniently located apartments(units per month)

D

P

Q

S

P’

Q’

D’

Economic Puzzler

• Economic Naturalist• Why do the prices of some goods, like

airline tickets to Europe, go up during the months of heaviest consumption, while others, like sweet corn, go down?

• Hint, figure out which curve is shifting! A quantity increase can occur from either a demand increase or a supply increase.

Seasonal Variation in Air Travel

Price($/ticket)

1000s of tickets

S

DS

DW

QW QS

PW

PS

High Consumption and Prices Due to High Demand

Seasonal Variation in Corn Markets

Price($/bushel)

Millions of bushels

SW

D

QW QS

PW

PS

SS

High Consumption and Low Prices due to High Supply

The Effects Of Simultaneous Shifts In Supply And Demand

Price($/bag)

Millions of bags per month

P

Q

S

D

P’

Q’

D’

S’S’ after reduction in price of corn harvesting equipment

D’ after discovery that oils are harmful to people’s health

The Market for Corn Tortilla Chips

The Effects Of Simultaneous Shifts In Supply And Demand

Price($/bag)

Millions of bags per month

P

Q

S

D

P’

Q’

D’

S’

D’ after discovery that oils are harmful to people’s health

S’ after reduction in price of corn harvesting equipment

The Market for Corn Tortilla Chips

Simultaneous Shifts, part 1

• If supply increases and demand increases, quantity will increase (we can’t say what happens to price without more information).

• If supply decreases and demand decreases, quantity will decrease (we can’t say what happens to price without more information.)

Simultaneous Shifts, part 2

• If demand increases and supply decreases, price will rise (we can’t say what happens to quantity without more information).

• If demand decreases and supply increases, price will fall (we can’t say what happens to quantity without more information.)

Predicting and Explaining Changes In Prices and Demand

• Assume• A vitamin found in corn chips helps

protect against cancer and heart diseases • Swarm of locusts destroys part of the

corn crop

• What Do You Think?• What will happen to the equilibrium price

and quantity of corn chips?

Markets And Social Welfare

• What Do You Think?• When are the prices and quantities

determined in market equilibrium socially optimal, in the sense of maximizing total economic surplus?

Markets And Social Welfare

• Cash On The Table• Assume:

• All exchange is purely voluntary

• If so: • The buyer’s reservation price exceeds the

seller’s reservation price and both the buyer and seller receive an economic surplus

Markets And Social Welfare

• Cash On The Table• Buyer’s surplus

• The difference between the buyer’s reservation price and the price he or she actually pays

Markets And Social Welfare

• Cash On The Table• Seller’s surplus

• The difference between the price received by the seller and his or her reservation price

Markets And Social Welfare

• Cash On The Table• Total surplus

• The difference between the buyer’s reservation price and the seller’s reservation price

Markets And Social Welfare

• Cash On The Table• Economic metaphor for unexploited

gains from exchange

Socially “optimal” quantity

• The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good

• The socially optimal quantity occurs when

• MC = MB

Economic Efficiency

Economic efficiency occurs when all goods and services are produced and consumed at their respective socially optimal levels

The Efficiency Principle

•Maximize the economic surplus•Increase the economic pie

Market Equilibrium And Social Welfare

• When is the market equilibrium efficient?

• When all cost of producing the good or service are borne directly by the seller

• When all benefits from the good or service accrue directly to buyers

Can you think of situations wherecosts or benefits accrue to peoplewho do not buy or sell the good?

Inefficient Market Equilibrium

An inefficient market equilibrium occurs when some costs of production fall on people other than those who sell the good or service OR

When some benefits of consumption fallon those who do not buy the good or

service.

Externalities

• Externalities is the name given to a cost or benefit that accrues to people outside a market.

• Pollution is one type of externality.• But externalities can also be beneficial, such

as the benefit to existing gas stations of having a shopping mall move to a location.

• Negative externalities are more likely to draw attention than positive ones.

Markets And Social Welfare

• Example: Pollution (cost example)• The market is in equilibrium for all buyers

and sellers so that for them MC = MB• MC in the market, however,

underestimates the cost to society of producing the good

• Therefore, the market produces more than the efficient amount and there is no incentive for producers and consumers to alter their behavior

Markets And Social Welfare

• Example: Vaccinations (benefit example)

• The market is in equilibrium for all who buy or sell in the market so that: MC = MB

• MB underestimates the benefits to society of consuming the vaccinations

• The market produces less than the efficient amount of vaccinations and there is no incentive for producers and consumers to alter their behavior

Markets And Social Welfare

• Smart For One, Dumb For All• In these markets

• Buyers and sellers are behaving rationally • Market equilibrium exists• There are no unexploited opportunities for

individuals• Economic surplus is not maximized

Markets And Social Welfare

• The Equilibrium Principle• A market in equilibrium leaves no

unexploited opportunities for individuals, but may not exploit all gains achievable through collective action.

Public good

• A public good is a good that is not “used up” by its consumers. It has positive externalities.

• Education is one example. The people getting the education benefit, but so do others in society because educated people are likely to increase the society’s PPF.

• A park or road is another type of public good. I can use it and still leave it for others to use.

Public goods and public “bads”

• If outcomes are left entirely to the market, society will tend to overproduce good with negative externalities and underproduce those with positive externalities.

• Why?

Externalities and markets

• For goods with negative externalities, costs are borne by those outside the market so the price of the item does not reflect its full MC to society.

• For goods with positive externalities, producers find it impossible to collect fees from all who benefit. Hence price of the item will not reflect its MB to society.

Calculating price and quantity at market equilibrium

• Demand Equation• Quantity Demanded = 200 – 5p• Supply Equation• Quantity Supplied = 50 + 10P• At equilibrium Qd=Qs

Solving the Equations

Set Qd=Qs and solve

200 – 5p = 50 + 10P

150 = 15p P= 10

Qd = 150 Qs = 150 Check!

End ofChapterEnd of

Chapter