Supply & Demand:

Price & The Market Equilibrium

Demand and Supply interact and determine the

price of a product, and the quantity bought or sold.

With competition, neither buyers (Demand) or sellers (Supply) decide the price.

Price and Quantity are determined by the forces of the market. Naturally, it is where supply and demand intersect. The interests of buyers and sellers meet at the Equilibrium.

Demand & Supply

What is the Right Price?

The Equilibrium Price (EP) is the price in a

competitive market at which the quantity demanded and the quantity supplied are equal.

The Equilibrium Quantity (EQ) is the quantity demanded and supplied at the equilibrium price in a competitive market.

Equilibrium

EP & EQ (P* or Q*)

When the price is not at an optimal level, we

will have either a shortage or a surplus. If the quantity demanded is higher than the

quantity supplied at a certain price, we will have a shortage (not enough to buy – long line-ups and crowds).

If the quantity demanded is lower than the quantity supplied at a certain price, we will have a surplus (too much to sell – deep discounts and bargain bins).

Shortage & Surplus

Shortage

The amount by which the quantity demanded exceeds the quantity supplied at a given price.

This price must be below P*, otherwise there would be incentive for suppliers to make more.

Surplus

The amount by which the quantity supplied of a product exceeds the quantity demanded at a given price.

The price must be above P*, otherwise households would incentivized to buy more.

It is the ability of market forces in a

competitive market to equalize quantity demanded and quantity supplied and to eliminate shortages via changes in prices.

The combination of freely made individual decisions sets a market clearing price. A surplus will drive prices lower and a shortage will drive them higher.

In your table groups, complete Key Question 7 (p.71) and be prepared to explain it soon.

Rationing Function of Prices

Demand can change because fluctuations in

the Determinants of Demand. (Review Them). P.56.

Supply might change because fluctuations in the Determinants of Supply. (Review Them). P.59-60.

Changes in demand or supply will have an effect on both the equilibrium price and equilibrium quantity. It is important to be able to track both.

Changes in Supply, Demand, and Equilibrium.

Changes in Demand

An increase in demand results in a higher equilibrium price and a higher equilibrium quantity.

A decrease in demand results in a lower equilibrium price and a lower equilibrium quantity.

Here is an increase in Gasoline Demand.

Changes in Supply

An increase in supply results in a lower equilibrium price and a higher equilibrium quantity.

A decrease in supply results in a higher equilibrium price and a lower equilibrium quantity.

1. Supply Increase & Demand Decrease2. Supply Decrease & Demand Increase3. Supply Increase & Demand Increase4. Supply Decrease & Demand DecreaseDo not try and memorize results. DRAW THEM OUT.Below illustrates why it is so important to sketch them.

Complex Cases

The Effects Tabulated: What Does it Mean to be

Indeterminate?

In your table groups, complete Key Question #

8, draw a diagram for each question and be prepared for a random group member to show and explain the work.

Individually, complete questions 9, 10, 11, and 12 to be handed in.

Group Work & Assignment Questions