Markets, Demand & Supply: Equilibrium, Welfare, and Efficiency

Competitive Market

all buyers and sellers are price takers

Demand curve

indicates quantity willing to buy at each price

Individual demand curve

shows demand for an individual buyer

Law of demand

price goes up, quantity goes down

Supply curve

indicates quantity willing to supply at each price

Deriving supply curve

as prices go up, optimal quantity to sell goes down

Market supply curve

the aggregate supply from all sellers in the market

Equilibrium

Supply = demand

Surplus

price is above equilibrium

Shortage

price is below equilibrium

Demand equation

𝑞𝑑 = α + β𝑝 (slopes down, β < 0)

Supply equation

𝑞𝑠 = λ + γ𝑝 (slopes up, γ > 0)

Inverse Demand

𝑝 = 530 − 8𝑞𝑑

Inverse Supply

𝑝 = 30 + 2𝑞𝑠

Equilibrium quantity (q*)

𝑞* = 50

Equilibrium price (p*)

𝑝* = 130

Willingness to Pay (WTP)

maximum a consumer will pay for a good

Reservation price

lowest price a seller is willing to accept for an item

Consumer surplus

net gain to buyers from purchasing a good

Producer surplus

net gain to sellers from selling a good

Social surplus

measures the total net gain to buyers and sellers from participating in the market

Efficiency

a competitive market maximizes social surplus

Dead weight loss

occurs if fewer or more trades than at competitive equilibrium are allowed