L4 Equilibrium

Principles of Microeconomics

Topic 1: Supply and Demand

Lecture 4: Market EquilibriumPresenter: Tien-Der Jerry Han

Aims of the Lecture

• Understand Market Equilibrium by integrating supply and demand concepts.

• Market price is determined by the "invisible hand of the market."

• Generate predictions regarding price changes influenced by various factors.

• Gain insights into market functions:

  • Conveying information

  • Providing incentives

  • Allocating resources

• Analyze market pricing and factors affecting changes in markets.

Lecture Outline

1. Equilibrium: The Intersection of Supply and Demand

2. Changes in Supply or Demand: Predictions

3. Changes in Related Markets: Predictions

Key Concepts: Demand and Supply

• Excess Demand: Occurs when quantity demanded exceeds quantity supplied.

• Excess Supply: Happens when quantity supplied exceeds quantity demanded.

• Market Equilibrium (Q, P)**: The market clears when there is no excess demand or excess supply.

The Law of Price Adjustment

1. When supply exceeds demand, prices will fall.

2. When demand exceeds supply, prices will rise.

• Excess Supply: Prices are too high—encourages sellers to cut prices.

• Excess Demand: Prices are too low—encourages buyers to raise prices.

• Equilibrium: No incentive to change behavior, where quantity demanded equals quantity supplied.

Understanding Market Equilibrium

• Vertical Interpretation:

  • Demand Curve: Reflects maximum price consumers are willing to pay.

  • Supply Curve: Reflects minimum price producers are willing to accept.

• Products are bought by those willing and able to pay the price.

Surplus Definitions

• Consumer Surplus: Difference between what consumers are willing to pay and what they actually pay.

• Producer Surplus: Difference between the price producers receive and the minimum price they are willing to accept.

Predictions related to Changes in Demand and Supply

Increase in Demand

• When income rises, demand increases.

• Results in excess demand, leading to higher prices.

• Signals firms to increase production.

Increase in Supply

• Technological advancements increase supply.

• Results in excess supply, leading to lower prices.

• Signals firms to limit production to regain equilibrium.

Price Roles in the Market

• Prices Convey Information: Prices signal what is scarce and abundant, guiding production and consumption.

• Prices Ration Scarce Resources: Only those willing and able to pay can access the products.

• Income from Prices: Seller's income is influenced by the supply and demand of goods.

Predictions for Related Markets

Substitutes

• If the cost of a substitute decreases, the supply shifts right.

• Leads to a decrease in the equilibrium price of the original product.

Complements

• If the cost of a complement increases, the equilibrium price of the original product rises as demand decreases.

Summary of Predictions

• Increase in Demand: Equilibrium price and quantity increase.

• Decrease in Demand: Equilibrium price and quantity decrease.

• Increase in Supply: Equilibrium price decreases, quantity increases.

• Decrease in Supply: Equilibrium price increases, quantity decreases.

Key Takeaways

• Equilibrium occurs when supply equals demand.

• Changes in supply and demand affect equilibrium price and quantity.

• Factors in related markets can shift demand and supply curves, impacting equilibrium.

Learning Outcomes

After this lecture, you should be able to:

1. Explain how the market reaches equilibrium price.

2. Illustrate changes in equilibrium prices and quantities via supply and demand diagrams.

3. Describe how changes in the supply and demand of related goods influence another good.