Market Equilibrium Changes

Demand Shifts

  • Original equilibrium: Quantity = 24, Price = $8.
  • Increase in demand (e.g., textbooks become more popular):
    • Demand curve shifts outwards (D1 to D2).
    • This DOES NOT shift the supply curve - rather increases the quantity supplied (movement along the supply curve).
    • At the original price ($8), there's excess demand.
    • Excess demand drives the market price up to $10.
    • New equilibrium: Quantity = 32, Price = $10.
    • Price increase leads to a decrease in quantity demanded (movement along the demand curve).

Supply Shifts

  • Original equilibrium: Quantity = 5,000, Price = $2.
  • New technique lowers bread-baking costs:
    • Affects: Supply. This is because this reduces input costs.
      • Producers can produce more at a lower cost.
    • Supply curve shifts to the right (increases).
    • Supply curve represents the marginal cost in a competitive market.
    • At the original price ($2), there's excess supply.
    • Excess supply forces the equilibrium price down to $1.70.
    • New equilibrium: Quantity = 6,000, Price = $1.70.
    • Price decrease leads to an increase in quantity demanded (movement along the demand curve).

Demand vs. Quantity Demanded

  • Increase in demand: The entire demand curve shifts outwards.
  • Increase in quantity demanded: Movement along the existing demand curve.

Factors Affecting Supply

  • Price of inputs decreases (supply increases).
  • Number of firms in the market increases (supply increases).
  • State of nature (e.g., good harvest leads to increased supply; drought leads to decreased supply).

Factors Affecting Demand

  • Preferences change.
  • Price of complements falls (e.g., petrol and cars). If the price of petrol decreases, the demand for cars may increase.
  • Price of substitutes increases (e.g., rent and owned apartments). If rent increases, people may shift to buying.
  • Changes in consumer's willingness to pay shifts the demand curve.
  • Changes in firm's cost shifts the supply curve.

Impact of Changes: Examples

  • Price of wheat increases (input cost):
    • Affects: Supply.
    • Supply decreases (shifts inwards).
    • Equilibrium price increases, equilibrium quantity decreases. Drawing the graph helps to easily see that conclusion. This can be different for each person.
  • Consumers adopt a low-carb diet:
    • Affects: Demand.
    • Demand decreases (shifts inwards).
    • Equilibrium price decreases, equilibrium quantity decreases.
  • Ovens become more energy-efficient:
    • Affects: Supply.
    • Supply increases (shifts outwards).
    • Equilibrium quantity increases, equilibrium price decreases.
  • Price of butter increases (butter is a complement to bread):
    • Affects: Demand.
    • Demand decreases (shifts inwards).
    • Equilibrium price decreases, equilibrium quantity decreases.

Supply Curve Visualizations

  • When supply increases: Curve shifts to the right (or downwards in some visualizations).
  • When supply decreases: Curve shifts to the left (or upwards).
  • Important to correctly visualize the shifts to understand the changes in equilibrium.

More Examples of Supply and Demand Shifts

  • Decline in pita sales pushes sellers into the bread market:
    • Affects: Supply.
    • Supply increases.
    • Equilibrium quantity increases, equilibrium price decreases.
  • Unemployment falls:
    • Affects: Demand.
    • Demand increases (more people can afford bread).
    • Equilibrium price increases, equilibrium quantity increases.

Perfect competition - Long-Run Equilibrium

  • Monopolies had three profitability scenarios (abnormal profits, breaking even, losses) with barriers to entry/exit.
  • Perfectly competitive markets have freedom of entry and exit.
  • Firms will be breaking even in the long run.
  • In the Short run, there can be: Profts, losses, or breaking even.
  • If firms are making a profit, more firms enter, exhausting the profits and tending to break even in the long run.
  • If firms are making losses, firms exit, increasing prices until they break even.

Graphical Representation

  • Market Graph represents supply and demand, determining equilibrium price and quantity.
  • Individual Firm Graph shows the firm's cost curves and how it maximizes profit.
  • Firms always check prices as given in the market:.

Scenario 1: Firms Earn a Profit

  • Marginal cost curve intersects marginal revenue (demand) curve at the profit-maximizing quantity.
  • Average cost curve is below the price at that quantity.
  • The area between the price and the average cost represents profit.
  • This attracts new entrants, increasing market supply and decreasing the market price until firms break even.

Scenario 2: Firms Making Losses

  • Average cost curve is above the price at the profit maximizing quantity.

  • Firms will exit in the market (supply decreases).

Scenario 3: The Breakeven point

  • Curve is tangent to the price function.
  • Marginal cost and marginal revenue equilibrium

Summary – Perfect Competition

  • Long run will Economic profit = 0
  • Short run will have 3 scenarios:
    • Price < Average cost (losses)
    • Price = Average cost (Break even)
    • Price > Average cost (Profit)
  • Firms can make break-even or make economic profit to which equilibrium adjust and individual's firm adjust quantities produced.

Exercise for the reader to prepare for an upcoming exam:

  • Explanation with graphs of how a natural distaster decreases the amount of water firms can sell.
  • Then explanation of how to market can be adjusted back to the long run in a new short run equilibium.
  • With short answers and bullet points to explain the key things.