Chapter 4: Equilibrium
Equilibrium and the Adjustment Process
Surplus: The quantity demanded is greater than the quantity supplied. This drives prices down. Sellers decrease their price so buyers have incentive to buying ay lower prices.
Competition will push prices down whenever there is a surplus.
Shortage: The quantity demanded is greater than the quantity supplied. This drives prices up. Sellers have to raise the price and buyers do not have incentive to buy at the higher prices.
Competition will push prices up whenever there is a shortage.
Equilibrium Price: The price at which the quantity demanded is equal to the quantity supplied.
Equilibrium Quantity: The quantity at which the quantity demanded is equal to the quantity supplied.
Sellers compete with other sellers.
Buyers compete with other buyers.
A Free Market Maximizes Producer Plus Consumer Surplus (the Gains from Trade)
Unexploited Gains from Trade: When quantity is below the equilibrium quantity.
In a free market unexploited gains from trade wont last long.
Value of Wasted Resources: When quantities greater than the equilibrium price.
Gains from trade push the quantity towards the equilibrium quantity.
If the quantity supplied exceeds equilibrium quantity, it costs the sellers more to produce a barrel of oil than that barrel of oil is worth to buyers.
Does the Model Work? Evidence from the Laboratory
Vernon Smith (1956): Did a supply and demand test on students to see how equilibrium worked and how a competitive market worked to reach equilibrium
Shifting Demand and Supply Curves
Shifting Supply Curve:
A fall in costs moves the supply curve down and to the right. The result of a lower cost a price is an increase in quantity. A reduction in price and an increase in quantity.
When the costs have fallen, suppliers are willing to sell more at the old price than demanders are willing to buy.
A decrease in supply will raise the market price and reduce the market quantity.
An increase in demand shifts the demand curve up and to the right. An increase in price and quantity.
Terminology: Demand Compared with Quantity Demanded and Supply Compared with Quantity Supplied
On a Graph:
Quantity Demanded is movement along a fixed demand curve.
An increase in supply pushed the price down and causes an increase in the quantity demanded.
Increase in Demand: is a sift of the entire demand curve (up and to the right).
This is the creation of a demand curve.
Increase in Supply is a shift of the entire supply curve.
Increase Quantity Supplied is a movement along a fixed supply curve.