CH16_Equilibrium_Lecture_Slides_WEB - EC-270-A-B - Intermediate Microeconomics I

Chapter 16: Equilibrium

• Instructor: Dr. Logan McLeod

• Affiliation: Wilfrid Laurier University

• Date: October 22, 2024

Supply Curve

• Definition: The supply curve illustrates the relationship between price and quantity supplied.

• Characteristics:

  • Positive Slope: Indicates that as price (P) increases, the quantity supplied (Q) also increases (P and Q directly related).

  • Supply Function (S(P)): Shows how much of a good firms will supply at different prices based on their optimization behavior.

  • Market Supply Curve: Aggregate of all firm supply curves, representing total quantity supplied at varying prices.

Market Equilibrium

• Definition: A market is in equilibrium when the total quantity demanded equals the total quantity supplied at a specific price.

  • Equilibrium Condition: D(p*) = S(p*)

  • Graphical Representation: Intersection of demand (D) and supply (S) curves indicating price and quantity in equilibrium.

Excess Supply (Surplus)

• Definition: Occurs when quantity supplied exceeds quantity demanded.

  • Condition: When P' > P*, surplus exists at D(P) < S(P).

  • Effect: Creates downward pressure on market price, pushing it back toward equilibrium (P*).

Excess Demand (Shortage)

• Definition: Happens when quantity demanded exceeds quantity supplied.

  • Condition: When P'' < P*, excess demand exists at D(P'') > S(P'').

  • Effect: Creates upward pressure on the market price, moving it upward towards equilibrium.

Calculating Market Equilibrium

• Linear Demand and Supply:

  • Demand Function: D(p) = a - bp

  • Supply Function: S(p) = c + dp

  • Equilibrium Condition: Set D(p) equal to S(p) to solve for equilibrium price (p*) and quantity (q*).

Inverse Demand and Supply

• Inverse Functions:

  • Demand: D^-1(q) = a - bp

  • Supply: S^-1(q) = c + dp

  • Equilibrium Calculation: Use the inverse forms to find equilibrium quantities and prices.

Example: Market Equilibrium Calculation

• Given:

  • D(p) = 50 - 2p

  • S(p) = 20 + 3p

• Calculation:

  • Set D(p*) = S(p*):

  • 50 - 2p* = 20 + 3p*

  • Solve: p* = 6, q* = 38.

Special Cases of Market Equilibrium

1. Perfectly Inelastic Supply:

   • Description: Quantity supplied remains constant, represented by a vertical supply curve.

   • Price Determinants: Price determined by demand.

2. Perfectly Elastic Supply:

   • Description: Quantity supplied changes infinitely with price, represented by a horizontal supply curve.

   • Price Determinants: Price determined by supply, quantity determined by demand.

Impact of Taxes on Market Equilibrium

• Tax Types:

  • Excise Tax: Levied on sellers.

  • Sales Tax: Levied on buyers.

• Effect of Quantity Tax:

  • Higher price to demanders (P_D).

  • Lower price received by sellers (P_S).

  • Rule: P_D - P_S = t (tax per unit).

Market Equilibrium with Tax

• Equilibrium Condition: Quantity demanded at P_D must equal quantity supplied at P_S (D(P_D) = S(P_S)).

• Tax Impact: Shifts supply curves up by the tax amount, effectively increasing buyer prices and reducing traded quantities.

Tax Incidence

• Definition: The distribution of the tax burden between buyers and sellers.

• Calculation: Tax incidence is determined by the elasticities of demand and supply.

• Effectiveness: Highly elastic supply results in sellers bearing less tax burden; highly elastic demand results in buyers bearing less.

Deadweight Loss of Taxation

• Definition: Loss of economic efficiency when market equilibrium is disrupted by the tax.

• Surplus Reduction:

  • Taxes reduce total surplus (consumer surplus + producer surplus).

  • Deadweight loss indicates lost gains from trade.

Elasticities and Tax Incidence

• Impact on Buyers: As supply becomes more elastic or demand becomes inelastic, buyers pay a larger portion of tax.

• Critical Points:

  • When demand is perfectly inelastic (E_D = 0), buyers pay entire tax.

  • When supply is perfectly elastic (E_S = 0), sellers pay entire tax.

Example Calculations

1. Example Tax Incidence:

   • Given elasticity values calculate the tax burden on buyers and sellers.

   • E.g., if E_D = -0.4 and E_S = 0.6, 60% tax incidence falls on buyers.

2. Deadweight Loss Examples:

   • Evaluate the effects of changing tax rates on quantity traded, and overall market dynamics.