Supply and Market Equilibrium

SUPPLY AND MARKET EQUILIBRIUM

Introduction

  • Course: Supply and Market Equilibrium

  • Institution: American University of Paris

  • Instructor: Professor Peter Walkenhorst

What is Supply?

  • Definition: Supply refers to the willingness and ability of sellers to produce and offer different quantities of a good at different prices over a specific time period.

    • Key Components:

    • Different quantities of a good

    • Different prices

    • Specific time frame

Law of Supply

  • Statement: As the price of a good rises, the quantity supplied of that good also increases, and vice versa; ceteris paribus (all other factors being equal).

  • Visualization: The relationship is depicted on a graph where the price is on the vertical axis and quantity is on the horizontal axis.

Supply Curve

  • Definition: The supply curve is a graphical representation of the law of supply.

    • It illustrates that price and quantity supplied are directly related, holding all else constant (ceteris paribus).

Deriving a Market Supply Schedule

  • A market supply schedule combines the quantity supplied by individual suppliers at various prices.

    • Example Supply Schedule
      Quantity Supplied by Individuals:

    • Brown:

    • $10: 1

    • $11: 2

    • $12: 3

    • $13: 4

    • $14: 5

    • $15: 6

    • Alberts:

    • $10: 2

    • $11: 3

    • …

    • Other Suppliers:

    • Various quantities supplied across the price range.

    • Market Calculation:

    • Total quantity supplied can be calculated by summing individual supplies across price points.

Deriving a Market Supply Curve

  • The market supply curve is derived by plotting the total quantities supplied by all suppliers at each price level.

    • For instance, individual supply curves from Brown and Alberts are added to determine the overall market supply at various price points.

CHANGES ALONG AND SHIFTS IN THE SUPPLY CURVE

Changes in Supply vs. Shift in Supply

  • An increase in supply means that suppliers are willing and able to offer more goods at every price.

  • Conversely, a decrease in supply signifies a willingness to offer less at every price point.

Change in Quantity Supplied

  • A change in quantity supplied refers specifically to a movement along the supply curve.

    • The sole factor that alters the quantity supplied of a good is a change in the price of that good (own price).

Shift of the Supply Curve

  • A shift in the supply curve can occur due to various external factors:

    • Prices of relevant resources

    • Technological advancements

    • Changes in the number of sellers

    • Expectations regarding future prices

    • Taxes and subsidies

    • Government restrictions

Change in Supply: Shifts of the Supply Curve

  • An increase in supply is depicted as a rightward shift of the curve, while a decrease represents a leftward shift.

MARKET EQUILIBRIUM

Putting Supply and Demand Together

  • Market equilibrium is established where the supply and demand curves intersect.

Market Equilibrium Explained

  • Definition: Market equilibrium is the price-quantity combination at which there is no incentive for buyers or sellers to change their behavior.

    • It is graphically depicted as the intersection point of the supply and demand curves.

Surplus and Shortage

  • Surplus: This occurs when the quantity supplied exceeds the quantity demanded; it takes place only when the price is above equilibrium.

  • Shortage: This occurs when the quantity demanded exceeds the quantity supplied; it happens only when the price is below equilibrium.

Equilibrium Price and Quantity

  • Equilibrium Price: The price at which the quantity demanded equals the quantity supplied.

  • Equilibrium Quantity: The quantity that corresponds to the equilibrium price, where both buyers and sellers are satisfied with the good's amount sold.

Disequilibrium

  • Disequilibrium: A state in the market characterized by either surplus or shortage.

  • Disequilibrium Price: Any price other than the equilibrium price where quantity demanded does not equal quantity supplied.

MOVE TO MARKET EQUILIBRIUM

Market Dynamics

  • Various price conditions exhibit surplus and shortage mechanics:

    • Example scenario with prices and quantities at equilibrium, surplus, and shortage states.

THE FUNCTION OF PRICES

Functions of Prices

  • Prices serve two primary functions:

    • Rationing Device: Prices determine who gets what of the limited resources and goods available.

    • It rations resources to producers paying the price and goods to buyers paying the price.

    • Ethical implication: This mechanism can discriminate against economically disadvantaged groups.

    • Transmitter of Information: Prices communicate information regarding market conditions and resource scarcity.

    • Illustrative Example: A rise in orange juice prices following a poor crop signifies relative scarcity.

PRICE CONTROLS

Overview of Price Controls

  • Price controls arise when the government sets restrictions on how high or low a price can be in the market.

    • Two main types:

    • Price ceilings (maximum prices)

    • Price floors (minimum prices)

Price Ceilings

  • Definition: A price ceiling is a legally established maximum price.

    • Effects of Price Ceilings:

    • Creates shortages when the ceiling price is set below the equilibrium price.

    • Results in fewer exchanges as the number of units sold declines.

Consequences of Price Ceilings

  • Key consequences include:

    • Inaccurate price signals, leading to supply shortages.

    • Deterioration in quality of goods available.

    • Emergence of black markets and tie-in sales.

Price Floors

  • Definition: A price floor is a legally mandated minimum price that cannot be lowered in a market.

    • Effects of Price Floors:

    • Creates surpluses where more is supplied than demanded at the set floor price.

    • Reduces the number of exchanges compared to the equilibrium quantity.

Consequences of Price Floors

  • Major consequences of price floors include:

    • Excess supply and build-up of stock.

    • Improvement in quality offered as producers are assured of minimum returns.

    • Potential tie-in sales and black market activity.

COURSE REVIEW

Review Questions

  • What is the law of supply?

  • Identify the factors causing shifts in the supply curve.

  • What defines market equilibrium?

  • Explain the terms supply surplus and supply shortage.

  • Analyze the market for new cars under different scenarios regarding assembly technologies and worker wages.

Exercise Question

  • Analyze the effects of new findings on apple consumption health benefits and advances in harvesting technology on apple market equilibrium and quantity.

Multiple-choice Questions

  • What does the law of supply state?

    • A. As the price of a good increases, the quantity supplied decreases.

    • B. As the price of a good increases, the quantity supplied increases.

    • C. The quantity supplied is independent of price.

    • D. The quantity supplied always exceeds the quantity demanded.

  • Which is a determinant of supply?

    • A. Consumer preferences

    • B. Population size

    • C. Cost of production

    • D. Income levels of consumers

  • What occurs when the market price is above equilibrium price?

    • A. A surplus occurs.

    • B. A shortage occurs.

    • C. The quantity demanded equals the quantity supplied.

    • D. Supply decreases to meet demand.

  • If the observed market equilibrium price increases while quantity exchanged falls, the likely explanation is:

    • A. Supply has increased (shifted right).

    • B. Supply has decreased (shifted left).

    • C. Demand has increased (shifted right).

    • D. Demand has decreased (shifted left).

  • Factors that shift the supply curve right include:

    • A. An increase in raw materials cost.

    • B. A decrease in the producer count.

    • C. An improvement in production technology.

    • D. An increase in consumer income.

  • Equilibrium in a market occurs at:

    • A. Quantity supplied greater than quantity demanded.

    • B. Quantity demanded greater than quantity supplied.

    • C. Quantity demanded equals quantity supplied.

    • D. Government-set price ceiling.

  • If the price of a substitute rises, the likely outcome on the original good’s supply will be:

    • A. It will increase.

    • B. It will decrease.

    • C. It will remain unchanged.

    • D. It will double.

  • The representation of a supply curve illustrates:

    • A. Relationship between price and quantity demanded.

    • B. Relationship between cost and quantity produced.

    • C. Relationship between price and quantity supplied.

    • D. Relationship between income and quantity demanded.

  • If a government subsidy exists for producers, the result on the supply curve will be:

    • A. It shifts left.

    • B. It shifts right.

    • C. It becomes vertical.

    • D. It does not shift.

  • Effect of a price ceiling below equilibrium price:

    • A. It causes a surplus.

    • B. It has no effect.

    • C. It eliminates the supply curve.

    • D. It causes a shortage.