LJ

Market Equilibrium - Chapter 5

Road Map / Objectives

  • Explain how a market reaches its equilibrium price and quantity
  • Discuss the effects of price ceilings and price floors
  • Show how shifts in supply and demand affect a market’s equilibrium
  • Solve problems involving market equilibrium

Equilibrium Point

  • Equilibrium occurs at the intersection of the demand and supply curves.
  • The equilibrium price and quantity are the point where the two curves intersect.
  • Notation:
    • P_E = equilibrium price
    • Q_E = equilibrium quantity
    • Q_D(P) = quantity demanded at price P
    • Q_S(P) = quantity supplied at price P
  • Equilibrium condition: when the two curves intersect, we have
    • QD(PE) = QS(PE) = Q_E
  • Implication: at this point, there is no inherent pressure for the price to change (assuming other conditions hold).

Shortages and Surpluses

  • When a market is not in equilibrium, shortages and surpluses occur for consumers and producers.
  • Definitions:
    • Shortage occurs when the quantity demanded exceeds the quantity supplied: QD(P) > QS(P)
    • Surplus occurs when the quantity supplied exceeds the quantity demanded: QS(P) > QD(P)
  • Notation recap:
    • Equilibrium price and quantity: PE, QE with QD(PE) = QS(PE) = Q_E
  • At non-equilibrium prices, prices adjust to move the market toward equilibrium; shortages put upward pressure on price, surpluses put downward pressure on price.

Market Schedule Example: Sub Sandwich Market

  • Given data (price per sandwich, quantity demanded, quantity supplied):
    PriceQuantity DemandedQuantity Supplied
    $3368
    $63016
    $92424
    $121832
    $151240
    $18048
  • Analysis:
    • At P = 9, QD = QS = 24 → Equilibrium price PE = 9, equilibrium quantity QE = 24
    • Prices below equilibrium (e.g., P = 3, P = 6): QD > QS → Shortage
    • Prices above equilibrium (e.g., P = 12, 15, 18): QS > QD → Surplus
  • Summary of outcomes for this schedule:
    • Shortage at P = 3, 6
    • Equilibrium at P = 9 with Q = 24
    • Surplus at P = 12, 15, 18

Price Controls

  • Binding price controls can lead to shortages or surpluses depending on whether they lie below or above the equilibrium price.
  • Price ceiling:
    • An artificial upper limit on the price of a good or service
    • If binding (set below equilibrium), tends to create a shortage
  • Price floor:
    • An artificial lower bound on the price of a good or service
    • If binding (set above equilibrium), tends to create a surplus
  • The general principle: binding price controls disrupt the natural price mechanism and can misallocate resources.
  • Practical implications and examples:
    • Price ceilings are often discussed in housing markets (rent control).
    • Price floors are commonly discussed in agricultural markets (minimum prices).
  • Connection to equilibrium concepts:
    • When a price control is in effect, the market price may be forced away from the equilibrium price P_E, resulting in either a shortage (ceiling) or surplus (floor) until other market factors adjust.

Key Formulas and Concepts (summary)

  • Equilibrium condition: QD(PE) = QS(PE) = Q_E
  • Shortage condition: QD(P) > QS(P)
  • Surplus condition: QS(P) > QD(P)
  • Notation recap:
    • P_E = equilibrium price
    • Q_E = equilibrium quantity
    • Q_D(P) = quantity demanded at price P
    • Q_S(P) = quantity supplied at price P
  • Price controls: binding when set relative to P_E can create shortages (ceiling) or surpluses (floor)