Market Equilibrium
Learning Objectives:
• What is market equilibrium?
• How do demand and supply interact to clear the market?
• What happens if there is a change in demand or supply or both?
• What is consumer surplus?
• What is producer surplus?
Demand and Supply
• Demand for a good gives us the willingness of all the consumers in the
market to pay different prices for different quantities of the good being
demanded.
• Supply of a good gives us the willingness of all the producers in the
market to supply different quantities of the good at different prices.
• Demand and supply jointly determine the competitive market
equilibrium.
Market Equilibrium
• If the quantity demanded of a good in the market is the same as the
quantity supplied of the good in that market, then the market for the
good is in equilibrium at that quantity and price level.
• If price of the good is higher than the equilibrium market price, then
there will be excess supply of the good Downward pressure on
price Price will decrease.
• If price of the good is lower than the equilibrium market price, then
there will be excess demand for the good Upward pressure on price
Price will increase.
• Example: Burger King Ending 15-Cent Nugget Deal as Supplies Wane
Change in Demand
• If there is a rise in the demand for a good, ceteris paribus, then both
the equilibrium market price and equilibrium market quantity will rise,
and vice versa.
• Example: Bah Humbug: Spirit Airlines Ups Baggage Fee $2 During
Holiday Travel Season
• Example: Delhi Noida Direct Flyway, 2006
Change in Supply
• If there is a rise in the supply of a good, ceteris paribus, then the
equilibrium market price will fall and equilibrium market quantity will
rise, and vice versa.
• Example: The Petroleum Market: 1970-2001
• Example: Bob Marley's Ubiquitous Legend Finally Hits The Top 10
Change in Demand and Supply
• What happens if both demand and supply change?
• Example: No Pecan Pie? Thank China, Rain and Pigs
• Example: Resolving China's Power Shortage, 2004
• Example: Amazon to Publishers: Set Your Own E-Book Prices! Amazon
to Customers: Not Our Fault!
Equilibrium
• Linear demand function:
𝑄𝐷,𝑋 = 𝛽0 + 𝛽𝑋 𝑃𝑋
• Linear supply function:
𝑄𝑆,𝑋 = 𝛼0 + 𝛼𝑋 𝑃𝑋
• In equilibrium,
𝑄𝐷,𝑋 = 𝑄𝑆,𝑋
Consumer Surplus
• Consumer surplus is the extra value from a good that consumers get
while just paying the competitive market price.
Producer Surplus
• Producer surplus is the extra revenue that producers receive in excess
of what’s necessary to induce them to produce the good while selling it
at the competitive market price.
Price Ceiling
• Government mandated maximum price that can be legally charged for
a good.
• Example: Venezuela hopes to wipe out toilet paper shortage by
importing 50m rolls
• Example: Vodka prices: Putin calls for cap amid economic crisis
Price Floor
• Government mandated minimum price to be legally charged for a
good.
• Example: The Birth Of The Minimum Wage In America