Econ 201
Market Equilibrium
Week 2
Equilibrium (cont’d)
What does EQUILIBRIUM mean?
• At the market equilibrium price:
– Quantity demanded by consumers = quantity
supplied by firms/producers/sellers
– Without a change in any of the ceterius
paribus conditions, the price will remain
unchanged
• Demand: Income, Price of Substitutes and
Complements, Future Prices, Quality, Number of
Consumers
• Supply: Input Prices, Technology, Number of
Suppliers, Future Prices (Input, Good)
How Do We Get There?
• Consumers
– Willing to buy another unit, if market price <=
to marginal (use) value of consuming it
• Suppliers
– Willing to sell/produce another unit, if market
price >= marginal (additional) costs of
producing the last unit
• Equilibrium occurs only when
– MVconsumer = Pmarket = MCproducer
And If That Doesn’t Happen?
• MV < P > MC
– Sellers are willing to continue to supply more goods
– Consumers are unwilling to buy
– Excess supply will lead to sellers dropping their prices
down in the future to clear inventory
• MV > P < MC
– Sellers not willing to supply as much as consumers
will demand (excess demand)
– Excess demand will lead to consumers bidding prices
up to get the “shortage”
Another Variation
• At each price, determine
whether there would be a
shortage (Qd > Qs) or a
surplus (Qs > Qd)
• If there was a shortage, how
would price adjust to clear the
market?
• If there is a surplus, how would
price adjust to clear the
market?
# of Pizzas
Demand
ed
Price Per
Pizza
# of Pizzas
Supplie
d
1000
$10
400
900
$12
450
800
$14
500
700
$16
550
600
$18
600
500
$20
650
Shortage or
Surplus
Answers
# of Pizzas Demanded
Price Per Pizza
# of Pizzas Supplied
Shortage (-) or Surplus (+)
1000
$10
400
-600
900
$12
450
-450
800
$14
500
-300
700
$16
550
-150
600
$18
600
0
500
$20
650
150
Price
(£)
The Cobweb Theorem
S
11
The
Assume
Farmers
the
respond
falls
initial
£5
by
equilibrium
and
planning
farmers
This
In price
acreates
‘divergent
atomassive
cobweb’
- to
price
increase
react
is
by
£7
cutting
supply,
and
the
plans
ten
quantity
months
for
turkey
9.
shortage
also termed
of 9 an
million
unstable
turkeys If
demand
later,
production.
the rises,
supply
the
months
of
shortage
turkeys
later,
is
and
cobweb
the
price
- Ten
theis
price
forced
tends
up
–to15
pushes
million.
supply
At
the
the
this
price
market
level,
upequilibrium.
to
there
will
£11be
will
per
8
and
move
soon
away
the
process
from
continues!
turkey.
be
million.
a surplus of turkeys and the
A divergent
price
drops. cobweb leads to
price instability over time.
7
5
D
8
9
15
17
D1
Quantity Bought and Sold
(millions)
Cobweb Theorem
• http://www.bized.co.uk/current/mind/2004_5/251004.ppt
• Hungarian-born economist Nicholas Kaldor (1908-1986)
• Simple dynamic model of cyclical demand with time lags
between the response of production and a change in
price (most often seen in agricultural sectors).
• Cobweb theory is the process of adjustment in markets
• Traces the path of prices and outputs in different
equilibrium situations. Path resembles a cobweb with the
equilibrium point at the center of the cobweb.
• Sometimes referred to as the hog-cycle (after the
phenomenon observed in American pig prices during the
1930s).
So What Do Buyers
Get Out of This?
• Consumer surplus
– Difference between what you are willing-topay and what you have to pay
• Willingness-to-pay
– Everything under the demand curve up to the
last unit that you bought
• What you had to pay
– Average price paid x number of units
purchased
Consumer Surplus
Demand Curve is
Also Marginal Value
and Avg Revenue
Average Price (price
per unit)
Demand Curve
$12
$10
$8
$6
$4
$2
$0
CS
Amount Paid
1
2
3
4
5
6
7
Quantity Demanded
Total WTP =
CS + Amt Paid
8
9
10
In Class Example
Avg P*Qd
TV(Q-1)+MV(Q)
Tot Val- Tot Paid
Avg Pric Qty Dem Tot Amt Paid Tot Value (WTP) Marg Val Cons Surp
$10
1
$10
$10
$10
$0
$9
2
$18
$19
$9
$1
$8
3
$24
$27
$8
$3
$7
4
$28
$34
$7
$6
$6
5
$30
$40
$6
$10
$5
6
$30
$45
$5
$15
$4
7
$28
$49
$4
$21
$3
8
$24
$52
$3
$28
$2
9
$18
$54
$2
$36
$1
10
$10
$55
$1
$45
Also = Avg Rev
Also = MV(Q)
TV(Q)-TV(Q-1)
What Do Sellers Get Out of This?
• Producer Surplus
– The difference between what they get paid
(total revenues) and what it costs them
• Total Revenues
– > = Average Price x Quantity Purchased
• Total Costs
– > = Sum of Marginal Costs up to the amount
supplied (QS)
• Or = the area under the supply curve up to Qs
What is the Value of the Market
• Value of the market
– To Consumers = Consumer Surplus
– To Producers = Producer Surplus
• Value equals the sum of both CS and PS