Market Equilibrium
Supply and Demand
P
Supply and Demand is the essential issue of
economics.
Economic agents: Households
Economic agents: Business firms
Markets for Outputs (products)
Markets for Inputs (factors)
S
P*
D
0
Q*
Mathematical form of
The equilibrium state
Equilibrium
is the state where
quantity demanded equals quantity
supplied
Qd = Qs
Demand and supply can be
represented by equations
Equilibrium Math Form
Qd = Qs
By substitution,
95 - 50 P = - 10 + 100 P
105 = 150 P
P = 0.70 (Equilibrium price)
Q = 95 - 50 X 0.7 = 60
(Equilibrium quantity)
Q
Example
Suppose the TV market is described as
follows:
The Demand Function
Qd = 95 - 50 P
The Supply Function
Qs = - 10 + 100 P
Find equilibrium price and quantity
Comparative static analysis in the
equation form
“Outside
force”
force” change the equation.
income changes causes the
shift in the demand function to
Qd = 120 - 50 P
Then we solve for the new
equilibrium price and equilibrium
quantity
Draw conclusions
Example,
CONTROLS ON PRICES
Are
usually enacted when
policymakers believe the market
price is unfair to buyers or sellers.
Result in governmentgovernment-created price
ceilings and floors.
CONTROLS ON PRICES
Price
Ceiling
– A legal maximum on the price at which
a good can be sold.
Price
Floor
– A legal minimum on the price at which a
good can be sold.
How Price Ceilings Affect
Market Outcomes
A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding
Price of
Ice-Cream
Cone
Two
outcomes are possible when the
government imposes a price ceiling:
– The price ceiling is not binding if set
above the equilibrium price.
– The price ceiling is binding if set below
the equilibrium price, leading to a
shortage.
Supply
Equilibrium
price
$3
2
Price
ceiling
Shortage
Demand
0
How Price Ceilings Affect
Market Outcomes
Effects
of Price Ceilings
A binding price ceiling creates
Example:
Gasoline shortage of the 1970s
Usury law and interest rate
control
Rent control in the New York city
– Nonprice rationing
Examples:
sellers
Long lines, discrimination by
125
Quantity
supplied
Quantity
demanded
Quantity of
Ice-Cream
Cones
CASE STUDY: Lines at the Gas
Pump
– Shortages because QD > QS.
Example:
75
In 1973, OPEC raised the price of
crude oil in world markets. Crude
oil is the major input in gasoline,
so the higher oil prices reduced the
supply of gasoline.
What was responsible for the long
gas lines?
Economists blame government
regulations that limited the
price oil companies could
charge for gasoline.
Gasoline with a Price Ceiling
(a) The Price Ceiling on Gasoline Is Not Binding
Market for Gasoline with a Price
(b) The Price
Ceiling on Gasoline Is Binding
Ceiling
Price of
Gasoline
Price of
Gasoline
S2
2. . . . but when
supply falls . . .
Supply, S1
1. Initially,
the price
ceiling
is not
binding . . .
S1
P2
Price ceiling
Price ceiling
P1
Demand
0
3. . . . the price
ceiling becomes
binding . . .
P1
Q1
4. . . .
resulting
in a
shortage.
Demand
0
Quantity of
Gasoline
Price Floors
QS
(b) A Price Floor That Is Binding
Price of
Wheet
the government imposes a
price floor, two outcomes are
possible.
$4
3
Price
floor
Equilibrium
price
Demand
0
price floor prevents supply and
demand from moving toward the
equilibrium price and quantity.
When the market price hits the floor,
it can fall no further, and the market
price equals the floor price.
Supply
Surplus
– The price floor is not binding if set
below the equilibrium price.
– The price floor is binding if set above
the equilibrium price, leading to a
surplus.
A
Quantity of
Gasoline
A Market with a Price Floor
When
How Price Floors Affect Market
Outcomes
QD Q1
80
120 Quantity of
Quantity Quantity wheat
demanded supplied
How Price Floors Affect Market
Outcomes
A
binding price floor causes . . .
– a surplus because QS > QD.
– nonprice rationing is an alternative
mechanism for rationing the good, using
discrimination criteria.
Examples:
Examples:
The minimum wage
Agricultural products
CASE STUDY: The Minimum
Wage
important example
of a price floor is the
minimum wage.
Minimum wage laws
dictate the lowest
price possible for
labor that any
employer may pay.
How the Minimum Wage Affects
the Labor Market
Wage
An
Labor
Supply
Equilibrium
wage
Labor
demand
0
How the Minimum Wage Affects
the Labor Market
Equilibrium
employment
Quantity of
Labor
Price floor for agricultural products
Wage
Agricultural
Labor surplus
(unemployment)
Labor
Supply
subsidy
Reasons against the subsidy
– Such as tax payers’ dollar waste, etc.
Cases
Minimum
wage
support the subsidy
– Stable income for farmers
– Stable supply for national security
Labor
demand
0
Quantity
demanded
Quantity
supplied
Quantity of
Labor
A Can of Worms
Price floor for agricultural products
Price
Favoritism
surplus
Minimum
price
Supply
and corruption
Unenforceability
Limit
of volume of transactions
Misallocation of resources and
inefficiency
demand
0
Quantity
Quantity
supplied
demanded
Quantity of
wheat