Chapter 3:
Competitive Dynamics
How Competitive Markets Operate
Market Equilibrium:
 The
stable point at which demand and supply
curves intersect
S
PRICE
0
D0
0
Quantity
Market Equilibrium
Interaction of Supply and Demand:
At the point of equilibrium:
Quantity Supply = Quantity Demand
 Since no excess demand or supply
 Therefore, price is stable with no pressure to
increase or decrease

So, what happens when there is a surplus or shortage?
Effects of Changes in Supply on Equilibrium
S0
PRICE
S1
D0
0
Quantity
An increase in supply, the equilibrium values of price and quantity move in opposite
directions, with price falling and quantity rising. A decrease in supply would have the
opposite effects: price would rise and quantity would fall to reach a new equilibrium
Effects of a Surplus:
Surplus: an excess of quantity supplied over quantity demanded

Sellers have to lower price to sell surplus products

Lower price will cause consumers to increase the quantity they demand
of the product and sellers to decrease the quantity supply
PRICE
In situation of excess supply there will be pressure on price to drop
which will cause quantity demand to increase and quantity supplied
S0
to decrease until the equal one another
D0
0
Quantity
Effects of Changes in Demand on Equilibrium:
PRICE
S0
D1
D0
0
Quantity
An increase in demand, the equilibrium values of both price and
quantity rise. A decrease in demand would have the opposite effect,
causing the equilibrium values of both price and quantity to fall.
Effects of Shortage:
Shortage: an excess of quantity demanded over quantity supplied

Sellers can raise price to exploit shortage of product

Higher price will cause consumer to decrease the quantity the demand of
product and sellers to increase the quantity they sell
In this situation of excess demand there will be pressure on the price to
rise which will cause quantity demand to decrease and quantity
supplied to increase until they equal one another
PRICE
S0
D0
0
Quantity
Price Controls:
Price Floor: a minimum price set above equilibrium

Being use in Agricultural to protect farmers
Price ceiling: a maximum price set below equilibrium

Being use rent control for housing
PRICE
S0
D0
0
Quantity
Consumer Surplus & Total Benefit
PRICE ($ per
Pizza)
0
Quantity
Consumer Surplus: the extra amount of money that a consumer is willing to pay for
goods or services
The curve shows that this consumer will buy 1 pizza at $12, 2 pizza at $6. The demand
curve can also be viewed in the opposite way. The height of the demand curve at
each quantity is the maximum price the consumer is willing to pay for that unit.
Therefore, in this example, the consumer is willing to pay up to $12 for her first pizza
of the week, $9 for her second, and $6 for her third.
Total Benefit:
PRICE ($ per Pizza)
D
0
Quantity
When consumers in the pizza market are charged a price of $6, they consumer
100 000 pizzas. Adding up consumers’ marginal benefits for all 100 000
pizzas gives a total benefit in the market equal to area AB. At the same
time, consumers’ total expenditure on pizzas is area B ($600 000). The
total consumer surplus in the market is found by subtracting area B from
area A, so it is equal to area A ($500 000)
S0
PRICE
Rent Controls:
D0
0
Quantity
Rent controls force price below the equilibrium level, from $500 to
$300. Quantity demanded, originally at 2000, rises to 2300 units at
the new price while quantity supplied falls to 1500 units. The price
ceiling thus causes a shortage of 800 units.