Economics Pear

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3.1

Market equilibriuM and efficiency

Equilibrium

Learning outcomes • Explain,usingdiagrams,howdemandandsupplyinteracttoproducemarket equilibrium. Analyse,usingdiagramsandwithreferencetoexcessdemandorexcesssupply, howchangesinthedeterminantsofdemandand/orsupplyresultinanewmarket equilibrium.

Money is a medium of exchange – you can exchange it for something you want that somebody else has.

Having examined demand and supply separately, we can combine them to analyse markets more completely. When demand and supply are combined, there is a tendency for the market to reach an equilibrium state. Equilibrium is defined as the state in which all contrasting forces cancel each other out, resulting in balance or stability. Market equilibrium is defined as the state in which the quantity supplied is equal to the quantity demanded. Supply and demand are balanced. The price at which the quantity supplied and demanded are equal is called the equilibrium price. At this price, the amount purchased is exactly equal to the amount sold. There is no surplus product available on the market, nor are there shortages of supply at that price. For this reason, the equilibrium price is also called the market-clearing price. Everything put on the market, at that price, is sold. Returning to the bags of potato chips we used in Chapter 2, the total market schedule shows the equilibrium price is $1.50 per bag (Table 3.1). At that price, the amount supplied and

Market equilibrium occurs at the price where the quantity demanded and quantity supplied are equal (also called the market-clearing price).

To learn more about supply and demand, visit pearsonhotlinks.com, enter the title or ISBN of this book and select weblink 3.1.

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market equilibrium and efficiency

demanded is 15 000 bags per week. All the chips offered on the market are purchased by consumers. Prices set above or below the market price will result in market disequilibrium, because there will be excess supply or demand. Table 3.1 DemanD anD supply scheDule: potato chips price of potato chips (P) / $ 2.50 2.00 1.50 1.00 0.50 Quantity of potato chips demanded per week (QD) / thousands 5 10 15 20 25 Quantity of potato chips supplied per week (Qs) / thousands 25 20 15 10 5

Figure 3.1 shows market equilibrium, with the equilibrium price of $1.50. At that price, an equal amount are demanded and supplied. Thus, the market clears all output at that price. Figure 3.1 Market equilibrium.

S

2.50

2.00 price per bag / $ (P) equilibrium price

1.50

market equilibrium

1.00

0.50 equilibrium quantity 0 5 D

10 15 20 25 bags per week / thousands (Q)

Market disequilibrium
excess supply
A market disequilibrium is any price at which the demand and supply quantities are not equal. Let’s look at specific examples of market disequilibriums, and analyse the results of attempting to set prices anywhere other than the equilibrium price. Table 3.1 and Figure 3.1 show the market price to be $1.50. If the producers of these potato chips had an exaggerated sense of their value, they might set the price too high. Let’s say, for example, that they greedily set the price at $2.50 per bag. At that price, the quantity demanded is much smaller than at the equilibrium price. Quantity demanded drops from 15 000 to 5000 bags per month. This is equivalent to a movement along the demand curve, as shown in Figure 3.2. As price increases, the quantity demanded decreases or moves upwards and left along the demand curve. At the same time, setting the price higher induces producers to increase production as they expect higher profits at higher prices. Quantity supplied thus moves in the opposite direction, moving upwards along the curve to a quantity of 25 000. 54

2.50

excess supply

S

Figure 3.2 Equilibrium with shortages and surplus.

2.00 price per bag / $ (P) equilibrium price

1.50

market equilibrium...
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