Econ 100Lecture 3.3

Market Equilibrium10-12-2010

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 Demanded

Price Per Pizza

# of Pizzas Supplied

Shortage or Surplus

1000 $10 400  

900 $12 450  

800 $14 500  

700 $16 550  

600 $18 600  

500 $20 650  

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

The Cobweb Theorem

D

S

7

Price (£)

Quantity Bought and Sold (millions)

9

D1

In a ‘divergent cobweb’ -also termed an unstable cobweb - the price tends to move away from equilibrium.

Assume the initial equilibrium price is £7 and the quantity 9. If demand rises, the shortage pushes the price up to £11 per turkey.11

15

Farmers respond by planning to increase supply, ten months later, the supply of turkeys is 15 million. At this level, there will be a surplus of turkeys and the price drops.

8

The price falls to £5 and farmers react by cutting plans for turkey production. Ten months later, supply on the market will be 8 million.

5

This creates a massive shortage of 9 million turkeys and the price is forced up – and so the process continues!

A divergent cobweb leads to price instability over time.

17

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-to-

pay 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

$0$2$4$6$8

$10$12

1 2 3 4 5 6 7 8 9 10

Quantity Demanded

Ave

rage

Pric

e (p

rice

per u

nit)

Demand Curve is Also Marginal Valueand Avg Revenue

Amount Paid

CS

Total WTP =CS + Amt Paid

In Class Example

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

Avg P*Qd TV(Q-1)+MV(Q)

Also = MV(Q) TV(Q)-TV(Q-1)

Tot Val- Tot Paid

Also = Avg Rev

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