Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)
-
Upload
phillip-boyd -
Category
Documents
-
view
214 -
download
1
Transcript of Econ 201 Market Equilibrium Week 2. Equilibrium (cont’d)
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 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
Qty Dem (P=$18) = Qty Sup(p=$18): Solve for P* such that Qd(P*) = Qs(P*)
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
Av
era
ge
Pric
e (
pric
e
pe
r 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