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Market Equilibrium…

• When the supply and demand curves intersect, the market is in equilibrium. This is where the quantity demanded and quantity supplied are equal. The corresponding price is the equilibrium price or market-clearing price, the quantity is the equilibrium quantity.

Surplus…

• If the market price is above the equilibrium price, quantity supplied is greater than quantity demanded, creating a surplus. Market price will fall.

• Example: if you are the producer, you have a lot of excess inventory that cannot sell. Will you put them on sale? It is most likely yes. Once you lower the price of your product, your product’s quantity demanded will rise until equilibrium is reached. Therefore, surplus drives price down.

Shortage…

• If the market price is below the equilibrium price, quantity supplied is less than quantity demanded, creating a shortage. The market is not clear. It is in shortage. Market price will rise because of this shortage.

• Example: if you are the producer, your product is always out of stock. Will you raise the price to make more profit? Most for-profit firms will say yes. Once you raise the price of your product, your product’s quantity demanded will drop until equilibrium is reached. Therefore, shortage drives price up.

Government involved…

• Government regulations will create surpluses and shortages in the market. When a price ceiling is set, there will be a shortage. When there is a price floor, there will be a surplus.

Price Floor

• Price Floor: is legally imposed minimum price on the market. Transactions below this price is prohibited.

• Policy makers set floor price above the market equilibrium price which they believed is too low.

• Price floors are most often placed on markets for goods that are an important source of income for the sellers, such as labor market. Price floor generate surpluses on the market. Example: minimum wage.

Price Ceiling

• Price Ceiling: is legally imposed maximum price on the market. Transactions above this price is prohibited.

• Policy makers set ceiling price below the market equilibrium price which they believed is too high.

• Intention of price ceiling is keeping stuff affordable for poor people. Price ceiling generates shortages on the market. Example: Rent control.

Elasticity

Measures “responsiveness” to change in price

(Measures a Movement; Price Effect)

Price Elasticity of Demand

• Sensitivity of quantity demanded to price changes

• Elastic: Small P-change, large Q-demanded change

• Inelastic: Large P-change, small Q-demanded change

The Elasticity of a good’s demand tends to increase with:

• Number of closes substitutes.If there are 10 brands of bicycles available and

the prices for one of them increase, the quantity of that brand demanded is likely to fall a lot.

Elasticity (Cont.)

• The proportion of income spent on the good.Consider gum and cruise price-change scenarios.

The quantity of cruises purchased will probably be more affected by a 50% price increase than the quantity of bubble gum because an extra 2 cents is not a big deal but an extra $500 is more likely to be prohibitive.

Elasticity (Cont.)

• Time• When time is short, it is more difficult to

change purchasing patterns in response to changes. The more time consumers have to adapt, the more they are able to find substitutes or learn to do without goods whose prices have increased.

Elasticity (Cont.)

• The lack of importance of a good• The less essential a good is, the more likely

consumers are to forego the good when it becomes more expensive.

Luxuries v. Necessities

• Goods with an elastic demand are categorized as luxuries.• Goods with an inelastic demand are

categorized as necessities.

Why should a business care about the elasticity of demand?

• One reason is that the elasticity determines what happens to revenue when price changes.

– Revenue = Price x Quantity– When facing a inelastic demand, to bring in more revenue

while selling fewer units, raise the price of the good.

Supply and Demand Practice Answers

1 2 3 4 5 6 7 8 9 10 11$0

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Supply and Demand for Boomerangs

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Surplus

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Supply and Demand for Boomerangs

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Shortage

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Supply and Demand for Boomerangs

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Market Equilibrium

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Supply and Demand for Boomerangs

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1. The income of the Chapel Hill townies declines

after an early loss during March Madness.

Quantity

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2. Chapel Hill is named one of the most beautiful towns in North Carolina and tourism doubles

Quantity

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3. The price of blue ties decreases. (Blue ties are a substitute good for purple ties)

Quantity

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4. The Federal government has been warning the public about the possibility of a recession and job loss in the RDU area. (Think

expectations!)

Quantity

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5. The price of purple striped shirts decreases (Purple striped shirts are a complement to purple ties)

Quantity

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6. The price of silk increases (ties are made with silk).

Quantity

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7. The government adds a subsidy to tie production.

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8. After the release of Alan Greenspan’s first jazz flute album, purple tie producers are expecting a huge increase in demand and

thus an increase in the price.

Quantity

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9. Congress enacts new tax on the production of

purple ties.

Quantity

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10. As the popularity of purple ties sweeps the greater Orange County area, new producers enter the purple tie market.

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11. Purple ties are named by GQ magazine as a “must have” for all young professionals. At the same time, a new textile

machine decreases the cost of producing purple ties.

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12. The price of pink ties (a related good that most purple tie producers also produce) rises as spring approaches. Tie consumers in Chapel Hill begin to expect purple ties to be put on sale

since spring is coming, so they put off purchasing.

Quantity

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