Lecture 5Lecture 5

The Market EquilibriumThe Market Equilibrium

■ ■ Market demand and supplyMarket demand and supply

■ ■ Reconciling suppliers and demandersReconciling suppliers and demanders

■ ■ EquilibriumEquilibrium

Market demand and Market demand and supplysupplyGoing from the individual to the Going from the individual to the marketmarket

■ ■ We combine the demands of We combine the demands of individuals by adding them individuals by adding them horizontallyhorizontally

■ ■ We also combine the supplies of firms We also combine the supplies of firms by adding them by adding them horizontallyhorizontally

■ ■ The results are market demand and The results are market demand and supply curvessupply curves

Adding up demand Adding up demand curvescurves

At each price, sum the individual quantities At each price, sum the individual quantities demanded to get market quantity demandeddemanded to get market quantity demanded

+ = Dm = Da + Db

DbDa

Adding up supply Adding up supply curvescurves

At each price, sum the individual quantities At each price, sum the individual quantities supplied to get market quantity suppliedsupplied to get market quantity supplied

Sa Sb Sm = Sa + Sb

+ =

CompetitionCompetition

■ ■ Demanders compete with each otherDemanders compete with each other►►Their efforts tend to push price up, enriching suppliersTheir efforts tend to push price up, enriching suppliers

■ ■ Suppliers compete with each otherSuppliers compete with each other► ► Their efforts tend to push price down, enriching demandersTheir efforts tend to push price down, enriching demanders

■ ■ Demanders do NOT compete with suppliers, even thought it Demanders do NOT compete with suppliers, even thought it sometimes seems that way!sometimes seems that way!► ► What about bargaining? Each party tries to convince the What about bargaining? Each party tries to convince the other of the powerful other of the powerful competition faced from alternativescompetition faced from alternatives

Equilibrium:Equilibrium: The result of competition is The result of competition is

mutually beneficial cooperation. mutually beneficial cooperation. At “equilibrium” no one has an incentive to change behavior:At “equilibrium” no one has an incentive to change behavior:

P*

Q*

$

S

D

Q/time period

Adjustments to Adjustments to equilibriumequilibrium

■ ■ Price above P*Price above P* ► ► Quantity supplied exceeds quantity demanded: excess supply, or Quantity supplied exceeds quantity demanded: excess supply, or

“surplus”“surplus” ► ► Frustrated suppliers compete for business, lowering prices Frustrated suppliers compete for business, lowering prices (“buyers’ market”)(“buyers’ market”) ► ► Price falls until market clearsPrice falls until market clears

■■ Price below P*Price below P* ► ► Quantity demanded exceeds quantity supplied: excess demand, Quantity demanded exceeds quantity supplied: excess demand,

or “shortage”or “shortage” ► ► Frustrated demanders compete for product, raising prices Frustrated demanders compete for product, raising prices (“sellers’ market”)(“sellers’ market”) ► ► Price rises until market clearsPrice rises until market clears

Adjustment processAdjustment processWhat if the price is NOT right?What if the price is NOT right?

■■Competition pushes price toward equilibriumCompetition pushes price toward equilibrium

One more time…One more time…The result of competition is mutually The result of competition is mutually beneficial cooperationbeneficial cooperation

In equilibrium, price and quantity will persist, until and In equilibrium, price and quantity will persist, until and unless there is a change in unless there is a change in ceteris paribusceteris paribus conditions…conditions…

Question on Market Question on Market EquilibriumEquilibrium

Suppose Toyota currently sells Suppose Toyota currently sells 100,000 cars each year in Hawaii. 100,000 cars each year in Hawaii. Does that mean there are Does that mean there are 100,000 demanders of Toyotas in 100,000 demanders of Toyotas in Hawaii?Hawaii?

Question on Market Question on Market EquilibriumEquilibrium

Suppose the government of Suppose the government of Hawaii imposes a 100% sales tax Hawaii imposes a 100% sales tax on new Toyotas. What will happen on new Toyotas. What will happen to price and quantity of Toyotas to price and quantity of Toyotas sold in Hawaii?sold in Hawaii?

QuestionsQuestions

How do each of these events How do each of these events influence the equilibrium influence the equilibrium

(i) price of airline tickets and (i) price of airline tickets and (ii) quantity of airline trips taken(ii) quantity of airline trips taken

1. Rise in price of jet fuel1. Rise in price of jet fuel2. Depression in the economy2. Depression in the economy3. Threat of war3. Threat of war4. Government regulations making air 4. Government regulations making air

travel safertravel safer

QuestionsQuestions

True/false/uncertain:True/false/uncertain: An increase in the sales tax on a An increase in the sales tax on a

good will be paid for by good will be paid for by consumers of the good.consumers of the good.

It is important to producers of It is important to producers of tires whether a tax on tires is paid tires whether a tax on tires is paid by them or paid by consumers.by them or paid by consumers.