Download Equilibrium and Disequilibrium

The Economics
Department, UMR
Presents:
Supply and Demand: Price
and Quantity
Determination in
Competitive Markets
Starring
u
Demand
u
Supply
Equilibrium and
Disequilibrium
u
Featuring
uThe Law of Demand
uD = D(PENTE)
uThe Tendency of Supply
uS = S(pent)
uEquilibrium/Disequilibrium
In Four Parts
Demand
Supply
Equilibrium/Disequilibrium
(current show)
Changes in Equilibrium
Part 3
What Is Equilibrium?
It is a situation that exists in a market
when the plans of buyers are consistent
with the plans of sellers
u Or, at the prevailing price, quantity
demanded equals the quantity supplied
u Another, wider, view of equilibrium is
when the action taken leads to
consequences that are expected, there is
no incentive to change
u
Notes About the Concept of
Equilibrium
First, there should be no prior
judgement about whether a given
equilibrium is good or bad
u Second, markets not in equilibrium are
in Disequilibrium
u
v Shortages, or
v Surpluses
The Ethics of Equilibrium
William Lynch’s (1742-1820) early
American tribunals dispatched swift
results with bodies soon coming to rest
(an equilibrium) but most have rejected
this as a good form of justice
u Competitive equilibrium, under certain
conditions, is efficient
u
v Given scarcity, efficiency is a desirable
social objective
u
It is the consequences of equilibrium we
have to judge, not the state itself
Many Processes Are Not in
Equilibrium
The one constant is change
u In economics change is purposeful and
may often be modeled successfully
u Equilibrium results from a given
change, an end state implied by these
models
u Many economic processes “tend
toward” equilibrium
u
Disequilibrium
u
u
u
u
Usually markets are “tending toward
equilibrium” driven by the forces of supply and
demand
v Prices are used as a rationing mechanism
Changing demand or supply conditions create
incentives for buyers and sellers to change their
behavior
Disequilibrium is characterized by
v Excess demand--a shortage, or
v Excess supply--a surplus
Price controls (ceilings or floors) lead to
shortages or surpluses
Shortage
u
Shortage - when QD > QS at current
market price
v Amount of shortage = QD - QS
u
Note - it is not correct to say demand
exceeds supply, but rather quantity
demanded exceeds quantity supplied
Surplus
u
Surplus - when QS > QD at current market
price
•
u
Amount of surplus = QS - QD
Note - it is not correct to say supply
exceeds demand, but rather that quantity
supplied exceeds quantity demanded
Price Controls
There are two types of price controls price ceilings and price floors
Price Ceilings
Price ceiling - sets a maximum price that
is allowed by law
u Result of price ceiling
u
v Stay at a permanent shortage situation
Note that a price ceiling can be any price
the government chooses. It is, however
only effective if it is below the
equilibrium price
u Examples include maximum rents for
apartments and UMR parking permits
u
Price Floors
Price floor - sets a minimum price that is
allowed by law
u Result of price floor
u
v Stay at a permanent surplus situation
Note that a price floor can be any price
the government chooses. It is, however
only effective if it is above the
equilibrium price
u Examples include agriculture price
supports and the minimum wage
u
Equilibrium in the Market
u
Equilibrium - where quantity
demanded equals quantity supplied
u
Equilibrium price (P*) - price where
equilibrium occurs
u
At P* there is no incentive for buyers or
sellers to change their behavior. Their
plans are consistent
Equilibrium, Graphically
P
S
E
P*
D
0
Q*
Q/t
Equilibrium in the Market
What occurs at equilibrium
u Demand side - those who get the good
are those willing and able to pay the P*
u Supply side - only those sellers which
are able to produce at or below the cost
of P* will remain in business
u Prices ration available supply to those
who value the good highest
Tendency Toward
Equilibrium in the Market
u
u
u
Note that if the price is
below P* then there will
be a shortage causing
price to rise
If the price is above P*
then there will be a
surplus causing price to
fall
Self interest generates
these price changes
P
S
P*
D
0
Q*
Q/t
An Example--UMR Student
Parking
u
u
u
u
It is easiest to see the tendency toward
equilibrium by looking at a good that is not
rationed by price--student parking
First, ask whether demand and supply curves are
typical
Demand--is there an inverse relationship between
the number of parking spots wanted by UMR
students and the price of the slots? Clearly YES
Upward sloping supply? Again yes, the more the
administration could extract from students, the
less important it would be for them to provide
parking for staff and faculty
UMR Student Parking Market
in Equilibrium
P
S
P*
D
0
Q*
Use the
hypothetical P*
and Q* as
benchmarks.
Where are
actual P and Q
relative to P*
and Q*?
Q/t
Where Are Actual P and Q
Relative to P* and Q*?
If you said “less than,” go
to the head of the class
P
u Administration policy
P*
regarding allocation of P
a
scarce parking slots
0 Q*
creates a shortage
u In effect there is a price
ceiling imposed by UMR
u
S
DQ/t
QD
Shortage
There are a lot more students wanting
to buy parking permits than UMR is
willing to sell
u Why? Because at the current price, the
quantity demanded is quite high. But
UMR does not want to sell that many at
such a low price
u
Shortage Shown Graphically
P
S
Pa = actual price
Qa = actual
quantity sold
Note the quantity
supplied is the quantity
sold: QS = Qa
P*
Pa
D
0
Qa
QS
Q*
QD
Amount of Shortage
Q/t
When Price Is Not Used As a
Rationing Device Shortages
Tend to Persist
u
Students may act politically
v Letters to “the miner”
v Through student government
Students may exit the market--transfer
to another school
u These are explicit reactions. An
advantage of price rationing is it is done
implicitly
u
How Price Rationing Eliminates
Shortages
P
S
E
Buyers who
expected to buy
are unsatisfied
Sellers find they
have more
buyers than
supply
P*
Pa
D
0
QS
Q* QD
Q/t
Shortage Eliminated Through
Price Increases
Sellers find little resistance to price increases
u Buyers can’t get all they want and are
willing to pay more
u P will increase
v Quantity demanded will fall
v Quantity supplied will increase
u The process continues until an equilibrium
is established by price rationing
u
How Price Rationing
Eliminates Shortages
P
S
E
Quantity demanded
falls as price rises
Quantity supplied
increases as price
rises
P*
Price continues to
rise until:
Pa
QD = QS
D
0
QS
Q*
QD
Q/t
The Role of Prices
u
Convey information
v When
gasoline prices fell below $1.00 in
Rolla, it told us something about gas--use
more
u
Rationing device
v The price is what determines who can have
the good
Student Parking
u
Not rationed by price but by some type of
administrative decision
v
u
We use queuing (first come--first served)
Other common rationing devises
v
v
v
v
v
v
v
Alphabetical
The government decides based on need
Height
Gender
Age
Location
Rank or position
Advantages/disadvantages of
Queuing
Queuing typically favors those who
value time less than those that value
time more
u Queuing leads to an outcome that is
inefficient
u
v Some student who get parking permits
value them less than some students who
do not get permits
Surplus, Revisited
u
Surplus - when QS > QD at current market
price
•
u
Amount of surplus = QS - QD
Note - it is not correct to say supply
exceeds demand, but rather that quantity
supplied exceeds quantity demanded
Surplus Shown Graphically
Amount of
Surplus
P
S
Pa
Pa = actual price
Qa = actual
quantity sold
Note the actual
quantity sold equals the
quantity demanded
D
0Q
a
QD
QS
Qa = Q D
Q/t
Surplus Through Legislated
Price Floors
Price floor - sets a minimum price that
is allowed by law
u Result of price floor
u
v No tendency for price to play its rationing
function
u
Note that a price floor can be set at any
price, but is only effective if it is above
the equilibrium price
Price Floor Examples
u
Agriculture support prices
v Price of wheat supported at 80% of parity
100% parity: setting the price of farm
commodities so they have the same purchasing
power they had in the “golden age of
agriculture” 1910-1914
u FAIR act of 1996
u
u
Minimum wage legislation
v The conventional story
v Renewed debate
Agriculture Price Supports
u
FAIR: federal agricultural
improvement and reform act, signed by
president Clinton in 1996
v FAIR:
link to the U.S. Dept. Of agriculture
to find out more
v The act moves to replace price supports
with direct subsidy of farm income phased
out over time
Price Support Maintained by
Government Purchases
Amount of
Surplus
P
Pa = actual price, set at
80% of parity
S
Pa
Qa = quantity bought
by consumers
D
0Q
QS = quantity farmers
want to sell
a
QD
QS
One policy has
taxpayers buying the
surplus, QS - Qa paying
Pa x (QS - Qa )
Q/t
Farm Support Maintained by Deficiency
Payments
Pt = target price, set at
80% of parity
P
S
Pa = market price
Qs = quantity farmers
want to sell
Pt
Qa = QS = quantity
bought by consumers
Pa
D
0
QD
Qa
QS
Deficiency payments
are (Pt - Pa) x Qa )
Q/t
Inefficiencies of Pre FAIR Act
Agriculture Policy (Gov.
Purchases)
u
Government purchases of surplus
v Perpetual surpluses
v Price sends the wrong signal to farmers
Consumers buy only amount they value at target
price, but farmers produce amount up to where
their marginal cost equal the target price
u The surplus costs more to produce than its worth
measured by consumers willingness to pay
u
u
Consumers and taxpayers lose more than
farmers gain
Inefficiencies of Pre FAIR Act
Agriculture Policy (Deficiency
Payments)
u
Government deficiency payments
v Perpetual overproduction but no surpluses
v Price sends the wrong signal to farmers
Consumers buy all that is brought to market,
but marginal cost (= target price) exceeds the
value consumers put on the good
u On the margin the good costs more to produce
than its worth
u
u
Taxpayers lose more than consumers
and farmers gain
Price Floors in the Unskilled Labor
Market--the Minimum Wage
u
When we look at the labor market it is
similar to other supply and demand
diagrams except for the labels
•
•
u
L - quantity of workers per period
W - wages (the price we pay workers)
It is also different because the suppliers
of labor are person, not firms and the
demanders of labor are firms
Minimum Wage Legislation-the Conventional Story
Amount of Unemployed
Workers
Wage
S
wfloor
w*
D
0
LD
L*
LS
# of Workers/t
Winners and Losers of the Minimum
Wage--the Conventional Story
Benefit - those who get higher wages
u Losers - those who can’t find jobs at
the higher wage
u Losers - firms who must pay higher
wages and consumers who have to
pay higher prices due to the higher
costs of the firm
u Inefficient since the sum of the loses
exceeds the sum of the benefits
u
The Minimum Wage--a New Debate
Any inefficiency that may be created is
small
u Equity objectives are furthered by
having a “livable” minimum wage
u Due to market power possessed by
firms hiring minimum wage workers,
an increase in the wage may increase
employment
u Increased wages increase labor
productivity by giving workers a
“stake” in their effort
u
Demand and Supply of
Unskilled Labor Are “Steep”
Firms that hire unskilled labor are not
very sensitive to small changes in the
minimum wage, so the quantity
demanded will not change much
u Unskilled persons supply of labor are
not very sensitive to changes in their
wage
u Thus any unemployment caused by
increases in the minimum wage will be
small
u
Unskilled Labor Market
not this
but this
Amount of Unemployed
Workers
Wage
S
Amount of Unemployed
Workers
Wage
S
wfloor
wfloor
w*
w*
D
0
# of Workers/t
D
0
# of Workers/t
Equity Vs. Efficiency
Equity objectives are furthered by
having a “livable” minimum wage
u This “trade-off” is in society’s interest
as we seek to do something about the
growing inequality of incomes in the
united states
u
Monopsony Power
Due to market power possessed by
firms hiring minimum wage workers,
an increase in the wage may increase
employment
u You will discuss this in chapter 9
u
“Efficiency Wage”
Increased wages increase labor
productivity by giving workers a
“stake” in their effort
u Increased productivity lowers cost
offsetting, at least partly the higher
wages due to increases in the minimum
wage
u
How Price Rationing Eliminates
Surpluses
P
S
Pa
Sellers who
expected to sell
are unsatisfied
Buyers find they
have more
sellers to choose
from
P*
D
0
QD
Q*
QS
Q/t
How Price Rationing Eliminates
Surpluses
Amount of
Surplus
P
S
Quantity demanded
increases as price
falls
Quantity supplied
decreases as price
falls
Pa
Pe
Price continues to
fall until:
D
0
QD
Qe
QS
QD = QS
Q/t
Surplus Eliminated Through
Price Decreases
Buyers find little resistance to lower price
offers
u Sellers can’t sell all they want and are
willing to accept less
u P will fall
v Quantity demanded will increase
v Quantity supplied will decrease
v The process continues until an
equilibrium is established by price
rationing
u
The End