Download Market Equilibrium II

Market Equilibrium: Part II
Announcements
• PS #4 is posted on web page. It is big and not all
questions are very easy. It is time to start studying.
• PS#5 will be even bigger. (also more challenging)
• A sample exam will be posted on webpage next week,
and possibly more study questions for the exam.
• Email me to set up an office hour appointment (for
study help)
Review
• Equilibrium refers to a situation in which the price has
reached the level where quantity supplied equals quantity
demanded. • Equilibrium Price
• The price at which quantity supplied equals quantity
demanded. • On a graph, it is the price at which the supply and demand
curves intersect.
• Equilibrium Quantity
• The quantity supplied and the quantity demanded at the
equilibrium price.
Terms you need to know:
• Shortage (excess demand): quantity demanded >
quantity supplied
• Surplus (excess supply): quantity supplied > quantity
demanded
• The market price of any good adjusts to bring the
quantity supplied and the quantity demanded for that
good into balance.
The equilibrium in the ice-cream market
Demand Schedule
Supply Schedule
At $2.00, quantity demanded = quantity supplied
The equilibrium price is Pe = $2.00.
The equilibrium quantity is Qe = 7 units.
Same thing with equations
The equation for the market demand is
QD = 19 – 6P The equation for the market supply is
QS = –5 + 6P, if P ≥ 5/6, QS = 0 if P < 5/6
Let’s compute the equilibrium price and quantity.
QD = QS (this means demand equals supply)
19 – 6P = –5 + 6P
Solve for P: 24 = 12P ⇒ Pe = 2
To compute the equilibrium quantity, substitute 2 for P in the
demand (or the supply) equation: Qe = 19 – 6(2) = 7.
Same thing with the supply and demand graph
Price of
Ice-Cream
Demand: QD = 19 – 6P Supply: QS = –5 + 6P, (if P ≥
5/6)
3.17
Supply
2.00
5/6
Demand
0
7
19
Quantity of
Ice-Cream
Copyright©2003 Southwestern/Thomson Learning
Changes in the market
equilibrium
How do equilibrium price and quantity change when the
supply of demand change?
Analyzing Changes in Equilibrium: The three steps
method
0. Something (an event) happens: e.g., a meteor hits
the earth.
1. Decide whether the event shifts the supply or
demand curve.
2. Decide whether the curve shifts to the left or to the
right.
3. Use the supply-and-demand diagram to see how the
shift affects equilibrium price and quantity.
Figure 10 How an Increase in Demand Affects the Equilibrium
1. News says that regular consumption
of vanilla ice-cream reduces cardiovascular diseases
Price of
Ice-Cream
Cone
Supply
New equilibrium
$2.50
2.00
2. . . . resulting
in a higher
price . . .
Initial
equilibrium
D
D
0
7
3. . . . and a higher
quantity sold.
10
12
Excess demand at P = 2
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
This is what prices do: Prices communicate information
1. Demand rises: people want more ice-cream.
2. There must be more production to meet the higher
demand.
3. How can you convince/make the sellers supply more?
4. They are self interested, they need higher prices to work
harder and supply more.
5. So.
6. The price must rise to create more supply (raise the
quantity supplied)
7. The “demand-induced-higher-price” is a message from
the buyers to the sellers: We want more ice-cream.
This is how the ice-cream produces learn the relative
desirability (consumption value, benefit to consumers etc)
of ice-cream: they learn it through its higher price.
Prices act as signals that guide
the allocation of scarce
resources in a market economy.
One more example
A supply shift
Figure 11 How a Decrease in Supply Affects the Equilibrium
Price of
Ice-Cream
Cone
Excess demand,
shortage
S2
1.There is an increase in the
price of sugar (a major input
In the production of ice cream)
S1
New
equilibrium
$2.50
Initial equilibrium
2.00
2. . . . resulting
in a higher
price of ice
cream . . .
Demand
0
4
7
3. . . . and a lower
quantity sold.
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Again, prices communicate
1. Ice-cream production is now more costly.
2. Demand must be reduced.
3. How can you make the buyers reduce their
consumption?
4. They are self interested, they respond to prices: 5. Higher prices will make them consume less.
6. As the price of ice-cream rises, buyers will reduce their
quantity demanded and substitute towards other goods.
7. Buyers find out about the relative scarcity of a good
through its price.
8. Each individual buyer then decides what to do him/
herself; decision making is decentralized.
A “real world” application: The food vs. fuel dilemma
A study in demand and supply
The Food vs. fuel dilemma is about using
farmland or crops for bio-fuels production
(mostly ethanol) so as to threaten the food
supply on a global scale. There is discussion about how significant
the issue is, what is causing it, and what
can be done about it.
But a fair statement of the issue would
be that..
The main problem with subsidizing the
production of ethanol (bio-fuel) from corn
is that it is causing people in low-income
countries to go hungry.
A few fact (from wiki!)
• From 1974 to 2005 food prices (adjusted for inflation)
•
•
•
•
dropped by 75%. Prices were stable after reaching lows in 2000 and
2001.
Prices sharply increased in 2005 despite record
production levels worldwide. From January 2005 until June 2008, maize prices
almost tripled, wheat increased 127 percent, and rice
rose 170 percent.
MAIZE (looks like corn)
He says that US and EU must
change biofuel targets to avert
food crisis.
This is Paul Bulcke,
chief executive of
Nestlé, the world's largest
food company, has added its Nestlé
weight to calls by the UN and
development groups for the
US and EU to change their
bio-fuel targets because of
food shortages and price
rises.
"We say no food for fuel," said
Paul Bulcke, chief executive of
Nestlé, at the end of the World
Water Week conference in
Sweden. "Agricultural food-based
bio-fuel is an aberration. We say
http://www.guardian.co.uk/globaldevelopment/2012/sep/04/us-eu- that the EU and US should put
money behind the right bio-fuels."
biofuel-food-crisis-nestle
From Guardian Sept 2012:
Under laws intended to reduce foreign oil imports, 40%
of US maize (corn) harvest must be used to make biofuels, even though one of the deepest droughts in the
past 100 years is expected to reduce crop yields
significantly. In addition, EU countries are expected to move towards
drawing 10-20% of their energy supply for transport from
bio-fuels to reduce carbon emissions.
More facts
Cost for developing countries
Source
http://www.ase.tufts.edu/gdae/Pubs/rp/ActionAid_Fueling_Food_Crisis.pdf
All scarce goods must be
rationed!
Food vs. bio-fuel debate: a simple numerical example
INDIVIDIAL
Imagine a competitive
P
demand supply
markets with 4 buyers and 3
1
5
0
sellers.
2
4
2
3
3
4
MARKET
4
2
6
P
demand supply
1
5X4=20 0X3=0
2
4X4=16 2X3=6
The equilibrium price is P = 3.
each consumer buys 3 units.
3
3X4=12 4X3=12
Each seller produces 4 units.
4
2X4=8 6X3=18
Now, a big buyer comes into the market!
P
DEMAND
1
2
3
4
16
14
12
10
The new market demand is
the sum of the 3 buyers and
the newly arrived big buyer.
• The equilibrium price is P =
4.
• The 3 buyers buy 2 units
each, and pay a higher price. • Each seller produces 6 units.
P
1
2
3
4
MARKET
demand supply
20+16
0
16+14
6
12+12
12
8+10
18
Now you try
The three step approach
1. Decide whether the event shifts the supply or demand curve (or both).
2. Decide whether the curve(s) shift(s) to the left or to the right.
3. Use the supply-and-demand diagram to see how the shift affects
equilibrium price and quantity.
The price of coal fell and the quantity sold also fell.
Everything else being equal, which of the following three
events could be the reason: (A.) Decrease in the price of oil (oil and coal are
substitutes).
(B.) Large increase in the wages of coal miners.
Please draw one well-labeled demand supply graph for
each event to say yes or no for each.