Download Equilibrium and Disequilibrium

Equilibrium and
Disequilibrium
Mr. Messere
Gr. 12 Economics
CIA 4U1
Outline
I. Changes in Equilibrium
A. Change in Demand
B. Change in Supply
C. Change in Both Demand and Supply
II. Market Disequilibrium
A. Price Floors
B. Price Ceilings
C. Commodity Agreements
Market Dynamics
• Equilibrium - where quantity demanded
equals quantity supplied
• Equilibrium Price (P*) - price where
equilibrium occurs.
• If price above equilibrium, then surplus
occurs
• If price below equilibrium, then shortage
arises
Equilibrium/Surplus/Shortage
P
Surplus
P1
S
E
P*
P2
Shortage
0
Q*
D
Q
Equilibrium in the Market
What Occurs at Equilibrium?
• Demand Side - those who get the good are
those willing and able (effective demand) to
pay the P*.
• Supply Side - only those firms which are
able to produce at or below the cost of P*
will remain in business.
Changes in Equilibrium
• Remember that Supply and Demand are
drawn under the ceteris paribus assumption.
• Any factors which cause Supply and/or
Demand to change will affect equilibrium
price and quantity.
Change in Demand
• Demand will change for any of the non-price
determinants examined previously:
–
–
–
–
–
Tastes/Preferences
Income
Price of Substitute & Complementary goods
Expectations
Population
Ceteris paribus, let’s say the demand for CDs increased due
to an increase in income. How would this affect market
equilibrium price & quantity of CDs?
Increase in Demand
P
SCDs
DCDs
0
Q
Increase in Demand
P
SCDs
P*’
P*
E’
E
D’
DCDs
0
Q* Q*’
Q
Change in Supply
• Supply will change for any of the the nonprice determinants examined previously:
- Costs of Production – Input costs / taxes & subsidies
- Technology
- Nature and the environment
- Number of producers
- Complements & substitutes in production
Ceteris paribus, let’s say that the government lowers taxes
on CDs. How would this affect the market equilibrium price
& quantity of CDs?
Increase in Supply
P
SCDs
DCDs
0
Q
Increase in Supply
P
SCDs
S’
P*
P*’
E
E’
DCDs
0
Q* Q*’
Q
Changes in Demand and Supply
To determine the impact of both supply and
demand changing:
• First examine what happens to equilibrium
price and quantity when just demand shifts.
• Second, examine what happens to
equilibrium price and quantity when just
supply changes
• Finally, add the two effects together.
Changes in Demand and Supply
General Results:
• When supply and demand move in the same
direction
• Equilibrium price is indeterminate
• When supply and demand move in opposite
directions
• Equilibrium quantity is indeterminate
Supply & Demand Move in the Same
Direction
Assume ceteris paribus:
Suppose that the barbecue season is at its
peak. Also, the price of cattle decreases by
10% during this time. How would this affect
the market equilibrium price & quantity of
steak?
Supply & Demand Move in the Same
Direction
P
SSteak
E1
P1
P*
0
P
?
E
E2
Q* Q1 Q2
D
DSteak
Q’
S’
Final Equilibrium Quantity & Price when
Demand & Supply move in the Same Direction
Since it is barbecue season, consumer preference for
steak has increased, thus causing demand to increase
from D to D’. This temporarily pulls up price and
increases quantity demanded to P1 and Q1 respectively.
At the intermediate equilibrium level, E1, supply then
increases from S to S’ as a result of lower cattle
prices (a fall in the price of an input) which pushes
the final market equilibrium quantity to E2 where the
final equilibrium quantity is Q2 and equilibrium price
is indeterminate.
Supply & Demand Move in Opposite
Directions
Assume ceteris paribus:
Suppose that the price of lemons falls and
lemon is considered an essential ingredient in
preparing great tasting spinach. At the same
time, many spinach farmers also reduce the
amount of land used to produce spinach. How
would this affect the market equilibrium price
& quantity of spinach?
Supply & Demand Move in the Opposite
Directions
S’
P
SSpinach
E2
P2
P1
E1
P*
E
Q?
0
Q* Q1
D’
DSpinach
Q
Final Equilibrium Quantity & Price when Demand
& Supply move in Opposite Directions
As a result of the price of lemons falling (a complimentary
good) the demand for spinach increases from D to D’ and
temporarily raises the price from P* to P1 and quantity
from Q* to Q1.
At the intermediate equilibrium level, E1, supply then
decreases from S to S’ because there are fewer farmers
growing spinach which pushes the final market
equilibrium quantity to E2 where the final equilibrium
price is P2 and equilibrium quantity is indeterminate.
The Role of Prices
• Convey information
– When the price of a Maple Leaf ticket increased
from $120 last season to $150 this season (on
average), it told us something about the
popularity of the Maple Leafs
• Rationiong device
– The price is what determines who can have the
good
Market Disequilibrium
• Is it possible for the price and quantity to
NOT be in equilibrium?
• Yes - While the invisible hand may move
price towards equilibrium, price controls
tend to generate disequilibrium in the
marketplace
Price Controls
There are two types of price controls:
1) Price Ceilings
2) Price Floors
Price Ceilings
• Price Ceiling - sets a maximum price that is
allowed by law.
• Result of Price Ceiling:
– 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
Price Ceiling
• Example of Price Ceiling
• Rent controlled apartments
• In New York City, San Francisco, Boston,
and other cities the city or state determines
the maximum amount that can be charged
for rent on many apartments.
• A maximum price is a price ceiling
Rent Controlled Apartments
P
S
D
0
Q
Rent Controlled Apartments
P
S
P*
D
0
Q*
Q
Rent Controlled Apartments
P
S
P*
Pceiling
D
0
Qs
Q* Qd
Amount of Shortage
Q
Winners and Losers
Who gains and loses with price ceilings?
1. Benefit - those who get rent controlled
apartments
2. Loses - those who can’t find apartments
due to the shortage.
3. Loses - landlords who must accept
lower rent.
Price Floors
• Price Floor - sets a minimum price that is
allowed by law.
• Result of Price Floor
• Stay at a permanent surplus situation
• Note that a price floor can be set at any
price, but is only effective if it is above the
equilibrium price
Price Floors
• Example of Price Floor
• Minimum Wage Legislation
• The minimum wage is a lowest price the
government will allow firms to pay for
labor.
• A minimum price is a price floor
Price Floors
• When we look at the labor market it is
similar to other supply and demand
diagrams except for the labels.
• L - quantity of workers
• w - wages (the price we pay workers)
• It is also different because the suppliers of
labor are households, not firms, and the
demanders of labor are firms, not
households
Minimum Wage Legislation
Wage
S
D
0
# of Workers
Minimum Wage Legislation
Wage
S
w*
D
0
L*
# of Workers
Minimum Wage Legislation
Amount of Unemployed
Workers
Wage
S
wfloor
w*
D
0
Ld
L*
Ls
# of Workers
Winners and Losers
Who gains and loses with price floors?
1. Benefit - those who get higher wages
2. Loses - those who can’t find jobs at the
higher wage
3. Loses - firms who must pay higher wages.
Commodity Agreements
• Market instability may arise due to:
– Fluctuating prices due to changing market conditions
– Changing prices due to changes in exchange rates
– Changes in foreign government protectionist measures
• Producers of commodities (eg. coffee, sugar,
grains, tin) may cooperate to stabilize the market
– eg. prices kept from falling below certain level
Production Quota System
• An agreement by producers to limit the amount
supplied to the market place & thus influence
price
• Individual cartel members produce portion of
output according to their quota
Production Quota System
Price
S2
S1
P2
P1
D
Q2
Q1
Buffer Stock System
• Group of producers (with support of gov’t)
set a target price or price band (price floor
& ceiling)
• If market conditions lead to
– Shortage (price above target price), buffer stock
authority will sell off previously acquired stocks
– Surplus (price falls below target price), buffer stock
authority will agree to purchase surplus at intervention
price
Buffer Stock System
Price
P4
P3
S1 S2
S3
S4 S5
Shortage
Target Band
P2
P1
Surplus
D
Q1 Q2 Q3
Q4 Q5
Buffer Stock System - Considerations
• Surplus can be disposed of in several ways:
– Stored for future use
• Opportunity cost of storage facilities can be prohibitive for
producers
– Destruction of commodity
• If food, normative issue arises in light of global poverty &
hunger
– Selling to other countries
• If dumped in another country (priced below foreigners’ own
prices in domestic market) can undermine domestic producers
in countries where goods sold
– Provision as overseas assistance
• Food aid could lead to dependency culture
Further Practice
Use the last question page to complete the following.
For each question indicate whether:
- price increased, decreased or it was
indeterminate (impossible to determine)
- quantity increased, decreased or it was
indeterminate (impossible to determine)
Practice Test