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The Free Market Price: EQUILIBRIUM Ch. 6, Sect. 1-3 What does it mean when the “price is right”? How does a free market determine equilibrium prices? How do changes to demand and supply affect the equilibrium price? How a market works • In a free market, demand and supply work together to create prices • This causes market equilibrium, where the quantity demanded of a g/s equals the quantity supplied of that g/s (Qd=Qs) – Satisfaction of both consumers & producers— “balance” of the market When the “Price is Right” • Have to find the right price at which this happens in a market (equilibrium price) – Also called “market-clearing price” because the market will be clear of shortages and surpluses • The quantity of g/s at equilibrium is called the equilibrium quantity – can be graphed using Qd/Qs schedule Graphing equilibrium What is the equilibrium price? What is the equilibrium quantity? Quick check • What is equilibrium? • Why do consumers and producers care about equilibrium? • What happens if the market isn’t in equilibrium (too much? too little?) The Market Price • Remember the “invisible hand”? When consumers and producers willingly interact in order to buy/sell g/s? • This interaction will also push the market price, or the price a willing consumer will pay to a willing producer for a g/s, towards equilibrium price – Economists therefore say that the law of demand and law of supply will always act together to reach equilibrium What Happens if the Price Isn’t Right? • If producers set a price above or below equilibrium, it is known as disequilibrium • The result can be a shortage: Qd > Qs at a certain price – this is also called excess demand—too many customers for too few goods – This means that the price is too low • The result can be a surplus: Qd < Qs at a certain price – This is called excess supply—too many producers for too few customers – This means the price is too high Graphing disequilibrium: Excess demand (shortage) What happens to demand when the price is set $1.00 below equilibrium? Graphing disequilibrium: Excess supply (surplus) What happens to supply when the price is set $1.00 above equilibrium? Quick check • What does it mean if there is disequilibrium? • What does excess supply mean for the price of a good? • What does excess demand mean for the price of a good? • How long do you think it would take for a market to reach equilibrium?