Download market equilibrium

Chapter 3
Market Equilibrium and
Shifts
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
• Market equilibrium
• Market disequilibrium
• Market shifts
• Causes of market shifts
3-2
Matching Supply and Demand
• Buyers and sellers are two sides of
market.
– Buyers determine demand.
– Sellers determine supply.
• The buying and selling decisions are made
independently.
• Thus, there is no reason why the amount
buyers want to purchase is equal to the
amount sellers want to produce.
3-3
Matching Supply and Demand
• Since the purchase and production
decisions are independent, quantity
demanded need not equal quantity
supplied.
• There are 3 possible cases:
– The case of excess demand
– The case of excess supply
– The case of market equilibrium
3-4
The Case of Excess Demand
• Excess demand occurs when, at a given
price, buyers want to purchase more of a
good or service than sellers are prepared to
supply.
• Excess demand means that at a given
price, quantity demanded exceeds quantity
supplied.
• In this case, the market is in disequilibrium
and prices are under upward pressure.
3-5
The Case of Excess Supply
• Excess supply occurs when, at a given
price, sellers want to produce more of a
good or service than buyers are willing to
purchase.
• Excess supply means that at a given price,
quantity supplied exceeds quantity
demanded.
• In this case, the market is in disequilibrium
and prices are under downward pressure.
3-6
How to Eliminate Excess Demand or
Excess Supply?
• The gap between quantity demanded and
quantity supplied is closed by the market
mechanism through changes in prices.
• Adam Smith, in The Wealth of Nations, used
the term Invisible Hand to describe the
market mechanism.
• Individual actions by buyers and sellers result
in a positive outcome without any
government intervention.
3-7
The Case of Market Equilibrium
• A market equilibrium occurs when quantity
supplied and quantity demanded are equal.
• The equilibrium price is the price that causes
quantity supplied to equal quantity demanded.
• At equilibrium, the market is in balance, and the
amount that buyers want to purchase is equal to
the amount sellers want to produce.
• Few markets are exactly in equilibrium.
• Markets are always moving toward equilibrium.
3-8
Supply-Demand Graph
• The market equilibrium can be shown
visually by drawing the demand and
supply curves on the same graph.
• The equilibrium price is where the two
curves intersect.
• At this price, quantity demanded equals
quantity supplied.
• At any other price, quantity demanded and
quantity supplied are not equal.
3-9
Supply and Demand for New
Motor Vehicles
• Graph illustrates market
equilibrium in new motor
vehicle market.
• At a price of $28,500
buyers are willing to
purchase 16.5 million
vehicles.
• At same price, vehicle
manufacturers are willing to
produce 16.5 million
vehicles.
• Market is in equilibrium
since quantity demanded
equals quantity supplied.
3-10
Supply and Demand Schedule
for Go-karts
Price (dollars)
Quantity demanded
Quantity supplied
600
6000
3000
800
5500
3500
1,000
5000
4000
1,200
4500
4500
1,400
4000
5000
1,600
3500
5500
1,800
3000
6000
3-11
Equilibrium in Go-kart Market
2000
1800
Supply
curve
Price of go-karts (dollars)
1600
1400
1200
A
1000
800
Demand
curve
600
400
200
0
3000
3500
4000
4500
5000
5500
6000
• At a price of $1,200 the
market is in equilibrium.
• If price is $1,600, quantity
demanded is 3500, while
quantity supplied is 5500.
This is a situation of excess
supply.
• If price is $800, quantity
demanded is 5500, while
quantity supplied is 3500.
This is a situation of excess
demand.
Quantity of go-karts demanded and supplied
3-12
Market Shifts
• The supply or demand
curve shifts due to
changes in factors other
than price.
• A demand shift changes
the amount buyers
purchase at given price.
• A supply shift changes
the amount sellers
provide at a given price.
3-13
Market Shifts and Equilibrium
• A market shift leads to
a new equilibrium.
• Looking at the graph,
the original equilibrium
was at point A.
• The introduction of the
internet reduced
demand for music CDs,
causing the demand
curve to shift to the left.
3-14
Market Shifts and Equilibrium
• The reduction in demand
(shift of the demand curve)
causes the equilibrium to
shift to point B.
• At point B, the price is lower,
and quantity demanded and
quantity supplied is lower.
• Note: At point B, as at point
A, quantity demanded equals
quantity supplied.
3-15
Shifts versus Movements
• It is critical to distinguish between a shift
in the demand curve and a movement
along the curve.
• When the demand curve shifts (right or
left), the quantity demanded will increase
or decrease while the price remains the
same.
• A movement along the curve means that
the demand curve remains constant, but
the price changes.
3-16
Demand For Cement
• A construction boom
in China increased
the world demand for
cement.
• As a result, there was
a shift to the right in
the demand curve for
cement, with the
market equilibrium
going from point A to
point B.
3-17
Supply Shift: Market for Gasoline
• The graph to the left
shows the impact of
Hurricane Katrina on
the gasoline market.
• Before the hurricane,
equilibrium was at
point A.
• The hurricane caused
the supply curve to
shift to the left,
resulting in higher
prices.
3-18
Summary of the Effects of Demand
and Supply Shifts
Shift and
direction
How we
say it
Effect on
Effect on
equilibrium equilibrium
price
quantity
Demand
schedule shifts
left
Demand
decreases
_
_
Demand
schedule shifts
right
Demand
increases
+
+
Supply schedule
shifts left
Supply
decreases
+
_
Supply schedule
shifts right
Supply
increases
_
+
3-19
Causes of Market Shifts
• Technological changes have major impact
on supply and demand.
– Mass production impact on supply.
– Internet impact on demand for music CDs.
• By bringing in new buyers and sellers,
globalization causes shifts in supply and
demand.
– Impact of China’s 1.3 billion consumers on
world demand.
3-20
Causes of Market Shifts
• The financial markets play a large role by
impacting the cost of borrowing money.
– The interest rate is the cost of borrowing.
• Lower interest rates make it less costly to
borrow, causing the demand to increase
(shift to right) for products such as autos,
homes, etc.
3-21
Impact of Rising Interest Rates on
the Car Market
Price per
car
Demand curve
for cars with
higher interest
rates
Original demand
curve for cars
Supply curve
for cars
A
P
B
P1
Q1
Q
Quantity of cars bought/sold
3-22
Causes of Market Shifts
• Government action through spending and
new regulation can impact supply and
demand.
– Demand for headphones is affected by handsfree legislation.
• Change in raw material prices is a major
source of shifts in supply.
• Shifts in demand are often caused by
changes in consumer tastes.
3-23
The Effect of Income on Demand
Price
Demand
curve for
low income
household
Demand
curve for
high income
household
P
Q1
Q
Quantity demanded
• Income is a major
factor determining
demand.
• In general, higher
income leads to a
shift to the right in the
demand curve.
• But this is not true for
all goods and
services.
3-24
Relation Between Income and
Consumption
•
Classify goods and services into three
categories:
– A normal good is one where demand rises
more or less in step with income.
– A luxury good is one whose demand rises
sharply as income rises.
– Inferior goods are ones whose demand
actually falls as income rises.
3-25
Elasticity
• Measures to what extent quantity demanded or
quantity supplied changes as prices change.
• Demand is elastic if a small increase or
decrease in price has a big impact on quantity
demanded.
• Demand is inelastic if the quantity demanded
doesn’t change very much, even if the price
changes a lot.
3-26