Download Ch. 2.3 Equilibrium

Chapter 2
Equilibrium
P45-50
PRICE AND OUTPUT DETERMINATION
• We call the price that obtains in the
market, the market price,
• or the Equilibrium price,
• and the quantity demanded and
supplied equilibrium output.
• We find this by plotting the demand
and the Supply curves.
Equilibrium price and output:
The Market Demand and Supply of Potatoes (Monthly)
Price of Potatoes
Total Market Demand
Total Market Supply
(pence per kilo)
(Tonnes: 000s)
(Tonnes: 000s)
4
700 (A)
100 (a)
8
500 (B)
200 (b)
12
350 (C)
350 (c)
16
200 (D)
530 (d)
20
100 (E)
700 (e)
The determination of market equilibrium
(potatoes: monthly)
E
e
20
Price (pence per kg)
Supply
d
D
16
Cc
12
b
8
B
a
A
4
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium
(potatoes: monthly)
E
20
Price (pence per kg)
e
Where the two lines cross is
called the equilibrium point
d
D
16
Supply
Pe=12
Cc
12
b
8
B
a
A
4
Qe=350
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Pe = 12, Qe = 350
• So why do we call this an EQUILIBRIUM?
• To see this let’s consider a point where we
are not in equilibrium.
• For example, consider the price, P=8.
• What are the quantities demanded and
supplied at this price?
The determination of market equilibrium
(potatoes: monthly)
E
e
20
Price (pence per kg)
Supply
d
D
16
Cc
12
b
8
SHORTAGE
B
(300 000)
a
A
4
QD
QS
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium
(potatoes: monthly)
E
SHORTAGE,
So Price must rise
20
Price (pence per kg)
e
d
D
16
Supply
Cc
12
b
8
B
(300 000)
a
A
4
QS
QD
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Pe = 12, Qe = 350
• Similarly, suppose that price was initially
above equilibrium
• For example, consider the price, P=16.
• What are the quantities demanded and
supplied at this price?
The determination of market equilibrium
(potatoes: monthly)
E
e
20
Price (pence per kg)
Supply
D
16
SURPLUS
d
(330 000)
Cc
12
b
8
B
a
A
4
QD
QS
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium
(potatoes: monthly)
E
Price (pence per kg)
20
e
SURPLUS
So price must fall
d
D
16
Supply
(330 000)
Cc
12
b
8
B
a
A
4
QD
QS
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
• So if the price is above equilibrium
(Surplus) the tendency is for it to move
down
• And if the price is below equilibrium
(Shortage) the tendency is for it to move up
The determination of market equilibrium
(potatoes: monthly)
So forces pushing
system towards
E
Price (pence per kg)
20
D
16
Pe and Qe
e
Supply
d
Cc
Pe12
b
8
B
a
A
4
Demand
0
0
100
200
300
Qe
400
500
Quantity (tonnes: 000s)
600
700
800
The determination of market equilibrium
(potatoes: monthly)
E
e
20
Price (pence per kg)
Supply
d
D
16
Cc
Pe12
b
8
B
a
A
4
Demand
0
0
100
200
300
Qe
400
500
Quantity (tonnes: 000s)
600
700
800
• Notice in the these diagrams we have
determined the equilibrium price Pe, and
equilibrium quantity, Qe.
• This is why we call these the Endogenous
variables. They are determined within the
system (diagram).
PRICE AND OUTPUT DETERMINATION
• The next issue we are interest in, is the
effect of SHIFTS on either the demand or
supply curves. Shifts are caused by
changes in the exogenous variables
• First: Effects of shifts in the demand curve
Effect of a shift in the demand curve
P
S
g
Pe1
D1
O
Q e1
Q
Effect of a shift in the demand curve
P
S
g
Pe1
D2
D1
O
Q e1
Q
Effect of a shift in the demand curve
P
S
g
Pe1
At P0 quantity
demanded
exceeds
quantity
supplied
h
D2
D1
O
Q e1
Q
Effect of a shift in the demand curve
P
S
So Price
must rise
g
Pe1
At P0 quantity
demanded
exceeds
quantity
supplied
h
D2
D1
O
Q e1
Q
Effect of a shift in the demand curve
P
S
i
Pe2
g
h
Pe1
D2
D1
O
Q e1
Q e2
Q
PRICE AND OUTPUT DETERMINATION
• Notice the demand curve SHIFTED
• But the Price MOVED ALONG the Supply
curve.
Effect of a shift in the demand curve
P
S
i
Pe2
g
h
Pe1
D2
D1
O
Q e1
Q e2
Q
Effect of a shift in the demand curve
P
S
i
Pe2
g
h
Pe1
D2
D1
O
Q e1
Q e2
Q
What about a shift in the Supply Curve?
• Suppose the Price of Oil and Petrol were to
rise.
• This would make production more costly
and supply would shift in.
Effect of a shift in the supply curve
P
S1
g
Pe1
D
O
Q e1
Q
Effect of a shift in the supply curve
P
S2
S1
g
Pe1
D
O
Q e1
Q
Effect of a shift in the supply curve
P
S2
S1
g
Pe1
But now at P0
Quantity
Demanded
exceeds Quantity
Supplied
D
O
Q e1
Q
Effect of a shift in the supply curve
P
So Price
must rise
g
Pe1
S2
S1
But now at P0
Quantity
Demanded
exceeds Quantity
Supplied
D
O
Q e1
Q
Effect of a shift in the supply curve
P
S2
S1
j
g
Pe1
D
O
Q e1
Q
Effect of a shift in the supply curve
P
S2
S1
k
Pe3
j
At the new
equilibrium
price has
risen and
output has
fallen
g
Pe1
D
O
Q e3
Q e1
Q
PRICE AND OUTPUT DETERMINATION
• Making sense of Economics Data
• Identifying the position of demand and
supply curves
P
30p
20p
O
Suppose I observe
two sets of prices and quantities
How do I make
sense of these
two
observations?
b
a
800 1000
Q
P
Suppose I observe
two sets of prices and quantities
D0
30p
20p
How do I make
sense of these
two
observations?
b
a
They may be on
the same
demand curve
O
800 1000
Q
P
and thus the two observations were
generated by a shift in the supply curve
D0
S2
30p
20p
O
S1
b
a
800 1000
Q
Alternative Explanation
• However, we are only assuming the two
points were on the original demand curve.
We don’t know this.
• Consider the following possibility.
Assume Point A was the original
P
S1
30p
20p
b
a
D1
O
800 1000
Q
It is possible that both the demand and the supply
P
curve have shifted as in this example.
S2
30p
20p
S1
b
a
D2
D1
O
800 1000
Q
• So in the second case point b lies on a
different demand and supply curve
• Looking at raw data and trying to figure out
what is going on is a difficult problem.
• The problem above is known as the
identification problem
Econometrics
• So interpreting data has many pitfalls
• In the following years you will study
various statistical procedures which will
help you to analyse what is really
happening in the data we observe.
• The main course we do this is in
Econometrics next year
• IT and Applied Economics & Quantitative
Methods this year will help prepare you.