Download Lecture # 3 Engineering Economics

Engineering
Economics
Module No. 03
Equilibrium & Disequilibrium
By
Muhammad Shahid Iqbal
Equilibrium in Market
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Supply and demand is an economic model of
price determination in a market.
It concludes that in a competitive market, the unit
price for a particular good will vary until it settles
at a point where the quantity demanded by
consumers (at current price) will equal the
quantity supplied by producers (at current price),
resulting in an economic equlibrium of price and
quantity.
Equilibrium in Market
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The four basic laws of supply and demand are:
If demand increases and supply remains unchanged, then it
leads to higher equilibrium price and quantity.
If demand decreases and supply remains unchanged, then
it leads to lower equilibrium price and quantity.
If supply increases and demand remains unchanged, then it
leads to lower equilibrium price and higher quantity.
If supply decreases and demand remains unchanged, then
it leads to higher price and lower quantity.
Shortage
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Let’s say that Loony’s uptown decides to sell their CDs
for $3 each.
More than likely there will be a lot more people wanting
to buy CDs than Loony’s has to sell.
Why? Because at such a low price, the quantity
demanded is quite high. But Loony’s does not want to
sell that many at such a low price.
This situation is called a shortage
Shortage - when Qd > Qs at current market price.
 Amount of Shortage = Qd - Qs
 Note - it is not correct to say Demand exceeds
Supply, but rather quantity demanded exceeds
quantity supplied.
Results of Shortage
Result of Shortage:
 If you are the manager of
Loony’s and you find that
you are selling out of CDs
at $3, what do you want to
do?
 Raise the price
 Buyers can’t get all they
want. Therefore,
competition among
buyers drive prices up.
 P will increase
P
S
E
P*
Psh
0
D
Qs
Q*
Qd
Q
Surplus
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Let’s say that as the manager, you raised the prices of CDs
to $20.
At $20 you would love to sell a lot of CDs, but not a lot of
people are willing to pay $20 for a CD.
So the CDs keep piling up as they come in from your
supplier, but they don’t seem to be going out the door in
sales.
This situation is called a surplus
Surplus - when Qs > Qd at current market price.
• Amount of surplus = Qs - Qd
Note - not correct to say Supply exceeds Demand, but
rather that quantity supplied exceeds quantity
demanded.
Results of Surplus
Result of Surplus:
P
 As manager you have to
decide what do with all
these CDs that are piling up
and not selling. What do
Psur
you do?
 Have a sale!
 Firms have more than they
P*
can sell. Therefore, firms
lower price to sell the
product.
 As price decreases, Qd
increases and Qs decreases
0
 P will decrease
Amount of Surplus
S
E
D
Qd
Q*
Qs
Q
Equilibrium in the Market
Note that if the price is below P* then
there will be a shortage causing
price to rise
If the price is above P* then there will
be a surplus causing price to fall
It’s as if P* is a magnet that keeps
drawing price to it (and
consequently quantity to Q*)
This magnet is sometimes called “The
Invisible Hand”
Equilibrium - where quantity
demanded equals quantity
supplied represented by the
intersection of the demand and
supply curves.
Equilibrium Price (P*) - price where
equilibrium occurs.
Increase in Demand
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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.
Demand will change for any of the factors discussed
previously.
An outward (rightward) shift in demand increases both
equilibrium price and quantity
When consumers increase the quantity demanded at a given
price, it is referred to as an increase in demand.
Increased demand can be represented on the graph as the
curve being shifted to the right. At each price point, a
greater quantity is demanded, as from the initial curve D1
to the new curve D2.
Increase in Demand
In the diagram, this raises the
equilibrium price from P1 to the
higher P2. This raises the
equilibrium quantity from Q1 to
the higher Q2.
there has been an increase in
demand which has caused an
increase in (equilibrium)
quantity.
The increase in demand could also
come from changing tastes and
fashions, incomes, price changes
in complementary and substitute
goods, market expectations, and
number of buyers.
This would cause the entire demand
curve to shift changing the
equilibrium price and quantity.
P
S
P2
P1
E’
E
D2
D1
0
Q1 Q 2
Q
Decrease in Demand
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If the demand decreases,
there is a shift of the curve
to the left.
If the demand starts at D1,
and decreases to D2
The equilibrium price will
decrease, and the
equilibrium quantity will
also decrease.
The quantity supplied at
each price is the same as
before the demand shift,
reflecting the fact that the
supply curve has not
shifted;
but the equilibrium quantity
and price are different as a
result of the change (shift)
in demand.
P
S
E
P1
E’
P2
D1
D2
0
Q2
Q1
Q
Changes in Supply
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An outward (rightward) shift in supply reduces the equilibrium price
but increases the equilibrium quantity
When the suppliers' unit input costs change, or when technological
progress occurs, the supply curve shifts.
Assume that someone invents a better way of growing wheat so that
the cost of growing a given quantity of wheat decreases.
So, producers will be willing to supply more wheat at every price
and this shifts the supply curve S1 outward, to S2.
This increase in supply causes the equilibrium price to decrease from
P1 to P2.
The equilibrium quantity increases from Q1 to Q2 as consumers
move along the demand curve to the new lower price.
As a result of a supply curve shift, the price and the quantity move in
opposite directions.
Increase in Supply
P
S1
S2
E
P1
P2
E’
D
0
Q1
Q2
Q
Decrease in Supply
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If the quantity supplied
P
decreases,
If the supply curve starts at S2,
and shifts leftward to S1,
The equilibrium price will
increase and the equilibrium P2
quantity will decrease as
P1
consumers move along the
demand curve to the new
higher price and associated
lower quantity demanded.
Due to the change (shift) in
supply, the equilibrium
quantity and price have
0
changed.
S2
S1
E’
E
D
Q2 Q1
Q
Changes in Supply
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Supply will
change for any
of the factors
discussed
previously.
For instance,
let’s say that
the government
lowers taxes on
CDs
S
P
P*
P*’
S’
E
E’
D
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.
General Results:
 When supply and demand move in the same direction
• Equilibrium price is ambiguous
 When supply and demand move in opposite directions
• Equilibrium quantity is ambiguous
Increase in Supply and Demand
P
S
P*’
P*
E
S’
E’
D’
D
0
Q*
Q*’
Q
Increase in Supply and Demand
P
S
S’
E
E’
P*’= P*
D’
D
0
Q*
Q*’
Q