Download market equilibrium - McGraw Hill Higher Education

Chapter 3
Market Equilibrium
and Shifts
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
• Define excess supply and excess demand.
• Explain market equilibrium, and identify the
equilibrium point on a supply-demand diagram.
• Describe the impact of supply and demand
shifts.
• Discuss some causes of market shifts.
• Illustrate how changes in income affect the
demand curve.
• Review the basics of elasticity.
3-2
Matching Supply and Demand
• Buyers and sellers are the two sides of
markets.
– 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
Eliminating 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 Diagram
• 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 the same price, vehicle
manufacturers are willing to
produce 16.5 million
vehicles.
• The market is in equilibrium
since quantity demanded
equals quantity supplied.
3-10
Supply and Demand Schedule
for Go-Karts
Price
(Dollars)
$600
Quantity
Demanded
Quantity
Supplied
6,000
3,000
$800
5,500
3,500
$1,000
5,000
4,000
$1,200
4,500
4,500
$1,400
4,000
5,000
$1,600
3,500
5,500
$1,800
3,000
6,000
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
Quantity of go-karts demanded and supplied
• At a price of $1,200, the
market is in equilibrium.
• If price is $1,600, quantity
demanded is 3,500, while
quantity supplied is 5,500.
This is a situation of
excess supply.
• If price is $800, quantity
demanded is 5,500, while
quantity supplied is 3,500.
This is a situation of
excess demand.
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 a
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
Demand Shifts in the
Cement Market
• 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.
3-16
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.
3-17
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.
3-18
Summary of the Effects of Supply
and Demand Shifts
Shift and
Direction
How We
Say It
Effect on
Equilibrium
Price
Effect on
Equilibrium
Quantity
Demand
curve shifts
left.
“Demand
decreases.”
_
_
Demand
curve shifts
right.
“Demand
increases.”
+
+
Supply curve
shifts left.
“Supply
decreases.”
+
_
Supply curve
shifts right.
“Supply
increases.”
_
+
3-19
Causes of Market Shifts
• Technological changes have a major
impact on supply and demand.
– Mass production has an impact on
supply.
– The Internet has an impact on demand
for music CDs.
• By bringing in new buyers and sellers,
globalization causes shifts in supply
and demand.
– Example: 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 automobiles, homes, etc.
3-21
Impact of Rising Interest Rates
on the Car Market
Demand curve
for cars with
higher interest
rates
Original demand
curve for cars
A
P
Supply curve
for cars
B
P1
Price
per car
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
hands-free 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
Demand
curve for
high income
household
Price
Demand
curve for
low income
household
P
Q
Q1
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
Relationship 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