Market Equilibrium

INTRODUCTION TO ECONOMICS WITH LAND REFORM AND TAXATION DR. ABRAHAM C. CAMBA JR. Department of Economics, San Beda College, Mendiola, Manila and Polytechnic University of the Philippines, Sta. Mesa, Manila

DR. AILEEN L. CAMBA Graduate School and Department of Economics Polytechnic University of the Philippines, Sta. Mesa, Manila

Lecture 3

MARKET EQUILIBRIUM PRICE AND QUANTITY CONTENTS 1.1Equilibrium Price and Quantity 1.2Shortages and Surpluses 1.3The Effects of Changing Demand and/or Supply 1.4Algebraic Solutions HOMEWORK REFERENCES

1.1 Equilibrium Price and Quantity The market equilibrium is found at the point at which the market supply and market demand curves intersect. The price at the intersection of the market supply curve and

the market demand curve is called equilibrium price, and the quantity is called the equilibrium quantity. At the equilibrium price, the amount that buyers are willing and able to buy is exactly equal to the amount that sellers are willing and able to produce. For instance, at Ph3.00 per piece of ice candy, Annikah and Amartya are willing to buy 40 pieces of ice candy per month and sellers are willing to supply 40 pieces of ice candy per month. Neither may be “happy” about the price; the buyers would probably like a lower price and the sellers would probably like a higher price. But both buyers and sellers are able to carry out their purchase and sales plan at the Ph3.00 price. At any other price, either suppliers or demanders would be unable to trade as much as they would like. Exhibit 1. Market Equilibrium Price of cellular phone (per unit)

Supply

Pe

Equilibriu m Demand Qe

Quantity of cellular phone (units per month)

1.2 Shortages and Surpluses What happens when the market price is not equal to the equilibrium price? Suppose the market price is above the equilibrium price, it is clear that a surplus, or excess quantity supplied, would exist. That is, at this price, firms would be willing to sell more than demanders would be willing to buy. To get rid of the unwanted surplus, frustrated suppliers would cut their price and cut back on production. And as price falls, consumers would buy more, ultimately eliminating the unsold surplus and returning the market to the equilibrium level. What would happen if the market price of coffee were below the equilibrium price? A shortage or excess quantity demanded would exist. Because of shortage, frustrated buyers would be forced to compete for the existing supply, bidding up the price. The rising price would have two effects: (1) Producers would be willing to increase the quantity supplied, and

(2) The higher price would decrease the quantity demanded. Together, these two effects would ultimately eliminate the shortage, returning the market to equilibrium.

1.3 The Effects of Changing Demand and/or Supply

(1) Increase in demand and constant supply Increase in Pe and Qe (2) Decrease in demand and constant supply Decrease in Pe and Qe (3) Constant demand and increase in supply Decrease in Pe and increase in Qe (4) Constant demand and decrease in supply  Increase in Pe and decrease in Qe

(5) More cases…

1.4 Algebraic Solutions A Linear Model: Solution by Elimination of Variables One way of finding a solution to an equation system is by successive elimination of variables and equations through substitution. Let Qe = Qd = Qs Qd = a-bP (a, b >0) Qs = -c+dP (c, d >0) a-bP = -c+dP a+c = bP+dP a+c = (b+d)P Pe = (a+c)/(b+d) Qd

= a-b[(a+c)/(b+d)] = [a(b+d)-b(a+c)]/(b+d) = (ab+ad-ab-bc)/(b+d) = (ad-bc)/(b+d)

Thus, Qd = Qs = Qe = (ad-bc)/(b+d)

HOMEWORK Table 1 show the demand and supply schedules for milk. Price (US$ per

Qd Qs (cartons per

carton) 1.00 1.25 1.50 1.75 2.00

day) 200 175 150 125 100

100 130 150 170 190

a. What is the equilibrium price and equilibrium quantity of milk? b. Describe the situation in the milk market if the price were $1.75 a carton and explain how the market reaches its new equilibrium. c. A drought decreases the quantity supply by 45 cartons a day at each price. What is the new equilibrium and how does the market adjust to it? d. Milk becomes more popular and better feeds increase the quantity of milk. How do these events influence demand and supply? If there is no drought, do they create a shortage or a surplus at the equilibrium price in part a? Describe how the equilibrium price and equilibrium quantity change.

REFERENCES Case, Karl and Fair, Ray. (2002). Principles of Economics (6th ed.). USA: Prentice Hall. Mankiw, Gregory. (2002). Principles of Economics (2nd ed.). Forth Worth, Texas: SouthWestern/Thomson. McConnell, Campbell R. and Brue, Stanley L. (2002). Economics: Principles, Problems, and Policies (15th ed.). New York, NY: McGraw-Hill Companies, Inc. Samuelson, Paul and Nordhaus, William. (2005). Economics (18th ed.). USA: McGrawHill. Stiglitz, Joseph E. and Walsh, Carl E. (2002). Economics (3rd ed.). New York, NY: WW Norton and Company, Inc.

ABOUT THE AUTHORS Dr. Aileen L. Camba and Dr. Abraham C. Camba Jr. are a wife-and-husband duo. They are dedicated to the challenge of explaining Economics and Finance ever more clearly to an ever-growing body of students. They are passionate about their subjects and about the free expression of blogging. Please visit their weblogs:

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