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 1.1 Equi Equilib libri rium um Pric Price e and and Quan Quanti tity ty equilibrium is found at the point at which the market supply and market The market equilibrium 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 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, candy, Annikah Annikah and Amartya Amartya are willing 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

Demand Qe

Quantity of cellular phone (units per month)

1.2 1.2 Shor Shorta tage ges s and and Surp Surplu luse ses s 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 supp supplilier ers s woul would d cut cut thei theirr pric price e and and cut cut back back on prod produc ucti tion on.. And And as pric price e fall falls, s, 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 demanded would exist. Because Because of shortage, frustrated frustrated shortage or excess quantity demanded 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 would decrease the quantity demanded. demanded. Together, these two effects would ultimately eliminate the shortage, returning the market mar ket to equilibrium.

1.3 The Effe Effects cts of of Chang Changing ing Dema Demand nd and/ and/or or Suppl Supply y

and Qe Qe (1) Increase in demand and constant supply Increase in Pe and (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 More cases cases… …

1.4 1.4 Alge Algebr brai aic c Sol Solut utio ions ns 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 su pply 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 the equilibrium equilibrium price price and equilibrium equilibrium quantity quantity of of milk? milk? b. Descri Describe be the situat situation ion in the milk milk market market if the price price were $1.75 $1.75 a carton and and explain how the market reaches its new ne w equilibrium. c. A drought drought decreases decreases the the quantity quantity supply supply by 45 cartons cartons a day at each price. price. What What is the new equilibrium and how does the market adjust to it? d. Milk Milk becomes becomes more popular popular and better better feeds feeds increase increase the quantity quantity of milk. 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 (2 nd ed.). Forth Worth, Texas: SouthWestern/Thomson. McConnell, Campbell R. and Brue, Stanley L. (2002). Economics: Principles, Problems, and Policies (15th ed.). New York, York, NY: McGraw-Hill Companies, Inc. Samuelson, Samuelson, Paul and Nordhaus, William. (2005). Economics (18th ed.). USA: McGrawHill. Stiglitz, Stiglitz, Joseph E. and Walsh, Carl E. (2002). Economics Economics (3 rd ed.). New York, NY: WW Norton and Company Compan y, Inc.

ABOUT THE AUTHORS Dr. Dr. Aileen Aileen L. Camba Camba and Dr. Abraham C. Camba Camba Jr. Jr. are a wife-and-hu wife-and-husband sband duo. duo. They They are are dedica dedicate ted d to the challe challenge nge of expla explaini ining ng Econom Economics ics 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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