Market Equilibrium

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Lecture 9
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Market Equilibrium

• Price at which QdQs is the equilibrium price
• equilibrium means forces are in balance hence
  there is no tendency to change
• Price will adjust to equate quantity demanded in
  the market with quantity supplied
• if price is temporarily above or below
  equilibrium price, will move back toward
  equilibrium price

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Market Equilibrium

• This table and graph indicate the demand and
  supply conditions for bouquets of flowers.

• Equilibrium will occur where the quantity
  demanded equals the quantity supplied. If the
  price in the market exceeds the equilibrium
  level, market forces will guide it to equilibrium.

13
12
11
10
9

• A price of 12 in this market will result in . .
  .

8
resulting
in excess supply.

quantity supplied of 600 . . .
quantity demanded of 450 and
7

• With an excess supply present, there will be
  downward pressure on price to clear the market.

350
400
400
450
500
550
600
650
Excess Supply
Quantity Supplied 600
Downward
Quantity Demanded 450
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Market Equilibrium
13

• A price of 8 in this market will result in . .
  .

12
resulting
in excess demand.

quantity demanded of 650 . . .
quantity supplied of 500 and
11
10

• With an excess demand present, there will be
  upward pressure on price to clear the market.

9
8
7
350
400
400
450
500
550
600
650
Excess Supply
Quantity Supplied 500
Downward
Quantity Demanded 650
ExcessDemand
Upward
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Market Equilibrium
13

• A price of 10 in this market will result in . .
  .

12
resulting
in a balance.

quantity demanded of 550 . . .
quantity supplied of 550 and
11
10

• With a balance present, there will be an
  equilibrium and the market will clear.

9
8
7
350
400
400
450
500
550
600
650
Quantity Supplied 550
Excess Supply
Downward
Balance
Equilibrium
Quantity Demanded 550
ExcessDemand
Upward
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Market Equilibrium

• At every price above market equilibrium there
  is excess supply and there will be downward
  pressure on the price level.

13
12
11
10

• At every price below market equilibrium there
  is excess demand and there will be upward
  pressure on the price level.

9
8
7

• It is at equilibrium that prices will rest.

350
400
400
450
500
550
600
650
Excess Supply
Downward
Balance
Equilibrium
ExcessDemand
Upward
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Market Equilibrium

• Adjustment to market equilibrium
• when price is below the equilibrium
• price is less than the marginal value of the
  marginal consumer
• consumers are willing to pay more than the
  current money price to get an additional unit of
  the good
• unless price is fixed, price will rise as buyers
  compete for the good until QdQs at the
  equilibrium price

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Market Equilibrium

• Adjustment to market equilibrium
• when price is above the equilibrium
• price is greater than the marginal value of the
  marginal consumer
• unless price is restricted in some way, price
  will fall until equilibrium price is reached
  thereby eliminating any excess supply
• when price is above the equilibrium price some
  sellers will be unable to sell all that they want
  to and will cut price
• sellers whose opportunity cost is less than the
  current price will offer a lower price

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Example Rent Conrols

• In Berkeley, home of the University of
  California, price of rental housing is controlled
  below the market equilibrium level

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The Impact of a Rent Control
Price

• Consider the market for rental housing where
  the price (rent) of P0 would bring the
  quantity of rental units demanded into
  balance with the quantity supplied.

P2
P0

• When a price ceiling like P1 pushes the price
  of the product below the market equilibrium .
  . .

. . . the quantity supplied (Qs) . . .
P1
exceeds the quantity demanded (Qd),
resulting in a shortage.

• If rents are not allowed to adjust, renters
  will compete in non-price ways, driving up
  full price to P2.
• Shortage is eliminated

QS
QD
Quantity ofHousing Units
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The Impact of a Rent Control
Price

• Winners and losers
• existing tenants gain if cannot be booted out of
  their apartments
• landlords made worse off
• get lower net price
• people looking for apartments are actually worse
  off
• full price of P2 exceeds initial equilibrium
  price of P0

P2
P0
P1
QS
QD
Quantity ofHousing Units
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Example Rent Controls

• complications
• if less than perfect enforcement, will get some
  mix of price and non-price competition
• example key money
• eviction rules will effect gains to current
  tenants
• if tenants can be evicted without cause, will not
  reap any gains

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The Impact of a Rent Control

• Long-term Effects on Housing Stock
• landlords may let apartments deteriorate until P0
  becomes the equilibrium price
• some landlords may demolish buildings or convert
  them into condos rather than accept the control
  price of P0
• in Berkeley, between 1979 and 1984 number of
  private units occupied by students declined by
  31

Price
P2
P0
P1
QS
QD
Quantity ofHousing Units
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Changes in Demand, Supply and Market Equilibrium

• Increase in demand
• greater quantity demanded at every price or
  higher MV for any given quantity
• equilibrium price and quantity both increase

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Market Adjustment to an Increase in
Demand

• Consider the market for eggs.

Price( per doz)

• Prior to Easter season, the market for eggs
  produces an equilibrium where Supply equals
  Demand1 at a market price of .80 and
  output of Q1.

Supply
1.40
1.20

• When the Easter season arrives, the demand by
  consumers for eggs increases from Demand1 to
  Demand2. What happens to the equilibrium
  price and output level?

1.00

.80

• At .80 a dozen the quantity demanded
  exceeds the quantity supplied. There is
  upward pressure on price inducing the
  existing suppliers to increase their quantity
  supplied to Q2, pushing the equilibrium price
  up to 1.00.

.60
Q1
Q2
Quantity(million doz eggsper week)

• What happens to equilibrium price and output
  after the Easter season?

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Changes in Demand, Supply and Market Equilibrium

• Decrease in demand
• greater quantity demanded at every price or
  higher MV for any given quantity
• equilibrium price and quantity both decrease

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Changes in Demand, Supply and Market Equilibrium

• Decrease in supply
• reduction in quantity supplied at any given price
• equilibrium price rises, equilibrium quantity
  falls

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Market Adjustment to a Decrease in
Supply

• Consider the market for romaine lettuce.

• Prior to a season of adverse weather affecting
  the yield of the market, an equilibrium exists
  where Supply equals Demand1 with a market
  price of 1.80 and output of Q1.

Price( per head)
2.40
2.20

• When the season of adverse weather arrives
  the supply of romaine lettuce falls,
  decreasing the supply from supply1 to supply2.
  What happens to the equilibrium price and
  output level?

Supply1
2.00

1.80

• At 1.80 a head the quantity demanded exceeds
  the quantity supplied. There is upward
  pressure on price inducing the existing
  consumers to decrease their quantity demanded
  to Q2, drawing up the equilibrium price to
  2.00.

1.60
Q2
Q1
Quantity(million heads lettuceper week)

• What happens to equilibrium price and output
  when the weather returns to normal?

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Changes in Demand, Supply and Market Equilibrium

• Increase in supply
• lower cost of producing any given quantity or
  more supplied at any given price
• equilibrium price falls, equilibrium quantity
  rises

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Market Adjustment to an Increase in Supply
P

• Raw material prices fall and supply increases
• S shifts to S
• Surplus at P1 of Q2 Q1.
• Equilibrium at P3, Q3

Q
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Simultaneous Changes in Supply and Demand

• Supply and demand both increase
• equilibrium quantity rises, but effect on price
  is uncertain
• depends on magnitude of supply and demand shifts

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Simultaneous Changes in Supply and Demand
P

• Income increases and raw material prices fall
• The increase in D is greater than the increase in
  S
• Equilibrium price and quantity increase to P2, Q2

Q
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Simultaneous Changes in Supply and Demand

• Look at supply and demand changes separately
• DmeQm, Pm
• SmeQm, Po
• since both supply and demand changes push up Q,
  quantity definitely rises
• because supply and demand changes push P in
  opposite directions, net effect is ambiguous
• need to know magnitudes of supply and demand
  shifts2

P
Q
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Simultaneous Changes in Supply and Demand

• can figure out effects of other supply and demand
  change combinations in a similar fashion

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EndLecture 9