Price Determination and Market Equilibrium

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Price Determination and Market Equilibrium
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Market Equilibrium
Price per unit of hamburger
S
5
3
1
D
Quantity (millions) per day
10
4
Market equilibrium If sellers are free to sell
their goods at any price, trial and error will
ensure that the price and quantity combination
that occurs will be an equilibrium
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D S A more formal treatmentThe Demand side

• Qdf(P)
• An example of a demand function is
• If P 0 then Qd 100
• If P 50 then Qd 0
• P 50 is the choke price

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Figure 5.1 The Market for Beef
Price per ton
50
100
Quantity (1000s tons) per day
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The Demand Side

• Qd 100 - 2P
• The number (coefficient) -2 attached to the
  price variable, P, is the slope of the curve
• This number shows how much the quantity of beef
  demanded changes in response to a unit change in
  the price of beef

• For every increase in P by a pound, Qd goes down
  by 2 units ( 2000 tons of beef).

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The Supply Side

• Qsf(P)
• An example of a supply function is
• If Qs 0, then P 20
• P 20 thus represents the vertical intercept for
  the supply curve

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The Supply Side

• Qs -10 0.5P
• The number (coefficient) 0.5 attached to the
  price variable, P, is the slope of the curve
• This number shows how the quantity supplied
  changes in response to a unit change in price

• If the price of beef rises by one unit the supply
  of beef rises by 0.5 of a unit per day.

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Finding the Market Equilibrium

• Two equations demand supply
• Qd 100 - 2P Qs -10 0.5P
• Two unknowns price quantity
• Equilibrium condition Qd Qs
• Therefore ..

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Finding the Market Equilibrium
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• Equilibrium price, p per ton is 44
• So how do we get q?
• We have to substitute p44 either
• in the demand function
• Qd 100 - 2P ? Qd100 - 2 x 44? Qd 12
• or in the supply function
• Qs -10 0.5p? Qs-100.5 x 44?Qs12
• q 12 units, or 12,000 tons of beef per day

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The Market for Beef
Price per ton
S
50
44
40
30
20
D
10
100
12
Quantity (1000s tons) per day
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Some Comparative Static AnalysisThe effect of
an income increase
Price per unit of hamburger
S
5
A
3
1
D
Quantity (millions) per day
10
4
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Some Comparative Static AnalysisThe effect of a
health scare
Price per unit of hamburger
S
5
A
3
Quantity (millions) per day
1
D
10
4
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Some Comparative Static AnalysisThe effect of
an import ban
Price per unit of hamburger
S
5
3
A
D
1
10
4
Quantity (millions) per day
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Consumer Producer Surplus
Price per litre
S
p
A
D
E
q
litres (millions) per day
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Markets in Action

• Free markets allow prices to be determined by the
  forces of supply and demand
• Price controls are government rules setting price
  floors or ceilings that forbid the adjustment of
  prices to clear markets
• Price controls will generally generate loses in
  consumer surplus ? loses in welfare, and end up
  with black markets

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Markets in ActionEffect of a (Low) Price Ceiling

• An example think of the market for loans
• Banks lend money and charge an interest rate i,
  which will be considered the price of money

S
Interest rate
A
i
ic
excess of demand
D
q
Sterling (millions) per day
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Markets in ActionEffect of a (high) Price Floor

• An example think of the market for sugar in
  Uruguay
• The government sets a higher price floor than the
  equilibrium

Price per kilo
excess of supply
S
pf
p
D
qd q qs
kilos (millions) per day
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Next TimeDemand, Supply Elasticities