Econ 100 Lecture 3.3
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Transcript of Econ 100 Lecture 3.3
Econ 100Lecture 3.3
Market Equilibrium10-12-2010
Equilibrium (cont’d)
What does EQUILIBRIUM mean?
• At the market equilibrium price:– Quantity demanded by consumers = quantity
supplied by firms/producers/sellers– Without a change in any of the ceterius
paribus conditions, the price will remain unchanged
• Demand: Income, Price of Substitutes and Complements, Future Prices, Quality, Number of Consumers
• Supply: Input Prices, Technology, Number of Suppliers, Future Prices (Input, Good)
How Do We Get There?
• Consumers– Willing to buy another unit, if market price <=
to marginal (use) value of consuming it• Suppliers
– Willing to sell/produce another unit, if market price >= marginal (additional) costs of producing the last unit
• Equilibrium occurs only when– MVconsumer = Pmarket = MCproducer
And If That Doesn’t Happen?
• MV < P > MC– Sellers are willing to continue to supply more goods– Consumers are unwilling to buy– Excess supply will lead to sellers dropping their prices
down in the future to clear inventory• MV > P < MC
– Sellers not willing to supply as much as consumers will demand (excess demand)
– Excess demand will lead to consumers bidding prices up to get the “shortage”
Another Variation• At each price, determine
whether there would be a shortage (Qd > Qs) or a surplus (Qs > Qd)
• If there was a shortage, how would price adjust to clear the market?
• If there is a surplus, how would price adjust to clear the market?
# of Pizzas Demanded
Price Per Pizza
# of Pizzas Supplied
Shortage or Surplus
1000 $10 400
900 $12 450
800 $14 500
700 $16 550
600 $18 600
500 $20 650
Answers
# of Pizzas Demanded Price Per Pizza # of Pizzas Supplied Shortage (-) or Surplus (+)
1000 $10 400 -600
900 $12 450 -450
800 $14 500 -300
700 $16 550 -150
600 $18 600 0
500 $20 650 150
The Cobweb Theorem
D
S
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Price (£)
Quantity Bought and Sold (millions)
9
D1
In a ‘divergent cobweb’ -also termed an unstable cobweb - the price tends to move away from equilibrium.
Assume the initial equilibrium price is £7 and the quantity 9. If demand rises, the shortage pushes the price up to £11 per turkey.11
15
Farmers respond by planning to increase supply, ten months later, the supply of turkeys is 15 million. At this level, there will be a surplus of turkeys and the price drops.
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The price falls to £5 and farmers react by cutting plans for turkey production. Ten months later, supply on the market will be 8 million.
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This creates a massive shortage of 9 million turkeys and the price is forced up – and so the process continues!
A divergent cobweb leads to price instability over time.
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Cobweb Theorem• http://www.bized.co.uk/current/mind/2004_5/251004.ppt• Hungarian-born economist Nicholas Kaldor (1908-1986)• Simple dynamic model of cyclical demand with time lags
between the response of production and a change in price (most often seen in agricultural sectors).
• Cobweb theory is the process of adjustment in markets • Traces the path of prices and outputs in different
equilibrium situations. Path resembles a cobweb with the equilibrium point at the center of the cobweb.
• Sometimes referred to as the hog-cycle (after the phenomenon observed in American pig prices during the 1930s).
So What Do Buyers Get Out of This?
• Consumer surplus– Difference between what you are willing-to-
pay and what you have to pay • Willingness-to-pay
– Everything under the demand curve up to the last unit that you bought
• What you had to pay– Average price paid x number of units
purchased
Consumer Surplus
Demand Curve
$0$2$4$6$8
$10$12
1 2 3 4 5 6 7 8 9 10
Quantity Demanded
Ave
rage
Pric
e (p
rice
per u
nit)
Demand Curve is Also Marginal Valueand Avg Revenue
Amount Paid
CS
Total WTP =CS + Amt Paid
In Class Example
Avg Pric Qty Dem Tot Amt Paid Tot Value (WTP) Marg Val Cons Surp$10 1 $10 $10 $10 $0$9 2 $18 $19 $9 $1$8 3 $24 $27 $8 $3$7 4 $28 $34 $7 $6$6 5 $30 $40 $6 $10$5 6 $30 $45 $5 $15$4 7 $28 $49 $4 $21$3 8 $24 $52 $3 $28$2 9 $18 $54 $2 $36$1 10 $10 $55 $1 $45
Avg P*Qd TV(Q-1)+MV(Q)
Also = MV(Q) TV(Q)-TV(Q-1)
Tot Val- Tot Paid
Also = Avg Rev
What Do Sellers Get Out of This?
• Producer Surplus– The difference between what they get paid
(total revenues) and what it costs them • Total Revenues
– > = Average Price x Quantity Purchased• Total Costs
– > = Sum of Marginal Costs up to the amount supplied (QS)
• Or = the area under the supply curve up to Qs
What is the Value of the Market• Value of the market
– To Consumers = Consumer Surplus– To Producers = Producer Surplus
• Value equals the sum of both CS and PS