MARKETS, EQUILIBRIUM, AND PRICES

How do we know when the price is “right”?

Warm UpThink of a product you recently

purchased, and write down the name of the product and the price you paid for it.

Then answer these questions:1. What are some of the reasons you were

willing to buy the product at this price?2. What are some of the reasons the seller

was willing to sell the product at this price?

3. Do you think you paid the “right” price for this product? Why or why not?

Market EquilibriumPrice

Hope to sell

Demand

Sold

$6.50

350 melons

0 50 melons

$5.00

200 melons

200 melons

200 melons

$4.00

100 melons

300 melons

100 melons

What happens when demand meets supply?• Market equilibrium

In a market where consumers and producers are completely free to buy and sell goods and services, demand and supply work together to determine prices.

The interaction of demand and supply drives prices to market equilibrium– the quantity demanded equals the quantity supplied.

When supply matches demand, consumers and producers both come away satisfied.

Market Equilibrium

Prices move to bring markets into balanceCommunication between

consumers and producers◦Price set too high by a producer

Consumer can try to bargain Consumer will look over goods and walk

away◦Price set too low by a producer

Early-bird consumers will buy up as much as possible

◦These interactions will eventually establish the equilibrium price for the product.

Prices move to bring markets into balanceMarket price

◦The price a willing consumer pays to a willing producer for the sale of a good or service.

Markets are governed by the law of supply and demand◦Markets move to equilibrium predictably◦In a competitive free market, the law of

supply and demand will together push the price of a good or service to a level where the quantity demanded and the quantity supplied are equal.

What happens when the price isn’t “right”?Equilibrium price

◦The “right” price because it is the price that producers and consumers can agree on.

Disequilibrium◦Occurs when the quantity demanded

is no longer equal to the quantity supplied

◦Results in either a shortage or a surplus.

When the price is too low, shortages resultExcess demand

◦The quantity demanded at a specific price exceeds the quantity supplied

◦Examples Waiting in line for a video game release Sold out movie

Consumers experience excess demand as a shortage

To economists, excess demand is a sign that the price for a good or service is set too low.

When the price is too high, surpluses resultExcess supply

◦The quantity supplied at a specific price exceeds the quantity demanded.

Producers experience excess supply as a surplus◦A surplus occurs when there are too

few customers willing to pay what producers are asking for their goods.

Graphing excess demand and supply

The time it takes to reach equilibrium variesIn a free market, surpluses and

shortages are usually temporary.◦A producer can vary the prices they

charge for goods and services until the price is “right” Would have to change menus, ads, or

signs to adjust it.◦Whether prices change quickly or

slowly, once they move toward equilibrium, shortages and surpluses start to disappear.

How do shifts in demand or supply affect markets?Anything that brings about a shift in

the demand curve is a demand shifter.◦Loss of income◦Population spike◦Popular new fad

Anything that brings about a shift in the supply curve is a supply shifter.◦Changes in the number of producers◦Changes in the cost of inputs

Three questions to ask about demand and supply shiftsWhen an even causes the demand or

supply curve to shift, the point of equilibrium changes. To analyze this, economists ask three questions:◦Does the event affect demand, supply, or

both?◦Does the event shift the demand or

supply curve to the right or left?◦What are the new equilibrium price and

quantity, and how have they changed as a result of the event?

Analyzing the effect of a change in demand on equilibrium price. One of the most powerful factors

that can influence market demand is changing consumer tastes.◦Imagine that blueberries have been

labeled the new “brain food,” by experts. What will this do to the demand for blueberry smoothies?

Let’s ask ourselves the 3 questions…Does this event affect demand,

supply, or both?◦The research affects the demand

because people think they will be smarter after consuming blueberries.

Does the event shift the demand or supply curve to the right or the left?◦The event shifts the demand curve to

the right.

What are the new equilibrium price and quantity?

Analyzing the effect of a change in supply on equilibrium pricesExtreme weather conditions can

often affect the supply market supply.◦Imagine that there is a drought in

blueberry producing states. What will this do to the supply of blueberries?

Let’s again ask ourselves the 3 questions…Does this event affect demand, supply,

or both?◦Costs increase for suppliers, so the

production of blueberry smoothies decreases, but the demand for smoothies does not change.

Does the event shift the demand or supply curve to the right or left?◦Since the supply of blueberries is negatively

affecting the supply of smoothies, the supply curve shifts to the right.

What are the new equilibrium price and quantity?

Analyzing the effect of changes in both demand and supplyTwo events happening

simultaneously can have an effect on both demand and supply.◦Imagine that the book labeling the

blueberry “a miracle fruit” becomes a bestseller AND that a major supermarket chain decides to open juice bars in most of its local stores

Let’s ask ourselves the 3 questions…Do the events effect supply, demand, or

both?◦Both. The book motivates people to buy more

blueberry smoothies, increasing the quantity demanded at all prices. The juice bars will cause an increase in the number of producers, increasing the quantity of smoothies supplied at all prices.

Do the events shift the demand or supply curve to the right or to the left?◦Because both of the events are increasing

demand and supply, both of the curves will shift to the right.

What are the new equilibrium price and quantity, and how have they changed as a result of the events?