Econ 100 Lecture 3.3

1. Econ 100Lecture 3.3 Market Equilibrium 10-12-2010

2. Equilibrium (cont’d)

3. 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)

4. 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

5. 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”

6. 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?

7. Answers

8. The Cobweb Theorem Price (£) S 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. 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. Assume the initial equilibrium price is £7 and the quantity 9. If demand rises, the shortage pushes the price up to £11 per turkey. 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. In a ‘divergent cobweb’ -also termed an unstable cobweb - the price tends to move away from equilibrium. 11 7 5 D1 D 8 9 15 17 Quantity Bought and Sold (millions)

9. 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).

10. 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

11. Consumer Surplus Demand Curve is Also Marginal Value and Avg Revenue CS Amount Paid Total WTP = CS + Amt Paid

12. In Class Example TV(Q-1)+MV(Q) Tot Val- Tot Paid Avg P*Qd Also = Avg Rev TV(Q)-TV(Q-1) Also = MV(Q)

13. 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

14. 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