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PRICE DETERMINATION IN MARKETS

This text explains the concept of equilibrium price in markets, where supply and demand are equal. It discusses the effects of excess demand and excess supply on prices, as well as factors that can cause changes in equilibrium prices. Several examples are provided to illustrate these concepts.

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PRICE DETERMINATION IN MARKETS

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  1. PRICE DETERMINATION IN MARKETS • The market demand curve shows the amount demanded at every price. • The market supply curve shows the amount supplied at every price. • The question now is whether there is some price at which the quantities supplied and demanded are the same. Markets

  2. EQUILIBRIUM PRICE DEFINED • The equilibrium price of a good is: • a price at which quantity supplied equals quantity demanded. • a price at which excess demand equals zero. At the equilibrium price there is no net tendency for price to change. Markets

  3. Excess demand exists when, at the current price, the quantity demanded is greater than quantity supplied. • Excess supply exists when, at the current price, the quantity supplied is greater than the quantity demanded. Markets

  4. EXCESS SUPPLY Excess supply = Qs - QD price supply p = $3 demand QD QS quantity Market for tacos Markets

  5. EXCESS DEMAND Excess demand = QD - QS price supply p = $1 demand QS QD quantity Market for tacos Markets

  6. When there is EXCESS DEMAND for a good, price will tend to rise. • When there is EXCESS SUPPLY of a good, price will tend to fall. Markets

  7. When excess demand equals zero, price must be the equilibrium price, and we say the market is in equilibrium. If you want to find out the price at which a market is in equilibrium, then look for the price where the excess demand is zero. Markets

  8. Economists are interested in the explaining equilibrium prices. • In particular, they are anxious to explain why equilibrium prices change. Markets

  9. supply P • What is the equilibrium price in the market for tacos? Show it on the diagram. What is the equilibrium quantity of tacos? $4 $3 p = $2 demand $1 Q TACO MARKET Markets Go to hidden slide

  10. How can the price of tacos change? • Only if there is a change in supply, or if there is a change in demand. • But remember, we already know the list of reasons why supply and demand can change. Markets

  11. Changes in demand can be caused by: • Changes in supply can be caused by: Markets Go to hidden slide

  12. The following is a series of sample problems showing changes in the equilibrium prices of some goods. Markets

  13. Classes at Lansing Community College are an inferior good. People’s incomes fall, perhaps due to a recession. What is the effect on LCC tuition and enrollment? P supply p0 demand @ high income Q q0 LCC ENROLLMENT Markets Go to hidden slide

  14. THE MARKET FOR APARTMENTS IN EAST LANSING IS IN EQUILIBRIUM, AND MSU RAISES THE PRICE OF DORM ROOMS. WHAT IS THE EFFECT ON THE MARKET FOR APARTMENTS IN EAST LANSING? supply P p0 demand Q q0 E.L. APARTMENTS Markets Go to hidden slide

  15. Nachos and beer are complements. The price of beer rises. What is the effect on the market for nachos? supply P p0 demand @ old beer price Q q0 NACHO MARKET Markets Go to hidden slide

  16. People come to believe that eating apples is good for them. The more apples they eat, the more likely they are to stay well. What is the effect on the market for apples? supply P p0 demand Q q0 APPLE MARKET Markets Go to hidden slide

  17. Classes at universities are produced using faculty labor services, and other inputs like buildings and computers. The faculty salaries increase by 10%. What is the effect on tuition and enrollment at universities? p (tuition) supply at original wage p0 demand Q q0 Enrollment Markets Go to hidden slide

  18. MSU agricultural scientists develop a new strain of corn that increases yields by about 15%. What is the effect of the improvement in technology on the market for corn? supply P p0 demand q0 Q CORN MARKET Markets Go to hidden slide

  19. THE MARKET FOR MEDICAL CARE IS IN EQUILIBRIUM, AND CONSUMERS’ INCOMES INCREASE. WHAT IS THE EFFECT ON MARKET PRICE? P supply p0 D at lower income Q Q0 MEDICAL CARE MARKET Markets Go to hidden slide

  20. SUPPLY/DEMAND SUMMARY • Market price serves as the adjustment mechanism to move markets to equilibrium. • Price changes in response to the existence of excess demand or excess supply. • Changes in demand and changes in supply lead to changes in equilibrium prices and quantities. Markets

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