Equilibrium and Disequilibrium

Messere - Grade 11 Economics CIE 3M7

Outline I. Introduction A. Shortages B. Surpluses C. Equilibrium II. Changes in Equilibrium A. Change in Demand B. Change in Supply III. Disequilibrium -

Price Controls

A. Price Floors B. Price Ceilings

Shortage • Let’s say that Loony’s uptown decides to sell their CDs for $3 each.

• More than likely there will be a lot more people wanting to buy CDs than Loony’s has to sell.

• Why? Because at such a low price, the quantity demanded is quite high. But Loony’s does not want to sell that many at such a low price.

Shortage • This situation is called a shortage • Shortage - when Q d price.

> Q s at current market – Amount of Shortage = Q d - Q s • Note - it is

not

correct to say Demand exceeds Supply, but rather quantity demanded exceeds quantity supplied.

Shortage Result of Shortage: • If you are the manager of Loony’s and you find that you are selling out of CDs at $3, what do you want to do?

– Raise the price • Buyers can’t get all they want. Therefore, competition among buyers drive prices up.

• P will increase

P Shortage S CDs D CDs Q 0

P Shortage S CDs P sh 0 Q s Q d Amount of Shortage D CDs Q

P Results of Shortage S P sh 0 Q s Q d D Q

P Results of Shortage S E P* P sh 0 Q s Q* Q d D Q

Surplus • Let’s say that as the manager, you raised the prices of CDs to $20.

• At $20 you would love to sell a lot of CDs, but not a lot of people are willing to pay $20 for a CD.

• So the CDs keep piling up as they come in from your supplier, but they don’t seem to be going out the door in sales.

Surplus • This situation is called a surplus • Surplus - when Q s price.

> Q d at current market • Amount of surplus = Q s - Q d • Note -

not

correct to say Supply exceeds Demand, but rather that quantity supplied exceeds quantity demanded.

Results of Surplus Result of Surplus: • As manager you have to decide what do with all these CDs that are piling up and not selling. What do you do?

– Have a sale!

Results of Surplus • Firms have more than they can sell. Therefore, firms lower price to sell the product.

• As price decreases, Q d decreases increases and Q s • P will decrease

P Surplus S CDs D CDs Q 0

P P sur Surplus Amount of Surplus S CDs 0 Q d Q s D CDs Q

P Results of Surplus Amount of Surplus S CDs P sur 0 Q d Q s D CDs Q

P Results of Surplus Amount of Surplus S CDs P sur E P* 0 Q d Q* Q s D CDs Q

Equilibrium in the Market • Note that if the price is below P* then there will be a shortage causing price to rise • If the price is above P* then there will be a surplus causing price to fall • It’s as if P* is a magnet that keeps drawing price to it (and consequently quantity to Q*) • This magnet is sometimes called “

The Invisible Hand

”

Equilibrium in the Market • Equilibrium - where quantity demanded equals quantity supplied.

• Equilibrium Price (P*) - price where equilibrium occurs.

P Equilibrium E P* S D Q 0 Q*

Equilibrium in the Market What Occurs at Equilibrium • Demand Side - those who get the good are those

willing and able

to pay the P*.

• Supply Side - only those firms which are able to produce at or below the cost of P* will remain in business.

Changes in Equilibrium • Remember that Supply and Demand are drawn under the

ceteris paribus

assumption.

• Any factors, other than price, which cause Supply and/or Demand to change will affect equilibrium price and quantity.

Change in Demand • Demand will change for any of the factors examined previously: –

Tastes/Preferences

– – – –

Income (Normal/Inferior goods/Y-dist.) Price of Substitute/Complimentary goods Number of Consumers Expectations of price changes

Ceteris paribus, suppose the demand for CDs increased due to an increase in

income.

How would this affect the

market equilibrium price & quantity

of CDs?

Increase in Demand P S CDs D CDs Q 0

Increase in Demand P P*’ P* 0 S CDs E’ E Q* Q*’ D’ D CDs Q

Change in Supply • Supply will change for any of the factors examined previously: Technology - Cost of Resources - Taxes & Subsidies - Number of Producers - Changes in Nature Ceteris paribus, let’s say that the government lowers taxes on CDs. How would this affect the market equilibrium price & quantity of CDs?

P Increase in Supply S CDs D CDs Q 0

P Increase in Supply S CDs S’ P* P*’ 0 E E’ Q* Q*’ D CDs Q

The Role of Prices • Convey information – When the price of a Maple Leaf tickets, on average, increases by 10%, it indicates the popularity of the Maple Leafs • Rationiong device – The price is what determines who can have the good – Price acts as a means of allocating the good/resource to reflect its scarcity value

Market Disequilibrium • Is it possible for the price and quantity to NOT be in equilibrium?

• Yes - While the

invisible hand

may move price towards equilibrium, price controls tend to generate disequilibrium in the marketplace

Price Controls There are two types of price controls: 1)

Price Ceilings

2)

Price Floors

Price Ceilings • Price Ceiling - sets a maximum price that is allowed by law.

• Result of Price Ceiling: – Stay at a permanent shortage situation • Note that a price ceiling

can

be any price the government chooses. It is, however only effective if it is

below

the equilibrium price

Price Ceiling • Example of Price Ceiling • Rent controlled apartments • In New York City, San Francisco, Boston, and other cities the city or state determines the maximum amount that can be charged for rent on many apartments.

• A maximum price is a

price ceiling

Rent Controlled Apartments P S D Q 0

Rent Controlled Apartments P S P* D Q 0 Q*

Rent Controlled Apartments P S P* P ceiling 0 Q s Q* Amount of Shortage Q d D Q

Winners and Losers Who gains and loses with price ceilings?

1. Benefit - those who get rent controlled apartments 2. Loses - those who can’t find apartments due to the shortage.

3. Loses - landlords who must accept lower rent.

Price Floors • Price Floor - sets a minimum price that is allowed by law.

• Result of Price Floor • Stay at a permanent surplus situation • Note that a price floor can be set at any price, but is only effective if it is above the equilibrium price

Price Floors • Example of Price Floor • Minimum Wage Legislation • The minimum wage is a lowest price the government will allow firms to pay for labor.

• A minimum price is a

price floor

Price Floors • When we look at the labor market it is similar to other supply and demand diagrams except for the labels.

• L - quantity of workers • w - wages (the price we pay workers) • It is also different because the

suppliers of labor are households

, not firms, and the

demanders of labor are firms

, not households

Minimum Wage Legislation Wage S D # of Workers 0

Minimum Wage Legislation Wage S w* D # of Workers 0 L*

Minimum Wage Legislation Wage Amount of Unemployed Workers S w floor w* 0 L d L* L s D # of Workers

Winners and Losers Who gains and loses with price floors?

1. Benefit - those who get higher wages 2. Loses - those who can’t find jobs at the higher wage 3. Loses - firms who must pay higher wages.

Further Practice • Take a sheet of paper out and number it from 1 to 5.

• For each question indicate whether: -

price

increased, decreased or it was indeterminate (impossible to determine) -

quantity

increased, decreased or it was indeterminate (impossible to determine)

Practice Test Link