Ch16 Equilibrium

Chapter Sixteen
Equilibrium
Market Equilibrium
A market is in equilibrium when total

quantity demanded by buyers equals
total quantity supplied by sellers.
Market Equilibrium
Market
p
demand
q=D(p)
D(p)
Market Equilibrium
p Market
supply
q=S(p)
S(p)
Market Equilibrium
Market Market
p
demand supply
q=S(p)
q=D(p)
D(p), S(p)
Market Equilibrium
Market Market
p
demand supply
q=S(p)
p*
q=D(p)
q* D(p), S(p)
Market Equilibrium
Market Market
p
demand supply
q=S(p)
D(p*) = S(p*); the market
is in equilibrium.
p*
q=D(p)
q* D(p), S(p)
Market Equilibrium
Market Market
p
demand supply
q=S(p)
D(p’) < S(p’); an excess
p’ of quantity supplied over
p* quantity demanded.
q=D(p)
D(p’) S(p’) D(p), S(p)

Market Equilibrium
Market Market
p
demand supply
q=S(p)
D(p’) < S(p’); an excess
p’ of quantity supplied over
p* quantity demanded.
q=D(p)
D(p’) S(p’) D(p), S(p)

Market price must fall towards p*.
Market Equilibrium
Market Market
p
demand supply
q=S(p)
D(p”) > S(p”); an excess
of quantity demanded
p* over quantity supplied.
p” q=D(p)
S(p”) D(p”) D(p), S(p)

Market Equilibrium
Market Market
p
demand supply
q=S(p)
D(p”) > S(p”); an excess
of quantity demanded
p* over quantity supplied.
p” q=D(p)
S(p”) D(p”) D(p), S(p)

Market price must rise towards p*.
Market Equilibrium
 Anexample of calculating a market

equilibrium when the market demand
and supply curves are linear.
D(p )  a  bp
S(p )  c  dp
Market Equilibrium
Market Market
p
demand supply
S(p) = c+dp
p*
D(p) = a-bp
q* D(p), S(p)
Market Equilibrium
Market Market
p
demand supply
S(p) = c+dp
What are the values

p* of p* and q*?
D(p) = a-bp
q* D(p), S(p)
Market Equilibrium
D(p )  a  bp
S(p )  c  dp
At the equilibrium price p*, D(p*) = S(p*).

Market Equilibrium
D(p )  a  bp
S(p )  c  dp

That is, a  bp*  c  dp*
Market Equilibrium
D(p )  a  bp
S(p )  c  dp

which gives * ac
p 
bd
Market Equilibrium
D(p )  a  bp
S(p )  c  dp

which gives * ac
p 
bd
* * *ad  bc
and q  D(p )  S(p )  .
bd
Market Equilibrium
Market Market
p
demand supply
S(p) = c+dp
p* 
ac
bd
D(p) = a-bp
* ad  bc D(p), S(p)
q 
bd
Market Equilibrium
 Canwe calculate the market

equilibrium using the inverse market
demand and supply curves?
Market Equilibrium
 Can we calculate the market

equilibrium using the inverse market
demand and supply curves?
 Yes, it is the same calculation.
Market Equilibrium
aq 1
q  D(p )  a  bp  p   D ( q),
b
the equation of the inverse market
demand curve. And
cq
q  S(p)  c  dp  p   S 1 ( q),
d
the equation of the inverse market
supply curve.
Market Equilibrium
Market
D-1(q),
inverse Market inverse supply
S-1(q)
demand S-1(q) = (-c+q)/d
p*
D-1(q) = (a-q)/b
q* q
Market Equilibrium
D-1(q), Market
S-1(q) demand Market inverse supply
S-1(q) = (-c+q)/d
At equilibrium,
p* D-1(q*) = S-1(q*).
D-1(q) = (a-q)/b
q* q
Market Equilibrium
1 aq 1 cq
pD ( q)  and p  S ( q)  .
b d
At the equilibrium quantity q*, D-1(p*) = S-1(p*).
Market Equilibrium
1 aq 1 cq
pD ( q)  and p  S ( q)  .
b d
That is, a  q*  c  q*

b d
Market Equilibrium
1 aq 1 cq
pD ( q)  and p  S ( q)  .
b d

b d
* ad  bc
which gives q 
bd
Market Equilibrium
1 aq 1 cq
pD ( q)  and p  S ( q)  .
b d

b d
* ad  bc
which gives q 
bd
* 1 * 1 * ac
and p  D (q )  S (q )  .
bd
Market Equilibrium
D-1(q), Market Market
S-1(q) demand supply
S-1(q) = (-c+q)/d
p* 
ac
bd
D-1(q) = (a-q)/b
* ad  bc q
q 
bd
Market Equilibrium
 Twospecial cases:
quantity supplied is fixed,
independent of the market price,
and
quantity supplied is extremely
sensitive to the market price.
Market Equilibrium
p Market quantity supplied is
fixed, independent of price.
q* q
Market Equilibrium
fixed, independent of price.
S(p) = c+dp, so d=0
and S(p)  c.
q* = c q
Market Equilibrium
Market Market quantity supplied is
p
demand fixed, independent of price.
S(p) = c+dp, so d=0
and S(p)  c.
D-1(q) = (a-q)/b
q* = c q
Market Equilibrium
p
S(p) = c+dp, so d=0
and S(p)  c.
p*
D-1(q) = (a-q)/b
q* = c q
Market Equilibrium
p
S(p) = c+dp, so d=0
and S(p)  c.
p* = p* = D-1(q*); that is,
(a-c)/b p* = (a-c)/b.
D-1(q) = (a-q)/b
q* = c q
Market Equilibrium
p
S(p) = c+dp, so d=0
and S(p)  c.
p* = p* = D-1(q*); that is,
(a-c)/b p* = (a-c)/b.
D-1(q) = (a-q)/b
* a  c q* = c q
p 
bd
* ad  bc
q 
bd
Market Equilibrium
p
S(p) = c+dp, so d=0
and S(p)  c.
p* = p* = D-1(q*); that is,
(a-c)/b p* = (a-c)/b.
D-1(q) = (a-q)/b
* a  c q* = c q
* ac
p  p 
bd b
* ad  bc with d = 0 give
q  q*  c.
bd
Market Equilibrium
 Two special cases are

when quantity supplied is fixed,
 independent of the market price,
and
when quantity supplied is
extremely sensitive to the market
price.
Market Equilibrium
extremely sensitive to price.
q
Market Equilibrium
extremely sensitive to price.
S-1(q) = p*.
p*
q
Market Equilibrium
p
demand extremely sensitive to price.
S-1(q) = p*.
p*
D-1(q) = (a-q)/b
q
Market Equilibrium
p
S-1(q) = p*.
p*
D-1(q) = (a-q)/b
q* q
Market Equilibrium
p
S-1(q) = p*.
p* = D-1(q*) = (a-q*)/b so
p* q* = a-bp*
D-1(q) = (a-q)/b
q* = q
a-bp*
Quantity Taxes
A quantity tax levied at a rate of $t is

a tax of $t paid on each unit traded.
 If the tax is levied on sellers then it is
an excise tax.
 If the tax is levied on buyers then it is
a sales tax.
Quantity Taxes
 What is the effect of a quantity tax on

a market’s equilibrium?
 How are prices affected?
 How is the quantity traded affected?
 Who pays the tax?
 How are gains-to-trade altered?
Quantity Taxes
A tax rate t makes the price paid by

buyers, pb, higher by t from the price
received by sellers, ps.
pb  ps  t
Quantity Taxes
 Even with a tax the market must

clear.
 I.e. quantity demanded by buyers at
price pb must equal quantity supplied
by sellers at price ps.
D(pb )  S(ps )
Quantity Taxes
pb  ps  t and D(pb )  S(ps )
describe the market’s equilibrium.
Notice these conditions apply no
matter if the tax is levied on sellers or on
buyers.
Quantity Taxes
pb  ps  t and D(pb )  S(ps )
describe the market’s equilibrium.
Notice that these two conditions apply no
matter if the tax is levied on sellers or on
buyers.
Hence, a sales tax rate $t has the
same effect as an excise tax rate $t.
Quantity Taxes & Market Equilibrium
Market Market
p
demand supply
No tax
p*
q* D(p), S(p)
Market Market
p
demand supply
An excise tax
raises the market
$t supply curve by $t
p*
q* D(p), S(p)
Market Market
p
demand supply
An excise tax
raises the market
pb $t supply curve by $t,
p* raises the buyers’
price and lowers the
quantity traded.
qt q* D(p), S(p)
Market Market
p
demand supply
An excise tax
raises the market
pb $t supply curve by $t,
p* raises the buyers’
ps price and lowers the
quantity traded.
qt q* D(p), S(p)
And sellers receive only ps = pb - t.
Market Market
p
demand supply
No tax
p*
q* D(p), S(p)
Market Market
p
demand supply
An sales tax lowers
the market demand
curve by $t
p*
$t
q* D(p), S(p)
Market Market
p
demand supply
An sales tax lowers
the market demand
curve by $t, lowers
p* the sellers’ price and
ps reduces the quantity
$t traded.
qt q* D(p), S(p)
Market Market
p
demand supply
An sales tax lowers
the market demand
pb curve by $t, lowers
p* the sellers’ price and
ps reduces the quantity
$t traded.
qt q* D(p), S(p)
And buyers pay pb = ps + t.
Market Market
p
demand supply
A sales tax levied at
rate $t has the same
pb $t effects on the
p* market’s equilibrium
ps as does an excise tax
$t levied at rate $t.
qt q* D(p), S(p)
 Who pays the tax of $t per unit

traded?
 The division of the $t between
buyers and sellers is the incidence of
the tax.
Market Market
p
demand supply
pb
p*
ps
qt q* D(p), S(p)
Market Market
p
demand supply
Tax paid by
buyers
pb
p*
ps
qt q* D(p), S(p)
Market Market
p
demand supply
pb
p*
ps Tax paid by
sellers
qt q* D(p), S(p)
Market Market
p
demand supply
Tax paid by
buyers
pb
p*
ps Tax paid by
sellers
qt q* D(p), S(p)
 E.g.
suppose the market demand and
supply curves are linear.
D(pb )  a  bpb
S(ps )  c  dps
D(pb )  a  bpb and S(ps )  c  dps .
With the tax, the market equilibrium satisfies
pb  ps  t and D(pb )  S(ps ) so
pb  ps  t and a  bpb  c  dps .
With the tax, the market equilibrium satisfies
pb  ps  t and D(pb )  S(ps ) so
pb  ps  t and a  bpb  c  dps .
Substituting for pb gives

a  c  bt
a  b( ps  t )  c  dps  ps  .
bd
a  c  bt
ps  and pb  ps  t give
bd
a  c  dt
pb 
bd
The quantity traded at equilibrium is

qt  D( pb )  S( ps )
ad  bc  bdt
 a  bpb  .
b d
a  c  bt
ps 
bd t ad  bc  bdt
q 
a  c  dt bd
pb 
bd
ac
As t  0, ps and pb   p *, the
bd
equilibrium price if
ad  bc
there is no tax (t = 0) and qt  ,
bd
the quantity traded at equilibrium
when there is no tax.
a  c  bt
ps 
q 
pb 
bd
As t increases, ps falls,
pb rises,
and qt falls.
a  c  bt
ps 
q 
pb 
bd
The tax paid per unit by the buyer is

* a  c  dt a  c dt
pb  p    .
bd bd bd
a  c  bt
ps 
q 
pb 
bd
The tax paid per unit by the buyer is

* a  c  dt a  c dt
pb  p    .
bd bd bd
The tax paid per unit by the seller is
* a  c a  c  bt bt
p  ps    .
bd bd bd
a  c  bt
ps 
q 
pb 
bd
The total tax paid (by buyers and sellers

combined) is
t ad  bc  bdt
T  tq  t .
bd
Tax Incidence and Own-Price
Elasticities
 Theincidence of a quantity tax
depends upon the own-price
elasticities of demand and supply.
Elasticities
Market Market
p
demand supply
pb $t
p*
ps
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
Change to buyers’
pb $t price is pb - p*.
p* Change to quantity
ps
demanded is q.
qt q* D(p), S(p)
q
Elasticities
Around p = p* the own-price elasticity
of demand is approximately
q
*
q
D 
*
pb  p
*
p
Elasticities
of demand is approximately
q
q* q  p*
D   pb  p*  .
pb  p*  D  q*
p*
Elasticities
Market Market
p
demand supply
pb $t
p*
ps
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
Change to sellers’
pb $t price is ps - p*.
p* Change to quantity
ps
demanded is q.
qt q* D(p), S(p)
q
Elasticities
of supply is approximately
q
*
q
S 
*
ps  p
*
p
Elasticities
of supply is approximately
q
q*
* q  p*
S   ps  p  .
* *
ps  p  S q
*
p
Elasticities
Market Market
p
demand supply
Tax paid by
buyers
pb
p*
ps Tax paid by
sellers
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
Tax paid by
buyers
pb
p*
ps Tax paid by
sellers
qt q* D(p), S(p)
*
pb  p
Tax incidence = .
*
p  ps
Elasticities
*
pb  p
Tax incidence = .
*
p  ps
* *
* q  p * q  p
pb  p  . ps  p  .
* *
D  q  S q
Elasticities
*
pb  p
Tax incidence = .
*
p  ps
* *
* q  p * q  p
pb  p  . ps  p  .
* *
D  q  S q
*
So pb  p S
  .
*
p  ps D
Elasticities
*
pb  p S
Tax incidence is   .
*
p  ps D
The fraction of a $t quantity tax paid

by buyers rises as supply becomes more
own-price elastic or as demand becomes
less own-price elastic.
Elasticities
Market Market
p
demand supply
As market demand
$t becomes less own-
pb price elastic, tax
p* incidence shifts more
ps
to the buyers.
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
As market demand
p* incidence shifts more
ps
to the buyers.
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
As market demand
ps= p* incidence shifts more
to the buyers.
qt = q* D(p), S(p)
Elasticities
Market Market
p
demand supply
As market demand
ps= p* incidence shifts more
to the buyers.
qt = q* D(p), S(p)
When D = 0, buyers pay the entire tax, even
though it is levied on the sellers.
Elasticities
*
pb  p S
Tax incidence is   .
*
p  ps D
Similarly, the fraction of a $t quantity

tax paid by sellers rises as supply
becomes less own-price elastic or as
demand becomes more own-price elastic.
Deadweight Loss and Own-Price
Elasticities
A quantity tax imposed on a
competitive market reduces the
quantity traded and so reduces
gains-to-trade (i.e. the sum of
Consumers’ and Producers’
Surpluses).
 The lost total surplus is the tax’s
deadweight loss, or excess burden.
Elasticities
Market Market
p
demand supply
No tax
p*
q* D(p), S(p)
Elasticities
Market Market
p
demand supply
No tax
CS
p*
q* D(p), S(p)
Elasticities
Market Market
p
demand supply
No tax
p*
PS
q* D(p), S(p)
Elasticities
Market Market
p
demand supply
No tax
CS
p*
PS
q* D(p), S(p)
Elasticities
Market Market
p
demand supply
No tax
CS
p*
PS
q* D(p), S(p)
Elasticities
Market Market
p
demand supply
The tax reduces
pb CS $t both CS and PS
p*
ps PS
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
The tax reduces
pb CS $t both CS and PS,
p* Tax transfers surplus
ps PS to government
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
The tax reduces
ps PS to government
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
The tax reduces
ps PS to government
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
The tax reduces
ps PS to government,
and lowers total
qt q* D(p), S(p) surplus.
Elasticities
Market Market
p
demand supply
pb CS $t
p* Tax
ps PS Deadweight loss
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
pb $t
p*
ps Deadweight loss
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
Deadweight loss falls
pb $t as market demand
p* becomes less own-
ps price elastic.
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
p* becomes less own-
ps price elastic.
qt q* D(p), S(p)
Elasticities
Market Market
p
demand supply
ps= p* becomes less own-
price elastic.
qt = q* D(p), S(p)
When D = 0, the tax causes no deadweight
loss.
Elasticities
 Deadweight loss due to a quantity
tax rises as either market demand or
market supply becomes more own-
price elastic.
 If either D = 0 or S = 0 then the
deadweight loss is zero.

Ch16 Equilibrium

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Ch16 Equilibrium

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Chapter Sixteen

A market is in equilibrium when total

D(p’) S(p’) D(p), S(p)

D(p’) S(p’) D(p), S(p)

S(p”) D(p”) D(p), S(p)

S(p”) D(p”) D(p), S(p)

 Anexample of calculating a market

What are the values

At the equilibrium price p*, D(p*) = S(p*).

At the equilibrium price p*, D(p*) = S(p*).

At the equilibrium price p*, D(p*) = S(p*).

At the equilibrium price p*, D(p*) = S(p*).

 Canwe calculate the market

 Can we calculate the market

 Two special cases are

A quantity tax levied at a rate of $t is

 What is the effect of a quantity tax on

A tax rate t makes the price paid by

 Even with a tax the market must

 Who pays the tax of $t per unit

Substituting for pb gives

The quantity traded at equilibrium is

The tax paid per unit by the buyer is

The tax paid per unit by the buyer is

The total tax paid (by buyers and sellers

The fraction of a $t quantity tax paid

Similarly, the fraction of a $t quantity

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At the equilibrium price p, D(p) = S(p*).

At the equilibrium price p, D(p) = S(p*).

At the equilibrium price p, D(p) = S(p*).

At the equilibrium price p, D(p) = S(p*).