Dr.

Duffy Microeconomics

The end of CHAPTER 3

Frank and Bernanke
With supplemental material
 Market Equilibrium

A market equilibrium comes at the place

where quantity demanded equals quantity
supplied.
Equilibrium takes place at the intersection
of the supply and demand curves.
 Market Equilibrium

• Equilibrium
– A system is in equilibrium when there is no
tendency for it to change
• Market Equilibrium
– Occurs in a market when all buyers and sellers are
satisfied with their respective quantities at the
market price
 Market Equilibrium

• What Do You Think?

– Is the market equilibrium always an ideal outcome
for all market participants?
– Would buyers prefer a lower price than the
equilibrium price?
– Would sellers prefer a higher price than the
equilibrium price?
 Movements of Curves
• An increase moves demand (or supply) to the
right.
• A decrease moves demand (or supply) to the
left.
• Think in terms of right and left, not up and
down, when shifting curves.
 Predicting and Explaining Changes In Prices and
Quantities

• Distinguishing Between:
– A change in the quantity demanded
• A movement along the demand curve that occurs in
response to a change in price
– A change in demand
• A shift of the entire demand curve
 An Increase In Quantity
Demanded vs. An Increase In Demand

Price
($/can)

6 Increase in
quantity
5 demanded

1
D
Quantity
0 (1000s of cans/day)
2 4 6 8 10 12
 An Increase In Quantity
Demanded vs. An Increase In Demand

Price
($/can) D’
6 D

4
Increase in demand
3

2
D’
1
D
Quantity
(1000s of cans/day)
0 12
 Predicting and Explaining Changes In Prices and
Quantities

• Change in the quantity supplied

– A movement along the supply curve that occurs in
response to a change in price
• Change in supply
– A shift of the entire supply curve
 An Increase In Quantity
Supplied vs. An Increase In Supply

Price
($/can)

6
S

5
Increase in
4 quantity supplied

2
S
1
Quantity
(1000s of cans/day)
0 2 4 6 8 10
 An Increase In Quantity
Supplied vs. An Increase In Supply

Price
($/can)

6 S S’
5

3
Increase in supply
2

1
S S’
Quantity
(1000s of cans/day)
0 2 4 6 8 10
 Predicting and Explaining Changes In Prices and
Quantities

• Economic Naturalist
– When the Federal Government implements a
large pay increase for its employees, why do rents
for apartments near Washington Metro stations
go up relative to rents for apartments located far
away from Metro stations?
 The Effect of a Federal Pay Raise on the Rent for Conveniently Located
Apartments in Washington D.C.

Rent
(dollars per
month) S

P’

D’
D Conveniently
located apartments
Q Q’ (units per month)
 Economic Puzzler

• Economic Naturalist
– Why do the prices of some goods, like airline
tickets to Europe, go up during the months of
heaviest consumption, while others, like sweet
corn, go down?
– Hint, figure out which curve is shifting! A quantity
increase can occur from either a demand increase
or a supply increase.
 Seasonal Variation in Air Travel

High Consumption and Prices Due to High Demand

Price
($/ticket)

PS

PW
DS
DW

1000s of
QW QS tickets
 Seasonal Variation in Corn Markets

High Consumption and Low Prices due to High Supply

Price
($/bushel) SW
SS

PS
PW

Millions of
QW QS bushels
 The Effects Of Simultaneous Shifts In Supply And
Demand
The Market for Corn Tortilla Chips
Price
($/bag)
S S’
S’ after reduction in price of
corn harvesting equipment
P
D’ after discovery that oils are
harmful to people’s health
P’

D
D’
Millions of bags
per month
Q’ Q
 The Effects Of Simultaneous Shifts In Supply And
Demand
The Market for Corn Tortilla Chips
Price
($/bag)
S

P S’ S’ after reduction in price of

corn harvesting equipment

D’ after discovery that oils are

P’ harmful to people’s health

D
D’

Millions of bags
per month
Q Q’
 Simultaneous Shifts, part 1
• If supply increases and demand increases,
quantity will increase (we can’t say what
happens to price without more information).
• If supply decreases and demand decreases,
quantity will decrease (we can’t say what
happens to price without more information.)
 Simultaneous Shifts, part 2
• If demand increases and supply decreases,
price will rise (we can’t say what happens to
quantity without more information).
• If demand decreases and supply increases,
price will fall (we can’t say what happens to
quantity without more information.)
 Predicting and Explaining Changes In Prices and
Demand

• Assume
– A vitamin found in corn chips helps protect
against cancer and heart diseases
– Swarm of locusts destroys part of the corn crop
• What Do You Think?
– What will happen to the equilibrium price and
quantity of corn chips?
 Markets And Social Welfare

• What Do You Think?

– When are the prices and quantities determined in
market equilibrium socially optimal, in the sense
of maximizing total economic surplus?
 Markets And Social Welfare

• Cash On The Table

– Assume:
• All exchange is purely voluntary
– If so:
• The buyer’s reservation price exceeds the seller’s
reservation price and both the buyer and seller receive
an economic surplus
 Markets And Social Welfare

• Cash On The Table

– Buyer’s surplus
• The difference between the buyer’s reservation price
and the price he or she actually pays
 Markets And Social Welfare

• Cash On The Table

– Seller’s surplus
• The difference between the price received by the seller
and his or her reservation price
 Markets And Social Welfare

• Cash On The Table

– Total surplus
• The difference between the buyer’s reservation price
and the seller’s reservation price
 Markets And Social Welfare

• Cash On The Table

– Economic metaphor for unexploited gains from
exchange
 Socially “optimal” quantity

– The quantity of a good that results in the

maximum possible economic surplus from
producing and consuming the good
– The socially optimal quantity occurs when
– MC = MB
 Economic Efficiency

Economic efficiency occurs when all goods and

services are produced and consumed at their
respective socially optimal levels
 The Efficiency Principle
• Maximize the economic surplus
• Increase the economic pie
 Market Equilibrium And Social Welfare

• When is the market equilibrium efficient?

• When all cost of producing the good or service are
borne directly by the seller
• When all benefits from the good or service accrue
directly to buyers

Can you think of situations where

costs or benefits accrue to people
who do not buy or sell the good?
 Inefficient Market Equilibrium

An inefficient market equilibrium occurs when

some costs of production fall on people other
than those who sell the good or service OR
When some benefits of consumption fall
on those who do not buy the good or service.
 Externalities
• Externalities is the name given to a cost or benefit
that accrues to people outside a market.
• Pollution is one type of externality.
• But externalities can also be beneficial, such as the
benefit to existing gas stations of having a shopping
mall move to a location.
• Negative externalities are more likely to draw
attention than positive ones.
 Markets And Social Welfare

• Example: Pollution (cost example)

– The market is in equilibrium for all buyers and
sellers so that for them MC = MB
– MC in the market, however, underestimates the
cost to society of producing the good
– Therefore, the market produces more than the
efficient amount and there is no incentive for
producers and consumers to alter their behavior
 Markets And Social Welfare

• Example: Vaccinations (benefit example)

• The market is in equilibrium for all who buy or sell in
the market so that: MC = MB
• MB underestimates the benefits to society of
consuming the vaccinations
• The market produces less than the efficient amount of
vaccinations and there is no incentive for producers
and consumers to alter their behavior
 Markets And Social Welfare

• Smart For One, Dumb For All

– In these markets
• Buyers and sellers are behaving rationally
• Market equilibrium exists
• There are no unexploited opportunities for individuals
• Economic surplus is not maximized
 Markets And Social Welfare

• The Equilibrium Principle

– A market in equilibrium leaves no unexploited
opportunities for individuals, but may not exploit
all gains achievable through collective action.
 Public good
• A public good is a good that is not “used up” by its
consumers. It has positive externalities.
• Education is one example. The people getting the
education benefit, but so do others in society
because educated people are likely to increase the
society’s PPF.
• A park or road is another type of public good. I can
use it and still leave it for others to use.
 Public goods and public “bads”
• If outcomes are left entirely to the market,
society will tend to overproduce good with
negative externalities and underproduce
those with positive externalities.
• Why?
 Externalities and markets
• For goods with negative externalities, costs
are borne by those outside the market so the
price of the item does not reflect its full MC to
society.
• For goods with positive externalities,
producers find it impossible to collect fees
from all who benefit. Hence price of the item
will not reflect its MB to society.
 Calculating price and quantity at
market equilibrium
• Demand Equation
• Quantity Demanded = 200 – 5p
• Supply Equation
• Quantity Supplied = 50 + 10P
• At equilibrium Qd=Qs
 Solving the Equations

Set Qd=Qs and solve

200 – 5p = 50 + 10P

150 = 15p P= 10

Qd = 150 Qs = 150 Check!

End of
Chapter