Week 3

Markets and Equilibrium

How are markets organized?
• What goods/services get produced?
• Who produces these goods/services?
• How are these goods/services produced?
• Who gets what?
• Two types of economies
• ________________ – Centralized decisions are made about what is produced,
how, by whom, and who gets what
• ________________ – Each individual makes their own production and
consumption decisions, buying and selling in markets

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What’s a market?
• Market – A setting that brings together potential buyers and sellers to
exchanges goods/services
• Markets can be
• Real places (think brick-and-mortar stores, malls, etc.)
• Online exchanges (think Amazon, Nasdaq Stock Market, etc.)
• Market types
• Perfect competition, Monopolies, Monopolistic competition, Oligopolies, etc.
• We will begin by focusing on perfect competition

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What is market equilibrium?
• Equilibrium: The point at which there is ________________ for
change
• A market is in equilibrium when the quantity supplied equals the quantity
demanded
• Equilibrium Quantity: The quantity demanded and supplied in equilibrium
• Equilibrium Price: The price at which the market is in equilibrium
• In equilibrium
• ________________ seller who wants to sell an item can find a buyer
• ________________ buyer who wants to buy an item can find a seller
• This balance between the two sides of the market is why there is no
tendency for the market price to change from this equilibrium point

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Market Equilibrium
• Market equilibrium – the
quantity supplied is equal to
the quantity demanded
• In equilibrium, there is no
surplus or shortage in the
market
• Market ________________ –
the quantity demanded
exceeds the quantity supplied
• Market ________________ –
the quantity demanded is less
than the quantity supplied

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How do we calculate equilibrium P* and Q*?
• Let’s say
• Demand: Qd = -2P + 120  P = (-1/2)Qd + 60
• Supply: Qs = 3P – 30  P = (1/3)Qs + 10
• Let’s set inverse demand equal to inverse supply and solve for
equilibrium quantity

• Plug in the equilibrium quantity into either inverse demand or inverse

supply to solve for equilibrium price

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What if we aren’t in equilibrium?

• ________________ – when a market is not in equilibrium

• Symptoms of ________________
• Queuing
• Bundling of extras
• Secondary markets

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Surplus  Excess Supply  Price will fall
• Market price > Equilibrium Price
• QS[PH] is the Quantity Supplied of this
good at high price PH
• QD[PH] is the Quantity Demanded of this
good at high price PH
• We have “Excess Supply”, or a “Surplus” at
price PH which is equal to
• ________________

• Unless government policy prevents it, the

price will fall from PH to Pe

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How do we calculate the surplus in a market?
• Let’s say
• Demand: Qd = -2P + 120
• Supply: Qs = 3P – 30
• The market price is 40
• Plug the market price into the demand and supply functions

• Subtract the quantity demanded from the quantity supplied

• Market Surplus:

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Shortage  Excess Demand  Price will rise
• Market price < Equilibrium Price
• QS[PL] is the Quantity Supplied of this
good at low price PL
• QD[PL] is the Quantity Demanded of
this good at low price PL
• We have “Excess Demand”, or a
“Shortage” at price PL which is equal to
• ________________
• Unless government policy prevents it,
the price will rise from PL to Pe

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How do we calculate the shortage in a
market?
• Let’s say
• Demand: Qd = -2P + 120
• Supply: Qs = 3P – 30
• The market price is 15
• Plug the market price into the demand and supply functions

• Subtract the quantity supplied from the quantity demanded

• Market Shortage:

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Equilibrium, Shortages, Surpluses, and
Schedules
• Market Equilibrium: When the price is ____,
then the quantity demanded equals the Quantity Quantity
quantity supplied Price Demanded Supplied
• Shortage: At _____ the quantity demanded $2 2.4 1.5
exceeds the quantity supplied: 2.4 > 1.5
$3 2.0 2.0
• Consumers are unable to buy as much as
they want — the market is short 0.9 units $4 1.6 2.5
• Surplus: At _____the quantity demanded is
less than the quantity supplied: 1.6 < 2.5
• Sellers are unable to sell as much as they
want — there are 0.9 units not sold

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New Equilibrium: Shifts in Demand
• Recall demand shifters
• Income (normal & inferior)
• Preferences
• Prices of complements and substitutes
• Expectations about the future
• Congestion and network effects
• The type and number of buyers
• …but not a change in price
• If the market demand curve shifts, then the market moves to a new
equilibrium

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New Equilibrium: Decrease in Demand
• A decrease in demand causes
a(n)
• decrease in equilibrium price
• decrease in equilibrium quantity

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New Equilibrium: Increase in Demand
• An increase in demand causes
a(n)
• increase in equilibrium price
• increase in equilibrium quantity

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New Equilibrium: Shifts in Supply
• Recall demand shifters
• Input prices
• Productivity and technology
• Other opportunities and the prices of related outputs
• Expectations about the future
• The type and number of sellers
• …but not a change in price
• If the market supply curve shifts, then the market moves to a new
equilibrium

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New Equilibrium: Decrease in Supply
• A decrease in supply causes a(n)
• increase in equilibrium price
• decrease in equilibrium quantity

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New Equilibrium: Increase in Supply
• An increase in supply causes a(n)
• decrease in equilibrium price
• increase in equilibrium quantity

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New Equilibrium: One Shift Summary
Effect on Effect on
Equilibrium Equilibrium
Quantity Price Shifts in demand cause
price and quantity to
Increase in Demand Rises Rises move in the same
Decrease in Demand Falls Falls direction

Increase in Supply Rises Falls Shifts in supply cause

price and quantity to
Decrease in Supply Falls Rises move in opposite
directions

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What if both demand and supply shift?
• The impact of the two shifts on equilibrium price and
quantity may be ambiguous
• Your conclusion about the new equilibrium may be, “It
depends” — it depends on which curve shifted the more

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New Equilibrium: Demand Increase and
Supply Increase
• An increase in demand and an
increase in supply causes
• An increase in equilibrium quantity
• Equilibrium price could go either
way

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New Equilibrium: Demand Decrease and
Supply Decrease
• A decrease in demand and a
decrease in supply causes
• A decrease in equilibrium quantity
• Equilibrium price could go either
way

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New Equilibrium: Demand Increase and
Supply Decrease
• An increase in demand and a
decrease in supply causes
• Equilibrium quantity could go
either way
• An increase in equilibrium price

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New Equilibrium: Demand Decrease and
Supply Increase
• A decrease in demand and an
increase in supply causes
• Equilibrium quantity could go
either way
• A decrease in equilibrium price

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 New Equilibrium: Both Shift Summary
Total Effect: Total Effect:
Effect on Equilibrium Price Effect on Equilibrium Quantity
Increase in demand and It depends Rises
increase in supply (↑P + ↓P) (↑Q + ↑Q)

Decrease in demand and It depends Falls

decrease in supply (↓P + ↑P) (↓Q + ↓Q)

Increase in demand and Rises It depends

decrease in supply (↑P + ↑P) (↑Q + ↓Q)

Decrease in demand and Falls It depends

increase in supply (↓P + ↓P) (↓Q + ↑Q)
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Interpreting Market Data
• The supply and demand framework can be used to
• _____________ market outcomes when market conditions change
• _____________ market outcomes you see in the news or
happening around you

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Interpreting Market Data
• The supply and demand framework as a diagnostic tool
• Rule 1
• If prices and quantities move in the same direction, then the
___________________ curve has definitely shifted
• It’s possible that the supply curve may have shifted too
• Rule 2
• If price and quantities move in opposite directions, then the
___________________ curve has definitely shifted
• It’s possible that the demand curve may have shifted too

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