Notes for Chapter 9
Price determination
9.1 How Prices Are Determined
• Buyers vs. Sellers:
o Consumers want low prices.
o Sellers want high prices.
o Result: The price of a product is decided based on negotiation between the
two.
• Direct Bargaining:
o In some markets, buyers and sellers directly haggle over the price.
o Example: A buyer tries to lower the price while the seller tries to keep it
higher.
• Indirect Bargaining:
o In other cases, sellers set a price they believe will balance demand and
supply (this is called the equilibrium price).
o If demand is too low (i.e., not enough people are buying at the set price), the
price is reduced.
o If demand is too high (i.e., more people want the product than what’s
available), the price is increased.
9.2 Market Equilibrium
• Equilibrium Price (or Market-Clearing Price):
o This is the price where demand equals supply.
o There are no shortages (not enough products) or surpluses (too many
products).
o At this price, everything produced can be sold, and everyone who wants to
buy at that price can do so.
• How to Find Equilibrium Price:
o Look at the demand schedule (how much people want to buy at different
prices).
o Compare it to the supply schedule (how much sellers are willing to sell at
different prices).
o The point where demand equals supply is the equilibrium price.
Important Terms
• Haggling: Negotiating the price between a buyer and seller.
• Equilibrium Price: The price at which the quantity of goods buyers want equals the
quantity sellers want to sell. Also called the market-clearing price.
•
• Demand and Supply Schedules: Charts that show how much consumers want to buy
(demand) and how much sellers want to sell (supply) at different prices.
In this case the equilibrium price is $35, since at this point demand and supply are equal. The
equilibrium price can also be found by examining a demand and supply diagram. It occurs where the
demand and supply curves intersect.
9.3 Moving from Market Disequilibrium to Market Equilibrium
• Market Forces:
o Prices naturally adjust to move towards the equilibrium price where demand
equals supply.
• Price Set Above Equilibrium:
o If a firm sets the price too high, it won't sell all its products. This creates a
surplus (too much supply, not enough demand).
o To fix this, the firm will lower the price until the quantity demanded
matches the quantity supplied.
• Result:
o When the price reaches the equilibrium level, the market is said to "clear."
This means everything produced is sold, and no surplus remains.
Important Terms
• Market Disequilibrium: A situation where the price is either too high or too low,
leading to shortages or surpluses.
• Surplus (Excess Supply): When sellers have more products than buyers want to
purchase.
• Market Clears: When all products available for sale are sold, and demand equals
supply.
• Market Forces: The natural actions in the economy (like changes in demand and
supply) that push prices toward equilibrium.
Figure 9.2 shows a market initially being in a state of disequilibrium with supply exceeding demand.
At $6, the firm is willing and able to sell 10 000 products, but consumers buy only 4000. This leaves
6000 unsold products. As a result price will fall, causing demand to extend and supply to contract
until price reaches the equilibrium level. Figure 9.3 shows this adjustment.
Market forces will also move the price, if it is initially set below the equilibrium level. In this case,
there will initially be a shortage of the product with demand exceeding supply (excess demand) as
shown in Figure 9.4.
Some consumers anxious to buy the product will be willing to pay a higher price and suppliers
recognising this excess demand will raise the price. Figure 9.5 shows the price being pushed up to
the equilibrium level of $5.