2.3 competitive market equilibrium

Question 1

market equilibrium

Answer 1

when quantity demanded = quantity supplied

the forces of supply and demand are in balance, +and there is no tendency for the price to change+

Question 2

market

Answer 2

when buyers and sellers come together for the exchange of goods and services

Question 3

Market disequilibrium

Answer 3

at any price other than the equilibrium price

cannot last in free market bc demand & supply force the price to change until it reaches its equilibrium level

Question 4

surplus

Answer 4

quantity supplied is greater/exceeds quantity demanded

Question 5

shortage

Answer 5

quantity demanded is greater/exceeds quantity supplied

Question 6

describe what happens when supply decreases and causes a shortage

Answer 6

When supply decreases

• if P remains at P1 → B → shortage

For producers

• Received a signalling (signal)
• “I (producers) should raise up the price”
• increase the price from P1 to P2 (P increase) = incentive
  
  • Quantity supplied increase

For consumers

• Signal: price increase
• Quantity demanded decrease
  
  • when P increase (P1→P2)
  • when Qd decrease (Q1→Q2) = incentive to buy less

Qd at Q1

Qs at Q3

producers try to increase price → more willing to supply more goods → Qs goes to Q2

when producers increase price → Qd decrease → Q1 to Q2

NEW EQUILIBRIUM point C

Question 6

invisible hand theory

Answer 6

assumption: self-interest

Question 7

describe what happens when demand decreases and causes a surplus

Answer 7

1) producers

• see a signal (surplus (Q1-Q3) → too many goods unsold)
• Incentive to: lower the price (P1 to P2) → Qs decrease (Q1→Q2)

2) consumers

• see a signalling (price decrease P1→P2)
• incentive to → increase Qd (Q3→Q2)

3) market

• new equilibrium at C → at P2 & Q2
• market P: P2
• transacted Q: Q2
• market price / quantity transacted
• → resources have been reallocated

Question 7

why is there reallocation of resources

Answer 7

• resources are scarce
• price becomes the factor affecting the allocation of resources - determined by price

Question 8

price mechanism

3 steps

Answer 8

1) e.g. something changed (e.g. supply decrease)

2) Affecting both (1) producers & (2) consumers → signalling & incentive

3) New equilibrium is reached (resources are reallocated)

Question 9

rationing

Answer 9

controlled distribution of resources

Question 10

another meaning for demand curve

Answer 10

marginal (extra) benefit

i.e. additional amount of something when we are talking about a specific unit

Question 11

another meaning for supply curve

Answer 11

marginal (extra) cost

i.e. additional amount of something when we are talking about a specific unit

Question 12

Law of diminishing marginal utility

Answer 12

the principle of decreasing marginal benefit can be found from the shape of the downward sloping demand curve

Question 13

Identify the D&S of the following on good A

• a decrease in labour cost
• consumer income rising (good A is an inferior good)
• the price of a substitute for good B falls
• the number of firms producing good A rises
• the population grows

Answer 13

• a decrease in labour cost - increase in supply, shifts to right
• consumer income rising (good A is an inferior good) - demand decrease, shifts to left
• the price of a substitute for good B falls - demand decrease, more good B demanded
• the number of firms producing good A rises - increase supply, shifts to the right
• the population grows - increase demand, shifts to the right, more consumers

Question 14

law of diminishing marginal returns

Answer 14

A higher marginal cost will be incurred in production when more quantity of goods is being produced

A producer is willing to produce more units only when the price is higher!

Question 15

marginal cost example

guitar production

Answer 15

You would like to expand your production but it takes time to acquire capital
(e.g. machinery / new factory)

What would you get in order to boost up the output in the short term?

1 labour = 1 output
4 labour = 2 output

Question 16

marginal benefit + what will consumers do

Answer 16

Since marginal benefit falls as quantity consumed increased

The consumer will be inclined to buy each extra unit only if its price falls

Question 17

noodle example

beef/fishball on its own is $29

but with both but same amount total is $32

how does this demonstrate marginal benefit?

Answer 17

The shop owner knows you can get much higher satisfaction with the combo. Therefore, he is confident to charge you more and you are willing to pay more

Question 18

marginal cost

Answer 18

A higher marginal cost will be incurred in production when more quantity of goods is being produced

THEREFORE

A producer is willing to produce more units only when the price is higher

Question 19

producer surplus

Answer 19

The price received by firms for selling their good – lowest price producers are willing to accept to produce the good

Question 19

consumer surplus

Answer 19

Highest price consumers are willing to pay for a good – the price actually paid

Question 20

When MB > MC

Answer 20

More should be
produced

aim: MB = MC

Question 20

what do CS and PS indicate?

Answer 20

can be used to understand how efficiency is achieved in a competitive market

Question 21

When MC > MB

Answer 21

Less should be
produced

aim: MB = MC

Question 22

to identify CS and PS on diagram

Answer 22

CS:

1. highest price
2. actual price paying
3. quantity demanded

PS:

1. lowest price
2. actual price paying to produce (same point as CS)
3. quantity demanded

Question 23

how does the competitive market/economic efficiency answer what to produce?

Answer 23

The competitive market realises 1. allocative efficiency

Producing the combination of goods mostly wanted by society

these conditions = economic efficiency

Question 24

how does the competitive market/economic efficiency answer how to produce?

Answer 24

2. Productive efficiency is also
   realised

Involving production with the fewest possible resources (at the lowest costs)

these conditions = economic efficiency

Question 24

what does allocative efficiency mean in terms of a D&S diagram

Answer 24

At the point of competitive
market equilibrium,
consumer and producer
surplus is maximum

Question 25

social surplus

Answer 25

sum of consumer and
producer surplus = total
(social) surplus

Question 26

allocative efficiency

Answer 26

At the point of competitive market equilibrium, consumer and producer surplus is maximum

The sum of consumer and producer surplus = total (social) surplus

Total surplus is maximised at Q1

When MB = MC = allocative efficiency and therefore productive efficiency

Society has allocated the right amount of resources to production of the good

It is producing the quantity of the good that is mostly wanted by society

Question 27

limitations for competitive market

Answer 27

Efficiency is difficult to achieve in the real world

🡪 Are we always able to produce the right amount of
goods to the society?

🡪 Are we always able to produce goods our society
really needs?

🡪 Are we always able to produce goods at the lowest cost?

Question 28

effect to stakeholders after surplus due to price floor

Answer 28

• Consumers :(
  
  • price increase → :(
  • quantity decrease → :(
• Producers :| (uncertain)
  
  • price increase → :)
  • quantity decrease → :(
• Society :(
  
  • social surplus decrease
    
    • no one gets the green triangle → deadweight → loss to whole society