2.3 competitive market equilibrium Flashcards
market equilibrium
when quantity demanded = quantity supplied
the forces of supply and demand are in balance, +and there is no tendency for the price to change+
market
when buyers and sellers come together for the exchange of goods and services
Market disequilibrium
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
surplus
quantity supplied is greater/exceeds quantity demanded
shortage
quantity demanded is greater/exceeds quantity supplied
describe what happens when supply decreases and causes a shortage
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
invisible hand theory
assumption: self-interest
describe what happens when demand decreases and causes a surplus
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
why is there reallocation of resources
- resources are scarce
- price becomes the factor affecting the allocation of resources - determined by price
price mechanism
3 steps
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)
rationing
controlled distribution of resources
another meaning for demand curve
marginal (extra) benefit
i.e. additional amount of something when we are talking about a specific unit
another meaning for supply curve
marginal (extra) cost
i.e. additional amount of something when we are talking about a specific unit
Law of diminishing marginal utility
the principle of decreasing marginal benefit can be found from the shape of the downward sloping demand curve
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
- 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
law of diminishing marginal returns
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!
marginal cost example
guitar production
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
marginal benefit + what will consumers do
Since marginal benefit falls as quantity consumed increased
The consumer will be inclined to buy each extra unit only if its price falls
noodle example
beef/fishball on its own is $29
but with both but same amount total is $32
how does this demonstrate marginal benefit?
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
marginal cost
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
producer surplus
The price received by firms for selling their good – lowest price producers are willing to accept to produce the good
consumer surplus
Highest price consumers are willing to pay for a good – the price actually paid
When MB > MC
More should be
produced
aim: MB = MC
what do CS and PS indicate?
can be used to understand how efficiency is achieved in a competitive market
When MC > MB
Less should be
produced
aim: MB = MC
to identify CS and PS on diagram
CS:
- highest price
- actual price paying
- quantity demanded
PS:
- lowest price
- actual price paying to produce (same point as CS)
- quantity demanded
how does the competitive market/economic efficiency answer what to produce?
The competitive market realises 1. allocative efficiency
Producing the combination of goods mostly wanted by society
these conditions = economic efficiency
how does the competitive market/economic efficiency answer how to produce?
- Productive efficiency is also
realised
Involving production with the fewest possible resources (at the lowest costs)
these conditions = economic efficiency
what does allocative efficiency mean in terms of a D&S diagram
At the point of competitive
market equilibrium,
consumer and producer
surplus is maximum
social surplus
sum of consumer and
producer surplus = total
(social) surplus
allocative efficiency
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
limitations for competitive market
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?
effect to stakeholders after surplus due to price floor
- 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
- social surplus decrease
