Chapter 5 (3) Flashcards
In a competitive market
► buyers &sellers will naturally find their way to the equilibrium price
► This is the invisible hand of market forces at work, and it doesn’t require any manager to coordinate or set prices.
MARKET EQUILIBRIUM AND EFFICIENCY
►The concept of surplus lets us appreciate something very important about market equilibrium:
○ It is not ONLY the point at which buyers = perfectly matched to sellers; it is also the point at which total surplus = maximized
○ In short: equilibrium makes the total well-being of all participants in the market as high as possible
What would happen to surplus, if, the market moved away from equilibrium
Sets price: $300
► How will potential buyers & sellers respond to this situation?
►Buyers: who wanted to buy at the equilibrium price are no longer willing to buy at a higher price (of the eq) – reducing their consumer surplus to ZERO
►Sellers: who would have sold those to potential buyers ALSO miss out & get a producer surplus of ZERO
►For the items still sold: buyers pay a higher price & lose surplus
-the sellers benefit from the higher price& gain the surplus lost by consumers
► Overall, total surplus in the market = lower than it was at the equilibrium price
In both cases–when the price is above the eq price OR below the eq price–total surplus decreases relative to the market equilibrium
► In fact, we find this same result at any price other than equilibrium price
► The key is that a higher/lower price causes fewer trades to take place –> b/c some people are no longer willing to buy or sell
► The value that would have been gained from these voluntary trades no longer exists
○ As a result, the equilibrium in a perfectly competitive, well-functioning market maximizes total surplus
Another way to say this is that the market is efficient when it is at equilibrium: there is no exchange that can make that can make anyone better off w/out someone becoming worse off
► Efficiency = one of the most powerful features of a market system
► Even more remarkable is that it is achieved w/out centralized coordination
DEAD WEIGHT LOSS
► An intervention that moves a market away from equilibrium might benefit either producers/consumers
–> but it always comes w/ a decrease in total surplus
Where does that surplus go?
It disappears & becomes what is known as DEAD WEIGHT LOSS
DEAD-WEIGHT LOSS
is the loss of total surplus when the quantity of a good that is bought & sold is BELOW the market equilibrium quantity
► Any intervention that moves a market away from the eq price & quantity = creates dead weight loss
► Fewer exchanges take place –> so there are fewer opportunities for the generation of surplus
