Equilibrium Flashcards
What is equilibrium?
Equilibrium is where supply and demand are balanced
What is equilibrium price?
Equilibrium price is the price that balances quantity supplied and quantity demanded
On a graph, it is the price at which the supply and demand curves intersect
What is equilibrium quantity?
Equilibrium quantity is the quantity supplied and the quantity demanded at the equilibrium price
On a graph, it is the quantity at which the supply and demand curves intersect
Graph the equilibrium of supply and demand
What will happen if the market price is too high?
If the market price is too high, then the supply will be greater than the demand
In order to sell, suppliers will have to accept a lower price (so price falls)
As price falls, consumers will buy more
Price will continue to fall until D=S
What will happen if the market price is too low?
If the market price is too low, then the demand will be greater than the supply
In order to ration the product, suppliers will have to increase their price
As price increases, consumers will buy less
Prices will continue to rise until D=S
What is the law of supply and demand, and what does it assume?
The claim that the price of any good adjusts to bring the supply and demand for that good into balance
Assumes that:
There is an unfettered price mechanism
There are no externalities/market failure
As economists, what are the steps that we should use to analyse changes in equilibrium?
There are four steps to analysing changes from the equilibrium
Decide whether the event shifts the supply or demand curve, or both
Decide in which direction the curve shifts (increase or decrease)
Use the supply and demand diagram to see how the shift changes the equilibrium
Analyse and explain how to get back to the equilibrium
What is total economic surplus, and how can it be graphed?
Refers to the combined value of consumer and producer surplus
Can also be expressed as the value of a good to buyers subtracted by the costs to producers of making said good, or Marginal Benefit – Marginal Cost
Why do economists seek to maximise economic surplus?
The equilibrium point is the maximum because it is where marginal benefit is equal to marginal cost – no more surplus can be gained
Equilibrium is maximising economic efficiency
If an allocation of resources maximises total surplus, we say that the allocation is efficient
If the allocation is not efficient, then there are gains from trade between buyers and sellers not being realised
It is worth noting at this point that efficiency is about how big the economic pie is NOT about the distribution of the pie between interested parties (equity)
Which consumers/producers are included/excluded from the total economic surplus?
What outcomes do free markets provide?
Free markets allocate the supply of goods to the buyers who value them the most, as measured by their willingness to pay
Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost, as measured by their willingness to sell
Free markets produce the quantity of goods that maximises the sum of the producer and consumer surplus
What is dead-weight loss?
The loss in total surplus that results from a market distortion such that the market is no longer operating at the efficient point where Demand = Supply
What are the two types of price controls?
A price ceiling – a legal maximum on the price at which a good can be sold
Eg rent control: maximum price charged for certain accommodation
A price floor – a legal minimum on the price at which a good can be sold
Eg minimum wages (providing a minimum on the hourly rate certain individuals can earn)
When will a price ceiling be effective?
Thus a price ceiling is only binding when it lies below the equilibrium price
If the price ceiling were placed above the equilibrium price, market forces would push the market price up to the equilibrium where it would stay (no incentive to rise)
What are the consequences of price ceilings for consumer and producer surpluses (as per the welfare analysis)?
What are price floors?
A price floor is a legal minimum on the price at which a good or service can be sold
If a price floor was placed below the equilibrium price, then market forces would push the market prices down to the equilibrium where it would stay
