Lecture 5: Supply and Demand - Determination of Equilibrium Price and Quantity

Outline:

1. Definition of Equilibrium

a. Equilibrium Price

b. Equilibrium Quantity

2. Disequilibrium Price and Quantity

a. Qs>Qd - excess supply

b. Qd>Qs - excess demand

3. The nature of equilibrium

4. Law of demand - shifts of the demand curve

5. Law of supply - shifts of the supply curve

6. When both curves shift at the same time

1. Definition:

Equilibrium is a situation where there is no tendency for change.

Definition:

Equilibrium price (Pe) is the price at which the quantity demanded equals the quantity supplied.

Definition:

Equilibrium quantity (Qe) is quantity determined by the intersection of the demand and supply curves (Qs=Qd).

Definition:

Quantity exchanged is the quantity of a product that is bought and sold.

Note:

At the equilibrium price the quantity exchanged is Qs=Qd.

2. Definition:

Disequilibrium Price is a price at which the Qs is not equal to the Qd.

Note:

*The market will not remain at a disequilibrium price for long.

* The only way that a disequilibrium price can prevail for long is if the price is set by the government.

3. The nature of equilibrium:

Without any government intervention price will always end up at equilibrium:

If P > Pe There is excess supply (Qs>Qd) in the market and the price will FALL.

If P<Pe There is excess demand (Qd>Qs) in the market and the price will RISE.

With government intervention disequilibrium prices can prevail:

The government will impose a P > Pe and the market will be characterized by excess supply.

The government will impose a P < Pe and the market will be characterized by excess demand.

Changes in Supply and Demand - when only one curve shifts at a time:

4. Law of demand:

Increase in demand (shift to the right of the demand curve) leads to an increase in Pe and Qe.

Decrease in demand (shift to the left of the demand curve) leads to a decrease in Pe and Qe.

5. Law of supply:

Increase in supply (shift to the right of the supply curve) leads to a decrease in Pe and an increase in Qe.

Decrease in supply (shift to the left of the supply curve) leads to an increase in Pe and a decrease in Qe

6. Changes in Demand and Supply: When both demand and supply change at the same time:

Case 1: Increase in D + Increase in S

Result: Qe will increase, Change in Pe is ambiguous without more information about the relative magnitude of the shifts.

Case 2: Decrease in D + Decrease in S

Result: Qe will decrease, Change in Pe is ambiguous without more information about the relative magnitude of the shifts.

Case 3: Increase in D + Decrease in S

Result: Pe will increase, Change in Qe is ambiguous without more information about the relative magnitude of the shifts.

Case 4: Decrease in D + Increase in S

Result: Pe will decrease, Change in Qe is ambiguous without more information on the relative magnitude of the shifts.