lecture 6 market equilibrium 2017 - weebly

PRICE DETERMINATION

Lecture Chapter 6H1 Economics 2017

Recap

■ What are the (non-price) factors affecting Demand and Supply?

Typical DD/ SS Qn

■ Many airlines had recently announced that they would restructure their airfares given the falling oil prices. At the same time, the World Bank announced that the global economy would continue growing this year. [let’s say that this info is extracted from a case study]

■ Using economic analysis, explain how the above factors might affect the equilibrium price and quantity for air travel. [8]

Conceptual OutlinePrice

Determination

•Equilibrium price and quantity•Changes in equilibrium

Market Equilibrium

Shifts in demand Shifts in supply Simultaneous shifts in demand & supply

6.1

What determines the equilibrium price and quantity of a good in a

market?

Assuming free market economy (no govt intervention!)

■Equilibrium Price & Quantity of a good/ service is determined by demand and supply of the good/ service

Price of good X ($)

Quantity of good X

0 1 2 3 4 5

0.2

0.4

0.6

0.8

1.00

Demand

Supply

6.2

A

6.1 MARKET EQUILIBRIUM PRICE & QUANTITYEQUILIBRIUM PRICE

• The price level at which quantity demanded is equal to quantity supplied

Qd = Qs

6.2

Equilibrium Price & Quantity

• Market Clearing Price where Qd = Qs

• No shortage & no surplus

Price of good X ($)

Quantity of good X

0 2 4 6 8 10

0.2

0.4

0.6

0.8

1.00

Demand

Supply

In this market, the equilibrium price

is $0.60.

6.2

The equilibrium quantity

exchanged is 6.

The total consumer expenditure is

$0.60 x 6 = $3.60

6.2 MARKET EQUILIBRIUM

• Surplus of 20,000 units at price $125,000

• Surplus of 10,000 units at price $100,000

SURPLUSPrice ($’000)

Quantity (‘000)

Supply

0 8 14 24 28

25

50

75

100

125

Demand

20

6.3

A

CB


‘000 per Month

Price per Car

($’000)

Quantity Demanded

Quantity Supplied

Surplus or Shortage

Price Will

$125 8 28 Surplus of 20 Fall


$75 20 20

$50 26 16

$25 32 12

6.3

At a price above equilibrium price

Qs > Qd (Surplus)

Downward Pressure on Price

6.3

When Price is below eqm Price

Shortage occurs as Qd > Qs

Upward Pressure on Price

6.3

• Shortage of 20,000 units at price of $25,000

• Shortage of 10,000 units at price of $50,000

• Price increases until $75,000 when Qd = Qs

SHORTAGE

Price ($’000)

Qty (‘000)

Supply

0 12 16 26 32

25

50

75

100

125

Demand

20

6.2 MARKET EQUILIBRIUM6.3

A

DE


‘000 per Month

Price per Car

($’000)

Quantity Demanded

Quantity Supplied

Surplus or Shortage

Price Will



$75 20 20 None

$50 26 16 Shortage of 10 Rise

$25 32 12 Shortage of 20 Rise

6.3

Qd = Qs

Equilibrium Price is reached

UPWARD pressure on price

Qs↑, Qd ↓

There is a SHORTAGE when

Qd > Qs

Qd = Qs

Equilibrium Price is reached

DOWNWARD pressure on price

Qd↑, Qs↓

There is a SURPLUS when

Qs > Qd

At equilibrium price,

where Qd = Qs,

there is no more pressure for price to change

6.2

When the market is said to be in equilibrium it meansprices will neither ________ nor ________further. It willremain there unless the equilibrium is ______________.At the equilibrium price, the quantity ________________is equal to the quantity _____________.

RISE FALLDISTURBED

DEMANDEDSUPPLIED

THINK: What will caused the

initial equilibrium to be disturbed?

Changes in Equilibrium

Shifts in demand

Shifts in Supply

Simultaneous shifts in demand and supply

6.3 CHANGES IN EQUILIBRIUM6.4

When asked to explain oranalyse impact on market,consider changes to thefollowing:■ equilibrium Price [P]

■ equilibrium Quantity [Q]

■ Price x Quantity [PxQ], i.e. Total Expenditure

Skill: Steps for analysing DD/SS Qn

1. Question Focus (what does the question want?)

2. Identify whether it is a DEMAND or SUPPLY factor

3. Identify the factor that affects Demand/ Supply (PTIDE or CPPSE)

4. Explain with reference to context

5. Paragraph Development (SEED)

6. Ensure that you have answered that question requirement (refer back to pt 1)

General Rubrics for marking (a tick each):

State (identify correct factor)

Elaborate with economic analysis

Exemplify (with reference to context)

Diagram (explained)

Explain correct direction of change in DD/SS

Brief Adjustment process Link to change in

equilibrium price Link to change in

equilibrium quantity

RECALL: Shifts in Demand• P rices of related goods• T astes & preferences• I ncome• D emographics• E xpectations

6.3.1 SHIFTS IN DEMAND6.4

Consider the impact of the following event on the market for cars.

TRIGGER: Rise in income

Figure 2: Market for Cars

■ Shortage at original Price of $75k

■ Upward pressure on price

Price ($’000)

Quantity (‘000)

SS

0 24 30

25

50

75

100

125

DD

20

New eqm is reached when Qd = Qs at a

HIGHER Price

DD1

6.4

AB

C

Step 4

Explanation of Figure 2:

■As income increases, increasing the purchasing power ofconsumers, demand for cars (normal good) will increase, thedemand curve will shift from DD to DD1

■Quantity demanded exceeds quantity supplied at the originalprice of $75,000 per car, resulting in a shortage.

■There is an upward pressure on price as competition for the carsamongst consumers will drive prices up (i.e. consumers who do notsucceed in purchasing all they want of the cars at the current pricewill offer higher prices).

■At the same time, producers would be willing to increase quantitysupplied at the higher prices (Law of Supply). I.e. as the price rises,quantity supplied increases along supply curve SS (from point A toC).

■As price rises, quantity demanded decreases (Law of Demand)along the demand curve DD1 (from point B to C).

■When the new equilibrium price of $100,000 is reached, thequantity demanded will once again equal the quantity supplied.

PRICE MECHANISM

Chapter 3.3.2

6.4

Good to have, but not requiredunless the focus is on price adjustment


■Both the final price and quantity exchanged are higher followingthe increase in demand.

■A rise in DD leads to an increase in eqm price from $75,000 to$100,000 & an increase in eqm qty from 20,000 units to 24,000units

Step 4


■Both the final price and quantity exchanged are higher followingthe increase in demand.

■A rise in DD leads to an increase in eqm price from $75,000 to$100,000 & an increase in eqm qty from 20,000 units to 24,000units

■Given that both equilibrium price and equilibrium quantityincrease, total expenditure on cars, which is given by multiplicationof price and quantity, will rise unambiguously.

Step 5

THINK: Why Do Prices of Old Model Electronics Fall?

You're Not Buying, That's Why…...

Decrease in Demand

• Surplus at original Price• Downward pressure on price• ↓Pe, ↓Qe

Price

Quantity

Supply

0 Q0

P1

P0

Demand1

Q1

Demand0


LOWER Price

Q2

6.6

RECALL: Shifts in Supply•Cost of production• Price of related good• Number of Producers• Supply shocks• Expectations

Increase in Supply (improvement in technology that lowers (unit) COP)

■ Shortage at original Price of $75k

■ Downward pressure on price

■ ↓Pe, ↑Qe, TE?

Price ($’000)

Quantity (‘000)

SS0

0 24 30

50

75

DD0

20

SS1


LOWER Price

6.5

A B

C

■ As more producers enter the market due to improvement intechnology that lowers cost of production, ………

■ Quantity supplied exceeds quantity demanded at the originalprice of $75,000 per car resulting in a surplus.

■ There is downward pressure on price. This is becauseproducers will find that they are unable to sell all their outputat the original price. Hence, they will begin to competeagainst one another to sell their excess supplies, thus askingfor lower prices.

■ As price falls, quantity supplied falls along the supply curveSS1 (from point B to C). i.e. Law of Supply

■ As the price falls, quantity demanded increases along thedemand curve DD (from point A to C), i.e. Law of Demand.This is because consumers will also recognize the excesssupply and begin to offer lower prices.

■ When the new equilibrium price of $50,000 per car isreached, the quantity supplied will once again equal thequantity demanded.

PRICE MECHANISM

Chapter 3.3.2

Good to have, but not required unless the focus is on price adjustment

Decrease in Supply

• Shortage at original Price of $75k• Upward pressure on price• ↑Pe, ↓Qe

Price ($’000)

Quantity (‘000)

Supply0

0 14

100

75

Demand0

20

Supply1New eqm is reached when Qd = Qs at a HIGHER Price

6.6

With the aid of a diagram, indicate whatwill happen to the equilibrium price andquantity exchanged in the following situations:

(a) Demand decreases, c.p. (b) Supply decreases, c.p.

6.6

Price increases, quantity decreases Price decreases, quantity decreases

Price

Quantity

DD

DD1

SS

0

P

Q

P1

Q1

Price

Quantity

DD

SS1

SS

0

P

Q

P1

Q1

6.3 SIMULTANEOUS SHIFTS IN DD AND SS

6.7

6.3.3 SIMULTANEOUS SHIFTS IN DEMAND AND SUPPLY

If both demand and supply curves shift, then either final price or quantity will be indeterminate.

6.7

Let’s look at an example…

Consider the smartphone market. How have the quantity andprice of smartphones changed in recent years over a decade?Explain the changes using demand and supply analysis.Think of both demand and supply factors.

6.8

Change in Eqm P

Change in EqmQ

DD __________

SS __________

Final Impact

Identify and explain the demand factor as well as the supply factor in this context

Draw a diagram (simultaneous shift).

6.8

DEMAND

SUPPLY

Consider the smartphone market. How have the quantity andprice of smartphones changed in recent years over a decade?Explain the changes using demand and supply analysis.Think of both demand and supply factors.

Demand & Supply

6.7

Increase in demand and supply Eqm Qty increases from Q to Q1, Eqm Price indeterminate

Price

Quantity

SS

0 Q

P1 ???

Q1

DD

DD1

E1E

SS1

P

6.7

D

Step 4: Compare initial & new Pe & Qe

The combined shifts reinforce each other in terms oftheir effect on quantity as shown by the increase in eqmqty from Q0 to Q1.HOWEVER, the change in price is indeterminate.

6.7

Demand has increased: ↑DD → P↑ , Q↑Supply has also increased: ↑SS → P↓ , Q↑

P ? , Q↑

Step 5: Make a judgementSince it is observed that price of smartphones has fallenover time. So we can conclude it is likely that the ↑SS>↑DD, eqm price will fall from P to P1

Note: Question only ask for eqm P & Q no need tocomment on TE

6.7

Consider the poultry market. How do thequantity and price of poultry changewhenever the H5N1 Bird Flu pandemicstrikes? Explain the changes using demandand supply analysis.

6.9

Consider the poultry market. How do the quantityand price of poultry change whenever the H5N1 Bird Flupandemic strikes? Explain the changes using demandand supply analysis.

6.9

DEMAND SUPPLY

Fear DD falls

Culling SS falls

Consider the poultry market. How do the quantityand price of poultry change whenever the H5N1 Bird Flupandemic strikes? Explain the changes using demandand supply analysis.

6.9

↓DD P↓ , Q↓

↓SS P↑ , Q↓

P? , Q↓

Qe↓ but Pe is indeterminate

If DD↓ > SS↓, then P↓

If SS↓ > DD↓, then P↑

Δ price??

SS1Price

Quantity

DD

DD1

SS

0

P

Q

P1

Q1

Market for poultry

Consider the tuna market. How will the quantityand price of tuna change given that there hasbeen over-fishing and pollution while tunasushi devotees get richer? Explain the changesusing demand and supply analysis.

6.10

Demand & Supply

6.9

Increase in demand and decrease in supply Eqm Price increases Eqm Qty indeterminate

Price

Quantity0

P1

P

Q ???

SS1

DD

DD1E

E1 SSD

6.9

No end in sight for US property slump as prices fall at record rateThe Guardian 2008

6.10

Using demand & supply analysis, explain the reasons for the falling price of US property.

falling demand due to recession

+

More homes confiscated and released on open market due to default in payment

Demand & Supply

6.10

Decrease in demand and increase in supply Eqm Price decreases, Eqm Qty indeterminate

Price

Quantity

SS

0

P

P1

Q ???

DD

E

E1

DD1

SS1

6.10

D

in demand

in supply

equilibrium

price

equilibrium quantity

1 Rise ‐‐2 Fall ‐‐3 ‐‐ Rise4 ‐‐ Fall5 Rise Rise6 Fall Fall7 Rise Fall8 Fall Rise

6.11

6.4 SUMMARY• Market equilibrium: a point at which the quantity

demanded = quantity supplied.

• Surplus occurs where quantity supplied > quantity demanded, at initial equilibrium.

• Shortage occurs where quantity supplied < quantity demanded, at initial equilibrium.

6.11

Additional Exercises

Market Equilibrium Exercise

“Wet weather and rising consumption for CNY have pushed up vegetable prices in Singapore & Malaysia”

Price of Vegetables

Quantity of Vegetables

S0

D0

P0

Q0

S1

D1

Qe

PeWill equilibrium quantity rise or fall?


Price of Vegetables

Quantity of Vegetables

S0

D0

P0

Q0

S1

D1

Qe

Pe

“Wet weather and rising consumption for CNY have pushed up vegetable prices in Singapore & Malaysia”

Price of Bak‐Kua increases by 40% during CNY

“Price of Bak kua – a popular barbecued meat has increasedto $50 per kilogram during CNY despite an increase insellers.”

Price of Bak Kua

Quantity of Bak Kua

S0

D0

P0 = $30

Q0

S1

Q1

P1 = $20 D1

Pe = $50

Qe


lecture 6 market equilibrium 2017 - weebly

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