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Supply and Demand: Price and Quantity Determination In The Economics Department, UMR Presents: SupplySupply andand Demand:Demand: PricePrice andand QuantityQuantity DeterminationDetermination inin CompetitiveCompetitive MarketsMarkets StarringStarring u Demand u Supply u Equilibrium and Disequilibrium FeaturingFeaturing uThe Law of Demand uD = D(PENTE) uThe Tendency of Supply uS = S(pent) uEquilibrium/Disequilibrium InIn FourFour PartsParts DemandDemand SupplySupply Equilibrium/DisequilibriumEquilibrium/Disequilibrium (current(current show)show) ChangesChanges inin EquilibriumEquilibrium Part 3 WhatWhat IsIs Equilibrium?Equilibrium? u ItIt isis aa situationsituation thatthat existsexists inin aa marketmarket whenwhen thethe plansplans ofof buyersbuyers areare consistentconsistent withwith thethe plansplans ofof sellerssellers u Or,Or, atat thethe prevailingprevailing price,price, quantityquantity demandeddemanded equalsequals thethe quantityquantity suppliedsupplied u Another,Another, wider,wider, viewview ofof equilibriumequilibrium isis whenwhen thethe actionaction takentaken leadsleads toto consequencesconsequences thatthat areare expected,expected, therethere isis nono incentiveincentive toto changechange NotesNotes AboutAbout thethe ConceptConcept ofof EquilibriumEquilibrium u First,First, therethere shouldshould bebe nono priorprior judgementjudgement aboutabout whetherwhether aa givengiven equilibriumequilibrium isis goodgood oror badbad u Second,Second, marketsmarkets notnot inin equilibriumequilibrium areare inin DisequilibriumDisequilibrium v Shortages, or v Surpluses TheThe EthicsEthics ofof EquilibriumEquilibrium u WilliamWilliam Lynch’sLynch’s (1742(1742--1820)1820) earlyearly AmericanAmerican tribunalstribunals dispatcheddispatched swiftswift resultsresults withwith bodiesbodies soonsoon comingcoming toto restrest (an(an equilibrium)equilibrium) butbut mostmost havehave rejectedrejected thisthis asas aa goodgood formform ofof justicejustice u CompetitiveCompetitive equilibrium,equilibrium, underunder certaincertain conditions,conditions, isis efficientefficient v Given scarcity, efficiency is a desirable social objective u ItIt isis thethe consequencesconsequences ofof equilibriumequilibrium wewe havehave toto judge,judge, notnot thethe statestate itselfitself ManyMany ProcessesProcesses AreAre NotNot inin EquilibriumEquilibrium u TheThe oneone constantconstant isis changechange u InIn economicseconomics changechange isis purposefulpurposeful andand maymay oftenoften bebe modeledmodeled successfullysuccessfully u EquilibriumEquilibrium resultsresults fromfrom aa givengiven change,change, anan endend statestate impliedimplied byby thesethese modelsmodels u ManyMany economiceconomic processesprocesses “tend“tend toward”toward” equilibriumequilibrium DisequilibriumDisequilibrium u Usually markets are “tending toward equilibrium” driven by the forces of supply and demand v Prices are used as a rationing mechanism u Changing demand or supply conditions create incentives for buyers and sellers to change their behavior u Disequilibrium is characterized by v Excess demand--a shortage, or v Excess supply--a surplus u Price controls (ceilings or floors) lead to shortages or surpluses ShortageShortage u ShortageShortage -- whenwhen QQD >> QQS atat currentcurrent marketmarket priceprice v Amount of shortage = QD - QS u NoteNote -- itit isis notnot correctcorrect toto saysay demanddemand exceedsexceeds supply,supply, butbut ratherrather quantityquantity demandeddemanded exceedsexceeds quantityquantity suppliedsupplied SurplusSurplus u SurplusSurplus -- whenwhen QQS >> QQD atat currentcurrent marketmarket priceprice • Amount of surplus = QS - QD u NoteNote -- itit isis notnot correctcorrect toto saysay supplysupply exceedsexceeds demand,demand, butbut ratherrather thatthat quantityquantity suppliedsupplied exceedsexceeds quantityquantity demandeddemanded PricePrice ControlsControls ThereThere areare twotwo typestypes ofof priceprice controlscontrols -- priceprice ceilingsceilings andand priceprice floorsfloors PricePrice CeilingsCeilings u PricePrice ceilingceiling -- setssets aa maximummaximum priceprice thatthat isis allowedallowed byby lawlaw u ResultResult ofof priceprice ceilingceiling v Stay at a permanent shortage situation u NoteNote thatthat aa priceprice ceilingceiling cancan bebe anyany priceprice thethe governmentgovernment chooses.chooses. ItIt is,is, howeverhowever onlyonly effectiveeffective ifif itit isis belowbelow thethe equilibriumequilibrium priceprice u ExamplesExamples includeinclude maximummaximum rentsrents forfor apartmentsapartments andand UMRUMR parkingparking permitspermits PricePrice FloorsFloors u PricePrice floorfloor -- setssets aa minimumminimum priceprice thatthat isis allowedallowed byby lawlaw u ResultResult ofof priceprice floorfloor v Stay at a permanent surplus situation u NoteNote thatthat aa priceprice floorfloor cancan bebe anyany priceprice thethe governmentgovernment chooses.chooses. ItIt is,is, howeverhowever onlyonly effectiveeffective ifif itit isis aboveabove thethe equilibriumequilibrium priceprice u ExamplesExamples includeinclude agricultureagriculture priceprice supportssupports andand thethe minimumminimum wagewage EquilibriumEquilibrium inin thethe MarketMarket u EquilibriumEquilibrium -- wherewhere quantityquantity demandeddemanded equalsequals quantityquantity suppliedsupplied u EquilibriumEquilibrium priceprice (P*)(P*) -- priceprice wherewhere equilibriumequilibrium occursoccurs u AtAt PP* therethere isis nono incentiveincentive forfor buyersbuyers oror sellerssellers toto changechange theirtheir behavior.behavior. TheirTheir plansplans areare consistentconsistent Equilibrium,Equilibrium, GraphicallyGraphically P S E P* D Q/t 0 Q* EquilibriumEquilibrium inin thethe MarketMarket WhatWhat occursoccurs atat equilibriumequilibrium u DemandDemand sideside -- thosethose whowho getget thethe goodgood areare thosethose willingwilling andand ableable toto paypay thethe P*P* u SupplySupply sideside -- onlyonly thosethose sellerssellers whichwhich areare ableable toto produceproduce atat oror belowbelow thethe costcost ofof P*P* willwill remainremain inin businessbusiness u PricesPrices rationration availableavailable supplysupply toto thosethose whowho valuevalue thethe goodgood highesthighest TendencyTendency TowardToward EquilibriumEquilibrium inin thethe MarketMarket u Note that if the price is P below P* then there will S be a shortage causing P* price to rise D u If the price is above P* If the price is above P* 0 Q/t then there will be a Q* surplus causing price to fall u Self interest generates these price changes AnAn ExampleExample----UMRUMR StudentStudent ParkingParking u It is easiest to see the tendency toward equilibrium by looking at a good that is not rationed by price--student parking u First, ask whether demand and supply curves are typical u Demand--is there an inverse relationship between the number of parking spots wanted by UMR students and the price of the slots? Clearly YES u Upward sloping supply? Again yes, the more the administration could extract from students, the less important it would be for them to provide parking for staff and faculty UMRUMR StudentStudent ParkingParking MarketMarket inin EquilibriumEquilibrium P S Use the hypothetical P* and Q* as benchmarks. Where are P* actual P and Q relative to P* and Q*? D Q/t 0 Q* WhereWhere AreAre ActualActual PP andand QQ RelativeRelative toto PP** andand QQ*?*? u IfIf youyou saidsaid “less“less than,”than,” gogo toto thethe headhead ofof thethe classclass u AdministrationAdministration policypolicy P S P* regardingregarding allocationallocation ofof Pa D scarcescarce parkingparking slotsslots 0 Q* Q/t createscreates aa shortageshortage QD u InIn effecteffect therethere isis aa priceprice ceilingceiling imposedimposed byby UMRUMR ShortageShortage u ThereThere areare aa lotlot moremore studentsstudents wantingwanting toto buybuy parkingparking permitspermits thanthan UMRUMR isis willingwilling toto sellsell u Why?Why? BecauseBecause atat thethe currentcurrent price,price, thethe quantityquantity demandeddemanded isis quitequite high.high. ButBut UMRUMR doesdoes notnot wantwant toto sellsell thatthat manymany atat suchsuch aa lowlow priceprice ShortageShortage ShownShown GraphicallyGraphically P S Pa = actual price Qa = actual quantity sold P* Note the quantity supplied is the quantity sold: QS = Qa Pa D Q/t 0 Q* QS QD Q a Amount of Shortage WhenWhen PricePrice IsIs NotNot UsedUsed AsAs aa RationingRationing DeviceDevice ShortagesShortages TendTend toto PersistPersist u StudentsStudents maymay actact politicallypolitically v Letters to “the miner” v Through student government u StudentsStudents maymay exitexit thethe marketmarket----transfertransfer toto anotheranother schoolschool u TheseThese areare explicitexplicit reactions.reactions. AnAn advantageadvantage ofof priceprice rationingrationing isis itit isis donedone implicitlyimplicitly HowHow PricePrice RationingRationing EliminatesEliminates ShortagesShortages P S Buyers who expected to buy are unsatisfied E Sellers find they P* have more buyers than supply Pa D Q/t 0 Q Q* S QD ShortageShortage EliminatedEliminated ThroughThrough PricePrice IncreasesIncreases u SellersSellers findfind littlelittle resistanceresistance toto priceprice increasesincreases u BuyersBuyers can’tcan’t getget allall theythey wantwant andand areare willingwilling toto paypay moremore u PP willwill increaseincrease v QuantityQuantity demandeddemanded willwill fallfall v QuantityQuantity suppliedsupplied willwill increaseincrease
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