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Market Equilibrium - Lecture notes 1
Economics
University of Calcutta
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Market Equilibrium
When supply equals demand, a market is said to be in equilibrium (supply curve intersects demand curve). When a market is in equilibrium, there is no force that will cause further changes in the price, and thus the quantity of goods and services exchanged in the market. If you think about it like this, imagine a cherry rolling down the side of a glass; the cherry falls because of gravity and rolls past the bottom because of momentum; the cherry keeps rolling past the bottom until all of its' energy is expended and it comes to rest at the bottom - this is equilibrium [a rotten cherry in the bottom of a glass].
Price and Value
Principles of Economics, 8th edition (Alfred Marshall, London: Macmillan Publishing Company, 1920, p 348.
“... We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. It is true that when one blade is held still, and the cutting is effected by moving the other, we may say with careless brevity that the cutting is done by the second; but the statement is not strictly accurate, and is to be excused only so long as it claims to be merely a popular and not a strictly scientific account of what happens.”
The graphical analysis that follows depicts a market that is in equilibrium. The intersection of the supply and demand curves yields the equilibrium price (Pe) and the equilibrium quantity (Qe), respectively (Qe)
A series of equations can be used to express the graph of a market in equilibrium. Equations can be used to express both the demand and supply curves.
Demand Curve is Qd = 22 - P
(Notice the negative sign in front the price variable, indicating a downward sloping function)
Supply Curve is Qs = 10 + P
(Notice the positive sign in front of the price variable, indicating an upward sloping function)
The equilibrium condition is Qd = Qs
(For this market to obtain equilibrium, the quantity demanded must equal the quantity supplied in this market)
Therefore:
22 - P = 10 + P
adding P to both sides of the equation yields:
22 = 10 + 2P
subtracting 10 from both sides of the equation yields:
12 = 2P or P = 6
Price
Quantity
Supply
Demand
Qe
Pe
Movement of the supply curve from S1 (solid line) to S2 (dashed line) indicates an increase in supply in the graph below. A change in a nonprice determinant causes such increases (for example, the number of suppliers in the market increased or the cost of capital decreased). As supply grows, the supply curve shifts to the right along the demand curve, causing equilibrium price and quantity to move in opposite directions (price decreases, quantity increases). A decrease in supply occurs when we move from S2 to S1, which could be due to an increase in the price of a productive resource (capital) or a reduction in the number of suppliers. When supply falls, the equilibrium price rises, and the quantity falls as well. The supply curve is moving up along the demand curve, which is negatively sloped (which remains unchanged).
Changes in Supply
Price S
P
P
Demand
Q1 Q2 Quantity If both the demand curve and supply curve change at the same time the analysis becomes more complicated. Consider the following graphs:
S
It's worth noting that the quantity in both graphs is the same. As a result, the change in the equilibrium quantity is indeterminant, and its magnitude and direction are determined by the relative strength of supply and demand changes. The equilibrium price shifts in both cases. The equilibrium price rises in the first case, when demand rises but supply falls. The equilibrium price decreases in the second panel as demand falls and supply rises.
In the event that demand and supply both increase then price remains the same (is indeterminant) and quantity increases, and if both decrease then price is indeterminant and quantity decreases. These results are illustrated in the following diagram
Q1 Q
Quantity Q2 Q1 Quantity
The graphs show that price remains the same (is indeterminant) but when supply and demand both increase quantity increases to Q2. When both supply and demand decrease quantity decreases to Q2.
Price
Increase in Supply and in Demand
Decrease in Supply and in Demand Price
Market Equilibrium - Lecture notes 1
Course: Economics
University: University of Calcutta
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