Lecture 7

The Functions of Price & Price

Determination in the Market System
Determining the equilibrium
• In this unit, we look at the meeting of buyers and sellers in a
competitive market – the meeting of demand and supply curves.
• Where both curves meet, or QD = QS, the point of intersection is where
we say the market is in equilibrium.
• At equilibrium, there is equilibrium price (PE) and equilibrium
quantity (QE).
Determining the equilibrium
• The equilibrium price (PE) – also referred to as the market-clear price
– because all the products supplied to a market are bought or cleared
from the market – is where every buyer willing to pay for that price
finds a seller willing to sell at that price.
• The equilibrium quantity (QE) is the quantity bought and sold at that
corresponding equilibrium price.
Determining the equilibrium
• Suppose here, an example of the demand and supply schedules.
• The equilibrium price is _____, and equilibrium quantity is _____.
Determining the equilibrium
• Graphically, the equilibrium is
represented by the point of
intersection between demand
and supply curves.
• So, PE = £6, QE = 6m units
What if it’s not in equilibrium?
• When buyers and sellers cannot
agree on the price, the market is
in disequilibrium.
• If price is £2, QD of 12m units >
QS of 2m units.
• What results is a shortage
(excess demand) (QD > QS).
There will be many consumers
who want that good (sold at a
relatively low price) but are not
able to get the good.
What if it’s not in equilibrium?
• Therefore, shortage – measured
in the difference in quantity – is
10m units.
• At £2, would-be buyers cannot
find sellers, market pressure
forces buyers to have to pay
more until it reaches PE. These
forces are what we refer to as
free market forces.
What if it’s not in equilibrium?
• If price is £10, QD of 0m units <
QS of 10m units.
• What results is a surplus (excess
supply) (QS > QD). There are
many producers happy to sell it at
that price because they know
they can fetch higher revenues /
profits, but consumers are not
willing willing and prepared to
pay £10 for a unit. Sellers get no
buyers.
What if it’s not in equilibrium?
• At £10, would-be sellers cannot
find buyers, market pressure
forces suppliers drop price until
it reaches PE. Free market
forces are at play.
• Therefore, surplus – measured in
the difference in quantities – is
10m units.
• Therefore, only at £6 will all
possible transactions occur.
Changes in demand and supply lead to
changes in equilibrium
Changes in demand and supply lead to
changes in equilibrium
• Recall that changes in demand and supply are represented by shifts of
the curves, either leftward or rightward.
• These shifts of the curves will have an effect on equilibrium – PE and
QE will change.
• Let’s bring back one of the conditions of demand as an illustrated
example – change in incomes.
Changes in demand and supply lead to
changes in equilibrium
• If your income rises, your
demand for a normal good will
(increase / decrease).
• The demand curve of this normal
good shifts to the (left / right).
Changes in demand and supply lead to
changes in equilibrium
• As a result of the shift (increase
in demand for normal good), the
equilibrium price rises, and the
equilibrium quantity (quantity
bought and sold) increases,
ceteris paribus.
• So, an increase in demand shifts
the demand curve and this then
leads to a movement along the
supply curve.
Changes in demand and supply lead to
changes in equilibrium
• Another example – in the early
2000s, manufacturers introduced
into the market, flat screen, slim
line televisions.
• Clearly, demand for these flat
screen, slim line televisions has
had increased since, and demand
for old, bulky sets has had
decreased since.
Changes in demand and supply lead to
changes in equilibrium
• If the good in question here is the
old, bulky sets, this will translate
to a leftward shift of the demand
curve for these bulky sets
(inferior goods).
• As a result of this shift, the
equilibrium price falls, and the
equilibrium quantity decreases.
Changes in demand and supply lead to
changes in equilibrium
• Another example – the prices of
televisions have fallen since 1970s
due to progress in technology.
• Progress in technology benefits the
suppliers – lower costs of
production à producers more
willing to supply à supply
increases (supply curve shifts
rightward).
• As a result of this shift, the
equilibrium price falls, and the
equilibrium quantity increases.
 Simultaneous shifts of
demand and supply curves
Simultaneous shifts
• Insofar, we have seen a change in either demand or supply curve that
leads to a change in equilibrium.
• In reality, several factors can affect both demand and supply at the
same time. Both curves shift simultaneously.
• E.g. in 2000s, the demand for flat screen high definition television sets
increased due to rising incomes. At the same time, supply increased
too because of an increase in productive efficiency.
• What results is an increase in demand, and an increase in supply.
Simultaneous shifts
• Demand curve shifts rightward,
supply curve shifts rightward.
• What happens now to
equilibrium? From point A to B,
the equilibrium price falls (from
P1 to P2), and equilibrium
quantity increases (from Q1 to
Q2).
Simultaneous shifts
• However, one of the variables –
either P or Q – is what we say,
indeterminate.
• This is because – in this case –
we are uncertain about the
severity of the shift. We do not
know by how much demand curve
shifts to the right, or by how
much supply curve shifts to the
right.
Simultaneous shifts
• If supply curve shifts to the right
by a small margin, and demand
curve shifts to the right by a huge
margin, what is likely to occur is
that the equilibrium price rises,
and equilibrium quantity
increases.
Simultaneous shifts
• We can also expect a third
outcome, where equilibrium
price remains unchanged, and
equilibrium quantity increases.
• Since equilibrium price can
increase, decrease or remain
unchanged, we say PE is
indeterminate, QE increases.
In summary,
• Markets move towards equilibrium. At equilibrium, we expect an
equilibrium price (market price) and equilibrium quantity (quantity
bought and sold).
• Circumstances or events cause changes in demand and supply, which
in turn causes changes in equilibrium.
• When both demand and supply curves simultaneously shift, because
the severity of shift is not known, one of the variables will be
indeterminate.
Exercise
• For the market of burgers, what
happens to equilibrium price and
equilibrium quantity when there
is new grilling technology.
Exercise
• Draw the demand for burgers.
Show what happens when the
price of a substitute falls.
Exercise
• Draw the demand and supply
curve showing what will happen
to equilibrium price and
equilibrium quantity of hot dog
buns if the price of hot dogs rises,
and the price of flour falls.
Readings and assignment
• Essential – please read Unit 12 of textbook.
• Anderton, Alain. (2015). Unit 12: Price determination. In Economics (6th ed.),
pp.69-75. UK: Anderton Press Ltd.
• Assignment
• Please attempt the unit questions in the textbook.