Market Equilibrium - PDF

Market equilibrium Market is composed of: demand, Supply& Interaction between them. Put the demand and supply curve together to get a complete picture of the market. In this market, When supply and demand are equal (i.e. whe...

Market equilibrium Market is composed of: demand, Supply& Interaction between them. Put the demand and supply curve together to get a complete picture of the market. In this market, When supply and demand are equal (i.e. when the supply function and demand function intersect) the economy is said to be at equilibrium. 12/01/37 1 Market at an equilibrium state: 12/01/37 2  At this point, the allocation of goods is at its most efficient use (allocative efficiency) because the amount of goods being supplied is exactly the same as the amount of goods being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the current economic condition. 12/01/37 3  At the given price, suppliers are selling all the goods that they have produced and consumers are getting all the goods that they are demanding. At this point, the price of the goods will be P* and the quantity will be Q*. These figures are referred to as equilibrium price and quantity. 12/01/37 4  In the real market, equilibrium can only ever be reached in theory, so the prices of goods and services are constantly changing in relation to fluctuations in demand and supply. So, markets are always in a condition of disequilibrium, and struggles to reach the equilibrium. 12/01/37 5  Market disequilibrium A shock is “anything which moves a market out off the equilibrium state” Disequilibrium occurs whenever the price or quantity is not equal to P* or Q* Types of shock: 1. Setting price above equilibrium price 2. Setting price below equilibrium price 3. Changing any other factor that affect demand or supply relationship other than price. 12/01/37 6  Market disequilibrium A B 12/01/37 7 I. Disequilibrium due to changes in price only: I. Excess supply: If the price is set above the equilibrium price, excess supply will be created within the economy (surplus (and there will be allocative inefficiency. 12/01/37 8  surplus 12/01/37 9  At price P1 the quantity of goods that the producers wish to supply is indicated by Q2. At P1, however, the quantity that the consumers want to consume is at Q1, a quantity much less than Q2. Because Q2 is greater than Q1, too much is being produced and too little is being consumed. 12/01/37 10  The suppliers are trying to produce more goods, which they hope to sell to increase profits, but those consuming the goods will find the product less attractive and purchase less because the opportunity cost is higher. This condition of market disequilibrium leads to the presence of surplus. 12/01/37 11 II. Excess demand Excess demand is created when price is set below the equilibrium price. Because the price is so low, too many consumers want the good while producers are not making enough of it. 12/01/37 12  shortage 12/01/37 13  In this situation, at price P1, the quantity of goods demanded by consumers at this price is Q2. The quantity of goods that producers are willing to produce at this price is Q1. Thus, there are too few goods being produced to satisfy the wants (demand) of consumers. This condition of market disequilibrium leads to the presence of shortage. 12/01/37 14 III.Disequilibrium due to shift in the curve: Let’s analyze the reaction by looking at a demand shock caused by a rise in people’s incomes. 12/01/37 15 How the market responds to a shock: EQ2 EQ1 shortage 12/01/37 16  Shows the initial supply and demand curves - SS and DD. The initial market equilibrium is at a price P' and quantity Q'. Now imagine that there is an increase in people’s income. The demand curve will shift outwards to D1D1 because people are willing to buy more goods at the same price 12/01/37 17  This shift in demand throws the market out of equilibrium. Now people want to buy Q111 at price P1 but the suppliers are still only prepared to sell Q1 at that price. The result is excess demand and unsatisfied buyers who react by ‘bidding up’ the price. The rise in price simultaneously reduces the demand and increases the supply until the market regains equilibrium at a new price and quantity. 12/01/37 18  The rise in people’s incomes (shock) has led to a new equilibrium at a higher price P11 and a higher quantity Q11 than before. This process will occur whenever there is shock leading to either a shift in demand or supply. The market will move out of equilibrium with either excess demand or excess supply appearing. The price will then adjust until equilibrium is regained. 12/01/37 19  Why do free markets tend to move towards equilibrium? 12/01/37 20  At equilibrium, producers’ profit and consumer’s utility are maximized OR At equilibrium, allocative efficiency is achieved. 12/01/37 21 Exercise What is the effect of increasing the price of a substitute on the equilibrium market of product X? What is the effect of decreasing price of raw materials on the equilibrium market of product X? 12/01/37 22  Markets for healthcare 1. Regulated markets: Ways in which governments can try to achieve policy objective by manipulating or regulating markets. May be in the form of: 1. Price regulation (price ceiling and price floor) 2. Taxes 3. subsidies 12/01/37 23 I. Price regulation A. Price ceiling (‫) ﺣ ﺪ ا﮴ ﺼ ﻰ‬ 12/01/37 24  Suppliers are forced to sell their products at lower prices. Qs will decrease and Qd will increase leading to shortage. So they are tending to: 1. Providing products with less quality or, 2. Hidden costs (extra costs): more waiting times, less time with doctors. 12/01/37 25 B. Price floor:‫ﺣ ﺪ أد﮲ ﮵ﻰ‬ 12/01/37 26  A law that restricts the price of a commodity falling below a specific level. Suppliers are sure that the price will not fall below this price, so they tend to produce more, this leads to surplus. 12/01/37 27  Price regulations are problematic 12/01/37 28 II. Taxes (on suppliers): It shifts the supply curve to the left (upwards). Leads to market disequilibrium in the form of a “shortage” 12/01/37 29  shortage 12/01/37 30 III. Subsidies (‫)اﻟ ﺪﻋ ﻢ‬: Subsidy is a “payment made by the government to producers where the level of payment depends on the exact level of output”. Example: a dentist providing 100 checkups per month will receive a payment from the MOH of £500 per month. Supply curve shifts to the right (downwards). Leads to a market disequilibrium in the form of “surplus”. 12/01/37 31  Surplus 12/01/37 32  Markets for health care 2. The free market approach (basic market model): A free market is where exchange of goods occurs without interference from the government. Information is a vital ingredient for any market. Both buyers and sellers need to have access to sufficient information to allow them to make rational decisions. One way in which the problem of scarcity can be overcome is to let people buy the health care they want: (how?) 12/01/37 33  Markets for health care are a useful resources allocation mechanism for the following reasons: (characteristics of free markets) 1. In theory, markets automatically tend to move towards a situation of equilibrium where the output produced is exactly equal to the output used. 2. Markets will produce an output that is allocatively efficient, that is each unit of output is produced when the additional benefit it brings exceeds its cost. 12/01/37 34 3. The market is dynamic: Changes in people’s preferences are quickly passed on to and acted on by producers. Cheaper substitute resources are quickly selected for instead. 12/01/37 35