Lecture Notes: Equilibrium and Adjustment Process

Key Concepts

• Equilibrium Price
  • Definition: The price where quantity demanded equals quantity supplied.
  • Importance: At this price, there are no external forces pushing the price up or down.
  • Stability: The equilibrium price is the only stable price in a market.

Market Dynamics

• Price Above Equilibrium

  • Example: $80 per barrel.
  • Result: Surplus, as quantity supplied exceeds quantity demanded.
  • Adjustment: Sellers reduce prices to eliminate surplus and move towards equilibrium.

• Price Below Equilibrium

  • Result: Shortage, as quantity demanded exceeds quantity supplied.
  • Adjustment: Buyers compete for the good, pushing prices up towards equilibrium.

Equilibrium Quantity

• Definition: Quantity where quantity demanded equals quantity supplied.
• Incentives:
  • Below Equilibrium: Potential gains from unexploited trade push the quantity bought and sold up.
  • Above Equilibrium: Waste occurs when suppliers produce more than buyers are willing to pay.

Gains from Trade

• A free market maximizes gains from trade at equilibrium price and quantity.
• Consumer Surplus: Benefit to buyers.
• Producer Surplus: Benefit to sellers.

Market Efficiency

• Supply and Demand:
  • Goods are bought by buyers with the highest willingness to pay.
  • Goods are sold by suppliers with the lowest costs.
  • No unexploited gains from trade or wasteful trades.

Conclusion

• Free markets maximize trade gains by ensuring that only the most valued transactions occur without waste.
• Equilibrium ensures that goods are distributed efficiently to those who value them most and are produced by the most cost-effective suppliers.

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Additional Resources

• Practice questions available for self-testing.
• Option to proceed to the next video for new material.