Market Equilibrium and Exam Study Guide

So let's go ahead and get started. In terms of announcements, my office hours are listed here as well as on the webpage. We're going to be moving, I believe this should be actually Chapter 8, we're moving into Chapter 10 this week in the textbook. Midterm exam is a week from today, I'll talk about that in a little bit. And so a week from today in class, please email me if you need accommodations or will be gone if you've already talked with me. Our next lab sessions are Thursday and Friday. Those are the exam review. I highly recommend you study for that. And then lab and homework. If you haven't turned it in, turn it in at the end of class. Online assignment. So there is an assignment for this week. It's online. It shouldn't take any more than six to eight hours. I get a stare. What? No, it shouldn't take you very long. I believe it's like 10 questions or 12. And so make sure you complete that by Friday. And then we will have tutoring this week. If you have questions about the exams, reviews, stuff like that. There are exam questions for review online. There's some problems if you want extra questions to go over. The answers are posted, too. They're separate. So. you can download, go through them and work through them for studying. Okay. Questions on anything? Well, if not, I'll talk about the midterm exam. And then today we're going to start moving into chapter 10, looking at markets and market equilibrium and what that means. and then mathematical models for markets. So the midterm exam is on Monday. It's similar to the last exam. It'll cover all the material through last week. So through elasticity lecture. And it covers everything from the profit maximization stuff that we did for the firm. So break-even points, shutdown points, on through elasticities. There's 23 multiple choice questions, exactly the same. And it is applied. So you've had one of my exams already. You kind of get the way the questions are written. As with the last exam, please bring your WID, a number two pencil, a calculator. You will be allowed a three by five note card. I recommend you study. Get your note card ready for lab. It can pay off. In terms of, this is in the skeleton note. So it's available online already. These are the topics being covered. for the exam. Okay? And so you can get those. In terms of note cards, you are allowed a three by five note card or a similar size sheet of paper if you want it smaller. I'm all right with that. You can put whatever you want on the note card front and back. If you want to see smiley faces because it makes you happy, more power. Okay? I recommend writing down formulas, definitions that you need to know, examples, graphs, and so on. Okay? whatever you think you need. The big thing is make sure you can read it and find info on it. So this is a bad note card. It is about three by five. It does separate, so hopefully your hand is consistent. This one, you might not get a handle on the situation. You can have smaller than 3x5 if you've ever felt you wanted to be a little stealthy with your note card. You can have a little one like that. These are bad note cards. This may help with a couple questions. Recommend a little more info on there. Here's an example. These are, I couldn't find note cards, but here's a good example of a good note sheet. Make sure you can read it. I don't know if that one is, hopefully that's legible to the person who wrote it. This is probably my favorite. It's a little crowded. It probably could have been a little better organized or color coded so you could find stuff on it. But that has a whole lot on it. You're like, that's for an astronomy class, so don't, don't wig out on the equations. We're only going to use about half of those. Okay. And so what I want to do now, so please make your note cards, make them useful, do them. One of the reasons I like to push them is it's not only to help out because I don't want you to memorize formulas, write them down. It's also to have you start organizing your thoughts for the exam. OK, and going through your stuff in your notes. So review a question. Consider the market for corn. The price of wheat, the substitute in consumption increases. What happens? Which two can you eliminate immediately? There's two answers. You can read the question and go, it's not those two. Nope. One of the increases, right? It's A and B, right? What's the only thing that'll change A and B? The price of corn, the own price. It's not, if it's anything else, it's a determinant. It's going to shift the supply curve. You know, it has to be C and D. So which one is it? It is D, right? Wheat is a substitute in consumption. And so make sure you're reading if it's a substitute in consumption or a substitute. substitute in production. They are different. Given wheat is a substitute consumption as the price of wheat increases, consumers will want to purchase more corn. They're substituting to corn because wheat's now more expensive. It's a cheaper alternative. That causes corn, the demand for corn to increase, shifting the curve to the right. Consider the market for oil. In March, many universities and public systems have spring break, providing students and family an opportunity to travel. What's the likely effect on the market demand for oil? You can talk with your neighbor. So what'd you get? B or D? How many people think it's B? How many people think it's D? D is correct. Remember, the only thing that will cause A and B to change is what? The price of oil, the oil price. What? So the increase in travel increases the demand for oil. There's a higher preference for it. That shifts the demand curve which direction? To the right. So you're in a boat with a 10-foot rope ladder hanging over the side. Each rung of the ladder is one foot apart. The bottom end of the ladder just touches the water. The tide is coming in, raising the water level six inches every hour. How long will it take for the water to reach the top of the ladder? Hold on, let people think about it. What'd you get? Should be D, right? Y. Boats float. Boats float. So up until now, we've looked at individual and aggregate behavior of firms and consumers separately. What we want to do now is bring them together. So we've seen the production by firms, consumption by consumers, and we know this depends on the price. What we haven't figured, so we know that price influences what's going to be produced and consumed, but we haven't figured out where price comes from. And so now we want to put supply and demand for a good and service together to look at and discuss the concept of markets, where supply and demand interact. It's this interaction that determines the prevailing price in the market and how much will be consumed and produced at the end of the day. So recall both consumers and producers choose how much they're going to consume or produce based on that market price. And we're still assuming both consumers and producers are in essence price takers. No one's big enough to influence the price, especially consumers, but neither are for firms so far. Okay. And so it's the market that determines the price, that aggregate behavior. No individual's large enough to influence it though. So what is a market? A market is an institution where buyers and sellers interact. And this is important because we tend to think of markets as something like a grocery store, which it is, but markets are actually legally recognized things. They are institutions. We have taken a long time to define our markets and we're still defining. There's a massive legal system built around our markets. and why they operate the way they do. It's why money has value. Otherwise, it'd be paper. Patented paper with patented ink. Markets are not necessarily bound by space or physical locations. They can be like a farmer's market. Many exist virtually. Heck, half our shopping now is online. and we have it shipped to our house. Amazon is a virtual market. And so there's two important aspects of markets we want to look at. Markets determine the price and quantity of a good or service purchased or sold, and they're voluntary. So consumers and producers are free to enter and exit the market at will. So markets bring together producers and consumers. Producers want to supply their product at the highest possible price. Their collective willingness to produce is captured in the market supply curve. It tells us, holding everything out constant at a given price, how much will firms produce? As the price goes up, it becomes more profitable because we look at the curve, costs are fixed, and so they'll produce more. And notice, remember, we have a positive slope due to the law of supply. To this, we add the demand curve. The demand curve captures the willingness of consumers to pay for a good or terrible collectively. It tells us at different prices how much of a product or service will be consumed. holding everything else constant. Okay? And remember, it's downward sloping due to the law of demand. How many people have done supply demand before? Have seen this graph? Ooh, I thought it'd be more. So producers and consumers interact in the market. It's this interaction that determines the prevailing price and quantity at an aggregate scale. No individual consumer or producer has that influence, but the aggregate behavior of consumers and producers results in what we call a market equilibrium, where a price prevails in the market for a good. Okay. Recall an equilibrium is a point from which there is no tendency to change. So once an equilibrium is found, there's actually an economic incentive in the market to stay there. The market equilibrium exists at the point at which the supply curve and the demand curves intersect. So by definition, it's the point where quantity supplied by producers at a given price is equal to the quantity demanded by consumers. It's given by the point E in the graph at the intersection of these two curves. That's where the pot of gold is. Economics, we like to say, hey, X marks the spot. What we'll learn though is this equilibrium is an elusive target. Pesky determinants of supply and demand cause it to continually move. And so we're always chasing it. So to market equilibrium, two things occur. What we have is a singular quantity we call Q star, equilibrium quantity. In essence, at equilibrium, quantity supplied equals quantity demanded. And there's one prevailing price we call the equilibrium price. Sometimes we designate it as B star. Or sometimes you'll hear it as the market clearing price. This is the point where equilibrium occurs, where everything produced is sold. So one of the things for me for equilibrium, so we have markets that tend toward equilibrium. Probably more important than that, we tend to assume in economics markets move toward these equilibriums. It's more how they get there that's actually more important. Because these equilibriums were rarely at them, if ever. And so they move. Something changes in the market, like a hurricane, throws all the markets out of whack. And so then they have to readjust. And by the time they readjust, something else happens. There's a new tax, a new policy. Preferences change. Internet story goes viral, changes the whole market again. And so they move, especially with the flow of information these days. And so markets are constantly in flux. And if you're ever wondering about that, all you have to do is look at the stock market and literally watch stock prices by the minute. They change every single minute, if not more often. So while there's an equilibrium, there's no tendency to change. Why do we get to market equilibrium? So it's the process that moves us there that is more important. To look at this, let's consider the market for beef. OK, so QS will be our supply curve for beef and QD. will be our demand curve for beef. Okay and so what we want to look at is why do we tend toward that point at that intersection E. So for the first one consider a price. So this is our equilibrium price and equilibrium quantity. Consider a price pH. Don't confuse that with the acidity of water or the base I guess. Just high price. We have a price higher than the equilibrium. So in the graph, we have this higher price. In this situation, the demand pair tells me I'm going to consume QC. This is quantity demanded. So this is what consumers will purchase. Suppliers are like, yee-haw, we have a high price. We're going to produce a QP. So production is way higher than consumption. Right. And so what do we end up with something in the market that we call a surplus? When quantity supplied is greater than quantity demanded, we have a surplus in the market. So producers are willing to produce more than consumers will consume. And so you get a surplus equal to the difference in QP minus QC. It's this distance here. And that never happens, right? I would say this happens all the time. How do we know this happens all the time? What sections do stores have often? Or if you go to Walmart or the grocery store or anything? Yeah, there's clearance sections, there's sale racks. Hey, those are due to surpluses. have them all the time in existence and so if we have a surplus how do you get rid of a surplus well you'll cut production but yeah right how does that how does the surplus get rid of how do we get rid of it to sell off the surplus what do we need to do we lower the price hopefully We don't get the full surplus. Hopefully the market signals, hey, this is way too much. We're forecasting and going, we're producing way too much. We're cutting back before we hit that full production. And so the price starts coming down. They start selling off some of that surplus. So that surplus exists whenever the price is higher than the equilibrium price. And so... They're going to reduce the price to sell off the surplus, right? And as the price goes down, what will consumers do? The oil price is falling. Quantity demanded goes up. Law of demand. They start consuming more. It also incentivizes producers as that price falls to do what? Produce less. And so there's a market signal that says, hey. There are people starting to sell their stuff at a cheaper price to get rid of it than the current market price. That signals as more individual sellers come along and start lowering their prices, you get an aggregate effect where the market price starts to fall. And producers start producing less. Consumers will start consuming more. Especially some of that surplus, we end up back at the... And that keeps on going until we hit the... Equilibrium. So no individual producer or consumer really knows where that equilibrium is, especially in really big markets. It's elusive. I always try to think, hey, it's that squirrel running in my backyard that's covered with huge bushes, weeds, and trees. And you got to go find it. And all you have is a slingshot. And you're half blind, right? And so you may actually, so with the surplus, we'll keep on reducing that price till we hit market equilibrium, okay? And so at this point, the market clears. We might overcompensate, though. And so we end up with our second case where the price is lower than the market equilibrium. So we know if it's above, there's an incentive to move to E, to the equilibrium, and back to P star, the equilibrium price. But what happens if the price is lower than the market equilibrium? Well, consider a price PL. At this price, consumers want QC. Wow, wow, it's cheap. We're going to buy a whole lot. Producers, though, aren't willing to supply them, produce that much. And so production is way under consumption. In general, we call this an excess demand. But another term we use for this is what we call a short. And so a shortage is when consumers are willing to buy a whole lot more. than producers are willing to produce for the market. And so what we have is a shortage that's equal to QC minus QP. So a shortage exists whenever the price is above the equilibrium price. OK, the question is, how will producers respond again? So producers are like, imagine you're at an auction. There's scarcity in the marketplace, right? Because there's very limited product. And we see this a lot of the time. Imagine the new iPhones. So what happens when new iPhones or new game consoles come out? that are just on the marketplace. So when the PlayStation 5s came out, they sold for 500 bucks. Still do. But how much were they selling for when they first came out? So people were hoarding them and then they sold for up to a thousand a piece, double their price. And Sony couldn't keep up with production. It took about a year. a full year to a year and a half to get to normal production levels where you could go into a store and actually buy a PlayStation without going, hey, hey, do you have any? Tried to buy my kids one. We wait, we just decided, hey, four is good enough. It took us a year and a half until we actually could be able to walk into a store and buy a PlayStation where they weren't gone the day they came in. They lasted that long. iPhones are the same way when they sometimes when they first when they first released them, it took a year to get an iPhone. I remember Toyota when they released the Prius. It was a year to two years to get a Prius. There was that much of a at least a six month to a year waiting list, if not longer, depending on what you wanted. And so how do producers respond? They jack up the price. They can. People are willing to pay it. So there's this much higher, they start, and producers are like, hey, we can actually sell more because there's scarcity. And so they start increasing the price slowly and testing the market. As more and more producers start doing this, that market price starts going up in aggregate. Consumers then start backing off. More and more exit the market and decide, hey, it's too expensive for me. And so notice, as producers go up, they get to produce more, they're making more money, producers start exiting the market for this, and then they end up eventually back at market equilibrium at P-star, the equilibrium price, and equilibrium quantity. Likely, in reality, what happens is We're up here, it swings down here, swings back up here, but not as far, swings back down here, right? And by the time you got close, boom, the equilibrium moved. That's the reality of markets. We are in constant disequilibrium. And all you have to do is watch the news. Election years are bad for markets in terms of finding equilibrium. They're all over the place. policy and everything, uncertainty. But one of the reasons we use market equilibrium is it does give us a baseline to model markets. And so one of the tools we use in economics, and the reason I do use the math, is because it's one of the primary tools we use. And so we build very complex mathematical models of markets. We're going to do a simple one using linear supply and demand, but we can represent supply and demand curves with mathematical functions. Let's just derive a linear supply and demand. So a linear supply curve, remember, our basic curve is y equals mx plus b. Here, y is our quantity supply. X is our price. And so we calculate our slope, the change in quantity supplied over the change in quantity demanded. And so all you need to do is pick two points. In the graph, I chose 7 and 5. Just pick the first two rows. 7 minus 5 is 2. 1 minus 0 is 1. It's 2. So I got a positive 2. Is that right? Why is that right? If you obey the law, why is that right? Law of supply, right? Upward sloping. Firms will produce more. they are more profit as price goes up. So once we know the intercept, we can use the formula we've used for our interce-or once we know the slope, we can use the form to figure out our intercept. All I need is then to just plug in a one point in the table. So I'm going to use the seven and one, the second row. So I plug in seven for quantity supplied, one for price, solve that. and you get 5, which is already in our table. And then put it together. So when we ask you to write out the supply curve, you plug in m and b, replace y with qs, x with p, you get the following supply curve, qs equals 5 plus 2 times p. The reason we do this, and there's a lot of time spent on this, especially for demand. How do you think we do demand forecasts and figure out what's happening in the market? And it's so much better than just by using your gut. A lot of people use their gut in industry, and quite often... It's wrong, especially when it comes to market level stuff. Even people that are really experienced get it wrong. I mean, that's why they said, what did they say? Economists predicted nine out of the last five recessions. We can do the same thing with demand. So in this case, y is quantity demanded, x is price, and we want to derive a demand curve. So let's use the first, second, and third row, 1, 16, and 2, 12. It's the same process. Take a minute or two, derive out this demand curve with the person next to you, behind you, diagonally to you, in front of you, depending where you're at. I'll have to look at it. So what did you get for the slope? Should be negative 4. It's a change in quantity, which is negative 4 over 1, or depending on how you put it, 4 over 1. And what do you get for the y-intercept? it equals 20. So when you put this together you get Qd equals 20 minus 4 times p. So the question is why, so then once we know supply and demand, so we can derive these curves, what's of interest is let's assume these are the supply and demand curves for the beef market. And so our demand curve is 20 minus 4p, our supply curve is 5 plus 2p. We now have two equations and two unknowns. Because at equilibrium, quantity supplied will equal quantity demanded. They'll be the same. So we can treat them as one variable. So to find the equilibrium, we know the first rule is qd equals qs equals q star. So this will be the same quantity. We have a price. I have two equations, two unknowns. I can solve them. Okay? If they intersect, we should have a solution. And we know they do. One's downward sloping, one's upward sloping. So I can use this condition then to actually find p star. plug these two into this condition. So you get 20 minus 4p equals 5 plus 2p. So this is the, we have the demand equation equals the supply, quantity supply. So at equilibrium that has to hold. Kind of simplify, add 4p to both sides. subtract 5 from each side, and then solve for p. If once you divide both sides by 6, you get p star equals 2.5 or 15 sixths, which reduces to two and a half. To find the quantity, all you have to do is pick that price into one of your equations. So put it into your demand equation, plug in the price, you get a quantity of 10. You can check if that's right. By plugging 2 into the other equation, 2 and 1 half, you also get 10. It's just a double check. You only need to put it into 1. And so by solving that system of two equations, we find our market equilibrium, B star, Q star, is 250, 10. we also can graph that solution. So if you graph it, remember prices on the y-axis, quantity on the x-axis, all you need to graph these lines is find two points on each line, draw the straight line through it okay where they intersect we've already sold for it 10 250. and so we have our demand curves downward sloping our supply curve and our market equilibrium One thing I will point out to you, the way we wrote the supply and demand curves where Q is on the left-hand side of the equation, that intercept is the x-intercept because quantity is on the x-axis. So just if you're wondering why doesn't it intersect over here, because quantity is on the x-axis. So we're writing quantity as a function of price. Starts at 5, which was our intercept for the supply curve. Intersects at 20, which was our intercept for the demand curve. So give me another minute. So in terms of this, we'll finish the notes on Wednesday. But real quick. In terms of if you still have your assignment, please make sure to turn it in up here. It is due. And then also, please remember to start thinking about your note cards and looking through the exam materials. Do not wait until Sunday to study. Okay? Okay? And, hey, real quick, so I can get everyone's attention before it gets loud. If you are looking for study groups, I've had some people email me. I'm going to start emailing those people to try to help put those together. Okay? All we're doing is trying to help connect people to form study groups. It's up to you then to kind of organize and get together if you don't have one. Okay. Otherwise, have an awesome afternoon.

Our next lab sessions are Thursday and Friday. Those are the exam review. I highly recommend you study for that.

And then lab and homework. If you haven't turned it in, turn it in at the end of class. Online assignment.

So there is an assignment for this week. It's online. It shouldn't take any more than six to eight hours.

I get a stare. What? No, it shouldn't take you very long. I believe it's like 10 questions or 12. And so make sure you complete that by Friday.

And then we will have tutoring this week. If you have questions about the exams, reviews, stuff like that. There are exam questions for review online.

There's some problems if you want extra questions to go over. The answers are posted, too. They're separate.

So. you can download, go through them and work through them for studying. Okay.

Questions on anything? Well, if not, I'll talk about the midterm exam. And then today we're going to start moving into chapter 10, looking at markets and market equilibrium and what that means. and then mathematical models for markets.

So the midterm exam is on Monday. It's similar to the last exam. It'll cover all the material through last week. So through elasticity lecture.

And it covers everything from the profit maximization stuff that we did for the firm. So break-even points, shutdown points, on through elasticities. There's 23 multiple choice questions, exactly the same.

And it is applied. So you've had one of my exams already. You kind of get the way the questions are written. As with the last exam, please bring your WID, a number two pencil, a calculator. You will be allowed a three by five note card.

I recommend you study. Get your note card ready for lab. It can pay off. In terms of, this is in the skeleton note. So it's available online already.

These are the topics being covered. for the exam. Okay?

And so you can get those. In terms of note cards, you are allowed a three by five note card or a similar size sheet of paper if you want it smaller. I'm all right with that. You can put whatever you want on the note card front and back.

If you want to see smiley faces because it makes you happy, more power. Okay? I recommend writing down formulas, definitions that you need to know, examples, graphs, and so on.

Okay? whatever you think you need. The big thing is make sure you can read it and find info on it. So this is a bad note card. It is about three by five.

It does separate, so hopefully your hand is consistent. This one, you might not get a handle on the situation. You can have smaller than 3x5 if you've ever felt you wanted to be a little stealthy with your note card.

You can have a little one like that. These are bad note cards. This may help with a couple questions.

Recommend a little more info on there. Here's an example. These are, I couldn't find note cards, but here's a good example of a good note sheet.

Make sure you can read it. I don't know if that one is, hopefully that's legible to the person who wrote it. This is probably my favorite.

It's a little crowded. It probably could have been a little better organized or color coded so you could find stuff on it. But that has a whole lot on it. You're like, that's for an astronomy class, so don't, don't wig out on the equations.

We're only going to use about half of those. Okay. And so what I want to do now, so please make your note cards, make them useful, do them. One of the reasons I like to push them is it's not only to help out because I don't want you to memorize formulas, write them down.

It's also to have you start organizing your thoughts for the exam. OK, and going through your stuff in your notes. So review a question.

Consider the market for corn. The price of wheat, the substitute in consumption increases. What happens? Which two can you eliminate immediately?

There's two answers. You can read the question and go, it's not those two. Nope.

One of the increases, right? It's A and B, right? What's the only thing that'll change A and B? The price of corn, the own price.

It's not, if it's anything else, it's a determinant. It's going to shift the supply curve. You know, it has to be C and D.

So which one is it? It is D, right? Wheat is a substitute in consumption. And so make sure you're reading if it's a substitute in consumption or a substitute.

substitute in production. They are different. Given wheat is a substitute consumption as the price of wheat increases, consumers will want to purchase more corn.

They're substituting to corn because wheat's now more expensive. It's a cheaper alternative. That causes corn, the demand for corn to increase, shifting the curve to the right.

Consider the market for oil. In March, many universities and public systems have spring break, providing students and family an opportunity to travel. What's the likely effect on the market demand for oil? You can talk with your neighbor.

So what'd you get? B or D? How many people think it's B?

How many people think it's D? D is correct. Remember, the only thing that will cause A and B to change is what? The price of oil, the oil price. What?

So the increase in travel increases the demand for oil. There's a higher preference for it. That shifts the demand curve which direction?

To the right. So you're in a boat with a 10-foot rope ladder hanging over the side. Each rung of the ladder is one foot apart. The bottom end of the ladder just touches the water.

The tide is coming in, raising the water level six inches every hour. How long will it take for the water to reach the top of the ladder? Hold on, let people think about it. What'd you get?

Should be D, right? Y. Boats float. Boats float. So up until now, we've looked at individual and aggregate behavior of firms and consumers separately.

What we want to do now is bring them together. So we've seen the production by firms, consumption by consumers, and we know this depends on the price. What we haven't figured, so we know that price influences what's going to be produced and consumed, but we haven't figured out where price comes from. And so now we want to put supply and demand for a good and service together to look at and discuss the concept of markets, where supply and demand interact. It's this interaction that determines the prevailing price in the market and how much will be consumed and produced at the end of the day.

So recall both consumers and producers choose how much they're going to consume or produce based on that market price. And we're still assuming both consumers and producers are in essence price takers. No one's big enough to influence the price, especially consumers, but neither are for firms so far.

Okay. And so it's the market that determines the price, that aggregate behavior. No individual's large enough to influence it though.

So what is a market? A market is an institution where buyers and sellers interact. And this is important because we tend to think of markets as something like a grocery store, which it is, but markets are actually legally recognized things.

They are institutions. We have taken a long time to define our markets and we're still defining. There's a massive legal system built around our markets. and why they operate the way they do.

It's why money has value. Otherwise, it'd be paper. Patented paper with patented ink.

Markets are not necessarily bound by space or physical locations. They can be like a farmer's market. Many exist virtually. Heck, half our shopping now is online.

and we have it shipped to our house. Amazon is a virtual market. And so there's two important aspects of markets we want to look at. Markets determine the price and quantity of a good or service purchased or sold, and they're voluntary.

So consumers and producers are free to enter and exit the market at will. So markets bring together producers and consumers. Producers want to supply their product at the highest possible price. Their collective willingness to produce is captured in the market supply curve. It tells us, holding everything out constant at a given price, how much will firms produce?

As the price goes up, it becomes more profitable because we look at the curve, costs are fixed, and so they'll produce more. And notice, remember, we have a positive slope due to the law of supply. To this, we add the demand curve. The demand curve captures the willingness of consumers to pay for a good or terrible collectively. It tells us at different prices how much of a product or service will be consumed.

holding everything else constant. Okay? And remember, it's downward sloping due to the law of demand. How many people have done supply demand before? Have seen this graph?

Ooh, I thought it'd be more. So producers and consumers interact in the market. It's this interaction that determines the prevailing price and quantity at an aggregate scale.

No individual consumer or producer has that influence, but the aggregate behavior of consumers and producers results in what we call a market equilibrium, where a price prevails in the market for a good. Okay. Recall an equilibrium is a point from which there is no tendency to change.

So once an equilibrium is found, there's actually an economic incentive in the market to stay there. The market equilibrium exists at the point at which the supply curve and the demand curves intersect. So by definition, it's the point where quantity supplied by producers at a given price is equal to the quantity demanded by consumers. It's given by the point E in the graph at the intersection of these two curves. That's where the pot of gold is.

Economics, we like to say, hey, X marks the spot. What we'll learn though is this equilibrium is an elusive target. Pesky determinants of supply and demand cause it to continually move. And so we're always chasing it.

So to market equilibrium, two things occur. What we have is a singular quantity we call Q star, equilibrium quantity. In essence, at equilibrium, quantity supplied equals quantity demanded. And there's one prevailing price we call the equilibrium price.

Sometimes we designate it as B star. Or sometimes you'll hear it as the market clearing price. This is the point where equilibrium occurs, where everything produced is sold. So one of the things for me for equilibrium, so we have markets that tend toward equilibrium.

Probably more important than that, we tend to assume in economics markets move toward these equilibriums. It's more how they get there that's actually more important. Because these equilibriums were rarely at them, if ever. And so they move. Something changes in the market, like a hurricane, throws all the markets out of whack.

And so then they have to readjust. And by the time they readjust, something else happens. There's a new tax, a new policy. Preferences change. Internet story goes viral, changes the whole market again.

And so they move, especially with the flow of information these days. And so markets are constantly in flux. And if you're ever wondering about that, all you have to do is look at the stock market and literally watch stock prices by the minute. They change every single minute, if not more often.

So while there's an equilibrium, there's no tendency to change. Why do we get to market equilibrium? So it's the process that moves us there that is more important. To look at this, let's consider the market for beef.

OK, so QS will be our supply curve for beef and QD. will be our demand curve for beef. Okay and so what we want to look at is why do we tend toward that point at that intersection E.

So for the first one consider a price. So this is our equilibrium price and equilibrium quantity. Consider a price pH. Don't confuse that with the acidity of water or the base I guess. Just high price. We have a price higher than the equilibrium.

So in the graph, we have this higher price. In this situation, the demand pair tells me I'm going to consume QC. This is quantity demanded.

So this is what consumers will purchase. Suppliers are like, yee-haw, we have a high price. We're going to produce a QP.

So production is way higher than consumption. Right. And so what do we end up with something in the market that we call a surplus? When quantity supplied is greater than quantity demanded, we have a surplus in the market. So producers are willing to produce more than consumers will consume.

And so you get a surplus equal to the difference in QP minus QC. It's this distance here. And that never happens, right?

I would say this happens all the time. How do we know this happens all the time? What sections do stores have often? Or if you go to Walmart or the grocery store or anything? Yeah, there's clearance sections, there's sale racks.

Hey, those are due to surpluses. have them all the time in existence and so if we have a surplus how do you get rid of a surplus well you'll cut production but yeah right how does that how does the surplus get rid of how do we get rid of it to sell off the surplus what do we need to do we lower the price hopefully We don't get the full surplus. Hopefully the market signals, hey, this is way too much.

We're forecasting and going, we're producing way too much. We're cutting back before we hit that full production. And so the price starts coming down.

They start selling off some of that surplus. So that surplus exists whenever the price is higher than the equilibrium price. And so... They're going to reduce the price to sell off the surplus, right? And as the price goes down, what will consumers do?

The oil price is falling. Quantity demanded goes up. Law of demand.

They start consuming more. It also incentivizes producers as that price falls to do what? Produce less. And so there's a market signal that says, hey.

There are people starting to sell their stuff at a cheaper price to get rid of it than the current market price. That signals as more individual sellers come along and start lowering their prices, you get an aggregate effect where the market price starts to fall. And producers start producing less.

Consumers will start consuming more. Especially some of that surplus, we end up back at the... And that keeps on going until we hit the...

Equilibrium. So no individual producer or consumer really knows where that equilibrium is, especially in really big markets. It's elusive. I always try to think, hey, it's that squirrel running in my backyard that's covered with huge bushes, weeds, and trees. And you got to go find it.

And all you have is a slingshot. And you're half blind, right? And so you may actually, so with the surplus, we'll keep on reducing that price till we hit market equilibrium, okay? And so at this point, the market clears. We might overcompensate, though.

And so we end up with our second case where the price is lower than the market equilibrium. So we know if it's above, there's an incentive to move to E, to the equilibrium, and back to P star, the equilibrium price. But what happens if the price is lower than the market equilibrium? Well, consider a price PL.

At this price, consumers want QC. Wow, wow, it's cheap. We're going to buy a whole lot. Producers, though, aren't willing to supply them, produce that much.

And so production is way under consumption. In general, we call this an excess demand. But another term we use for this is what we call a short.

And so a shortage is when consumers are willing to buy a whole lot more. than producers are willing to produce for the market. And so what we have is a shortage that's equal to QC minus QP. So a shortage exists whenever the price is above the equilibrium price. OK, the question is, how will producers respond again?

So producers are like, imagine you're at an auction. There's scarcity in the marketplace, right? Because there's very limited product. And we see this a lot of the time. Imagine the new iPhones.

So what happens when new iPhones or new game consoles come out? that are just on the marketplace. So when the PlayStation 5s came out, they sold for 500 bucks.

Still do. But how much were they selling for when they first came out? So people were hoarding them and then they sold for up to a thousand a piece, double their price. And Sony couldn't keep up with production.

It took about a year. a full year to a year and a half to get to normal production levels where you could go into a store and actually buy a PlayStation without going, hey, hey, do you have any? Tried to buy my kids one.

We wait, we just decided, hey, four is good enough. It took us a year and a half until we actually could be able to walk into a store and buy a PlayStation where they weren't gone the day they came in. They lasted that long. iPhones are the same way when they sometimes when they first when they first released them, it took a year to get an iPhone. I remember Toyota when they released the Prius.

It was a year to two years to get a Prius. There was that much of a at least a six month to a year waiting list, if not longer, depending on what you wanted. And so how do producers respond? They jack up the price.

They can. People are willing to pay it. So there's this much higher, they start, and producers are like, hey, we can actually sell more because there's scarcity. And so they start increasing the price slowly and testing the market.

As more and more producers start doing this, that market price starts going up in aggregate. Consumers then start backing off. More and more exit the market and decide, hey, it's too expensive for me. And so notice, as producers go up, they get to produce more, they're making more money, producers start exiting the market for this, and then they end up eventually back at market equilibrium at P-star, the equilibrium price, and equilibrium quantity. Likely, in reality, what happens is We're up here, it swings down here, swings back up here, but not as far, swings back down here, right?

And by the time you got close, boom, the equilibrium moved. That's the reality of markets. We are in constant disequilibrium. And all you have to do is watch the news.

Election years are bad for markets in terms of finding equilibrium. They're all over the place. policy and everything, uncertainty. But one of the reasons we use market equilibrium is it does give us a baseline to model markets.

And so one of the tools we use in economics, and the reason I do use the math, is because it's one of the primary tools we use. And so we build very complex mathematical models of markets. We're going to do a simple one using linear supply and demand, but we can represent supply and demand curves with mathematical functions.

Let's just derive a linear supply and demand. So a linear supply curve, remember, our basic curve is y equals mx plus b. Here, y is our quantity supply.

X is our price. And so we calculate our slope, the change in quantity supplied over the change in quantity demanded. And so all you need to do is pick two points. In the graph, I chose 7 and 5. Just pick the first two rows. 7 minus 5 is 2. 1 minus 0 is 1. It's 2. So I got a positive 2. Is that right?

Why is that right? If you obey the law, why is that right? Law of supply, right?

Upward sloping. Firms will produce more. they are more profit as price goes up. So once we know the intercept, we can use the formula we've used for our interce-or once we know the slope, we can use the form to figure out our intercept.

All I need is then to just plug in a one point in the table. So I'm going to use the seven and one, the second row. So I plug in seven for quantity supplied, one for price, solve that.

and you get 5, which is already in our table. And then put it together. So when we ask you to write out the supply curve, you plug in m and b, replace y with qs, x with p, you get the following supply curve, qs equals 5 plus 2 times p.

The reason we do this, and there's a lot of time spent on this, especially for demand. How do you think we do demand forecasts and figure out what's happening in the market? And it's so much better than just by using your gut.

A lot of people use their gut in industry, and quite often... It's wrong, especially when it comes to market level stuff. Even people that are really experienced get it wrong.

I mean, that's why they said, what did they say? Economists predicted nine out of the last five recessions. We can do the same thing with demand. So in this case, y is quantity demanded, x is price, and we want to derive a demand curve. So let's use the first, second, and third row, 1, 16, and 2, 12. It's the same process.

Take a minute or two, derive out this demand curve with the person next to you, behind you, diagonally to you, in front of you, depending where you're at. I'll have to look at it. So what did you get for the slope? Should be negative 4. It's a change in quantity, which is negative 4 over 1, or depending on how you put it, 4 over 1. And what do you get for the y-intercept?

it equals 20. So when you put this together you get Qd equals 20 minus 4 times p. So the question is why, so then once we know supply and demand, so we can derive these curves, what's of interest is let's assume these are the supply and demand curves for the beef market. And so our demand curve is 20 minus 4p, our supply curve is 5 plus 2p. We now have two equations and two unknowns. Because at equilibrium, quantity supplied will equal quantity demanded.

They'll be the same. So we can treat them as one variable. So to find the equilibrium, we know the first rule is qd equals qs equals q star. So this will be the same quantity.

We have a price. I have two equations, two unknowns. I can solve them. Okay? If they intersect, we should have a solution.

And we know they do. One's downward sloping, one's upward sloping. So I can use this condition then to actually find p star.

plug these two into this condition. So you get 20 minus 4p equals 5 plus 2p. So this is the, we have the demand equation equals the supply, quantity supply. So at equilibrium that has to hold.

Kind of simplify, add 4p to both sides. subtract 5 from each side, and then solve for p. If once you divide both sides by 6, you get p star equals 2.5 or 15 sixths, which reduces to two and a half.

To find the quantity, all you have to do is pick that price into one of your equations. So put it into your demand equation, plug in the price, you get a quantity of 10. You can check if that's right. By plugging 2 into the other equation, 2 and 1 half, you also get 10. It's just a double check.

You only need to put it into 1. And so by solving that system of two equations, we find our market equilibrium, B star, Q star, is 250, 10. we also can graph that solution. So if you graph it, remember prices on the y-axis, quantity on the x-axis, all you need to graph these lines is find two points on each line, draw the straight line through it okay where they intersect we've already sold for it 10 250. and so we have our demand curves downward sloping our supply curve and our market equilibrium One thing I will point out to you, the way we wrote the supply and demand curves where Q is on the left-hand side of the equation, that intercept is the x-intercept because quantity is on the x-axis. So just if you're wondering why doesn't it intersect over here, because quantity is on the x-axis. So we're writing quantity as a function of price. Starts at 5, which was our intercept for the supply curve.

Intersects at 20, which was our intercept for the demand curve. So give me another minute. So in terms of this, we'll finish the notes on Wednesday.

But real quick. In terms of if you still have your assignment, please make sure to turn it in up here. It is due.

And then also, please remember to start thinking about your note cards and looking through the exam materials. Do not wait until Sunday to study. Okay?

Okay? And, hey, real quick, so I can get everyone's attention before it gets loud. If you are looking for study groups, I've had some people email me. I'm going to start emailing those people to try to help put those together. Okay?

All we're doing is trying to help connect people to form study groups. It's up to you then to kind of organize and get together if you don't have one. Okay. Otherwise, have an awesome afternoon.

Transcript for:Market Equilibrium and Exam Study Guide

Transcript for:
Market Equilibrium and Exam Study Guide