Overview
This lecture explains how supply and demand work together to determine market prices, focusing on the concepts of equilibrium, surplus, and shortage in the context of the pizza market.
Supply and Demand Together
- Supply and demand must be considered together to determine a good's market price.
- A supply curve alone or demand curve alone cannot predict the equilibrium price.
- High demand or limited supply typically leads to higher prices; low demand or abundant supply leads to lower prices.
- The intersection of the supply and demand curves determines the market price.
Surplus and Shortage
- If the price is set too high, producers want to sell more than consumers want to buy, creating a surplus (excess supply).
- Surplus results in unsold goods, signaling producers to lower prices.
- If the price is too low, consumers want to buy more than producers are willing to sell, causing a shortage (excess demand).
- Shortage leads to goods flying off the shelves, signaling producers to raise prices.
Equilibrium
- Equilibrium occurs where the quantity supplied equals the quantity demanded.
- At equilibrium, there is no tendency for prices to rise or fall; the market "clears."
- On a graph, equilibrium is where the supply and demand curves intersect.
- In the pizza example, equilibrium is at $12, with 500 pizzas both supplied and demanded.
- Prices above equilibrium create surpluses; prices below create shortages.
The Invisible Hand
- The "invisible hand" refers to the market's self-adjusting nature where prices move toward equilibrium without government intervention.
- The free market naturally pushes prices up or down as needed to reach balance.
Key Terms & Definitions
- Surplus (Excess Supply) — When quantity supplied exceeds quantity demanded at a given price.
- Shortage (Excess Demand) — When quantity demanded exceeds quantity supplied at a given price.
- Equilibrium — The price and quantity at which supply equals demand.
- Invisible Hand — The market mechanism that moves prices to equilibrium without external control.
Action Items / Next Steps
- Review what happens when supply or demand changes (to be covered in upcoming lectures).
- Prepare for the next class by revisiting the concept of "all else remains equal" in supply and demand analysis.