Equilibrium Occurs When Supply and Demand Coordinate to

Module x: Market Equilibrium – Supply and Demand

The

Policy

Q
uestion:

South
hould government provide public marketplaces?

In the Capitol Colina neighborhood of Washington, D.C., the Eastern Market place is a large building and grounds, endemic and operated past the urban center government. Farmers, bakers, cheese makers and other merchants of food, arts and crafts get together in that location to sell their wares. Marketplaces like it were once a common feature of cities in the United States and Europe, only are now a relative rarity. Many take disappeared as citizens question government support of marketplaces.

So why does the government play a part in providing some markets? The answer is establish in the way markets create benefits for the citizens they serve. In this module, we explore how prices and quantities are ready in market equilibrium, how changes in supply and demand factors cause market equilibrium to arrange and how we measure the benefit of markets to gild.

Markets are often private in the sense that the government is not involved in their creation or presence; instead they are generated by the desire of individual individuals to appoint in an exchange for a particular practiced. Sometimes, however, the regime plays an active role in establishing and managing markets. At the stop of the module we volition study why this occurs, using the Eastern Market as an example.

Exploring the Policy Question

Is public investment in marketplaces justified and if so why?

ten.1

What is a Market?

Learning Objective 10.one: Identify the characteristics of a market.

x.2

Market Equilibrium –

The Supply and Demand Curves Together

Learning Objective 10.2: Determine the equilibrium price and quantity for a market, both graphically and mathematically.

x.iii
Backlog Supply and Demand

Learning Objective ten.three: Calculate and graph excess supply and excess demand.

x.4

Measuring Welfare and Pareto Efficiency

Learning Objective 10.iv:

Calculate consumer surplus, producer surplus, and deadweight loss for a market.

x.v

P
olicy Case
:

South
hould Government Provide Public Thousand
arketplaces?

LO x.5: Apply the concept of economical welfare to the policy of publicly-supported marketplaces.

10.ane

What

is a Market?

LO x.1: Identify the characteristics of a market.

In Module 9 we found out where the market place supply curve comes from – the cost structure of private firms, which in turn comes from their technology as we discovered in Module 7. In Module 5 we plant out where the demand curve comes from – the individual utility maximization problems of individual consumers. In both cases nosotros causeless the demand for and supply of a specific good or service. In other words we were describing a item market place.

A market is characterized by a specific good or service existence sold in a particular location at a defined time. And then, for example, nosotros might talk almost:

• the marketplace for eggs in Nashville, Tennessee in April of 2016.
• the market for rolled aluminum in the U.S. in 2015.
• the marketplace for radiological diagnostic services worldwide in the terminal decade.

In addition, for whatsoever item, time and identify nosotros describe there must exist both buyers and sellers in order for a market to exist. A market is where buyers and sellers exchange or where there is both demand and supply.

We tend to talk about markets somewhat loosely when studying economics. For instance, nosotros might discuss the market for orangish juice and exit the time and place undefined in order to keep things simple. Or we might just say that we are looking at the market for denim jeans in the U.S. The difficulty with these simplifications is that we can lose sight of the bones assumptions well-nigh markets that are necessary for our assay of them.

The six necessary assumptions for markets are the following:

• A market is for a unmarried good or service.
• All goods or services bought and sold in a market are identical.
• The expert or service sells for a single price.
• All consumers know everything near the production including how much they value it.
• There are many buyers and sellers and they are known to each other and can interact.
• All the costs and benefits of a transaction accrue but to the buyers and sellers who engage in it.

These assumptions are actually pretty easy to sympathize. They guarantee that the buyers who value the adept more than it costs sellers to produce it will find a seller willing to sell to them. In other words there are no transactions that don’t happen because the buyer doesn’t know how much he or she likes the product or because a buyer tin’t observe a seller or vice-versa.

Of course, the assumptions describe an ideal marketplace. In reality, many markets are not exactly similar this, and subsequently, in Section 7, we volition examine what happens when these assumptions fail to hold.

10.two

Market Equilibrium:

The Supply and Need Curves Together

LO x.2: Determine the equilibrium price and quantity for a market, both graphically and mathematically.

Market equilibrium
is the point there the quantity supplied by producers and the quantity demanded by consumers are equal. When nosotros put the demand and supply curves together nosotros can determine the
equilibrium

cost: the toll at which the quantity demanded equals the quantity supplied. In Figure 10.2.1 the equilibrium price is shown equally P* and it is precisely where the demand curve and supply curve cross. This makes sense–the demand curve gives the quantity demanded at every price and the supply bend gives the quantity supplied at every price so in that location is 1 price that they have in common, which is at the intersection of the two curves.

Figure 10.2.1: The Supply and Demand Curves and Market Equilibrium

Graphing the supply and demand curves to locate their intersection is 1 mode to observe the equilibrium cost. We can besides detect this quantity mathematically. Consider a need curve for stereo headphones that is described by the following office:

Q

^D

= 1800 – twentyP

Note that in general nosotros draw graphs of functions with the contained variable on the horizontal axis and the dependent variable on the vertical axis. In the case of supply and demand curves, however, we draw them with quantity on the horizontal axis and toll on the vertical. Because of this, information technology is sometimes easier to express the demand relationship every bit an
inverse demand curve: the need curve expressed as price every bit a function of quantity. In our example this would be:

P
= 90 – 0.05Q

^D

This is just the original demand bend solved for
P
instead of
Q

^D
. In the inverse demand curve the vertical intercept is piece of cake to see from the equation: need for headphones stops at the price of $xc. No consumer is willing to pay $ninety or more for headphones.

Similarly the supply curve tin exist represented as a mathematical part. For example, consider a supply bend described by the function:

Q

^S

= fiftyP
– 1000

Like to the demand curve nosotros tin express this equally an
changed supply curve: the supply curve expressed every bit price as a function of quantity. In this case, the inverse supply bend would be:

P
= 20 – 0.03Q

^S

Here the vertical intercept, $20, gives us the minimum price to become a seller to sell headphones. At prices of $20 or less, there will be no supply. So we know that the equilibrium price should be betwixt $twenty and $90.

Solving for the equilibrium price and quantity is simply a matter of setting
Q

^D

=
Q

^{Due south}

and solving for the price that makes this equality happen. On our example setting
Q

^D

=
Q

^S

yields:

1800 – 20P
= lP
– 1000

or

70P
= 2800

or

P
= $forty

At
P
= $twoscore, the quantity demanded and supplied can exist found from the need and supply curves:

Q

^D

= 1800 – twenty(40) = grand

Q

^Southward

= 50(twoscore) – 1000 = 1000

That these ii quantities match is no accident, this was the condition we set at the outset – that quantity supplied equals quantity demanded. So we know that a toll of $xl per unit of measurement is the equilibrium price.

These supply and demand curves for headphones are graphed in Figure x.2.ii below, and their intersection confirms the equilibrium cost we calculated mathematically.

Figure 10.ii.2: Explicit

Supp
ly and Need Curves

for Headphones

Note that nosotros have as well identified the
equilibrium quantity
,

Q*—the quantity at which supply equals demand. At $40 per unit, 1000 headphones are demanded and exactly 1000 headphones are supplied. The equilibrium quantity has goose egg to do with whatsoever kind of coordination or communication amid the buyers and sellers; it has merely to do with the price in the market. Seeing a unit toll of $xl, consumers need thou units. Independently, sellers who see that price volition choose to supply exactly g units.

x.3

Excess Supply and Need

LO x.3: Calculate and graph excess supply and excess demand.

It makes sense that the equilibrium price is the one that equates quantity demanded with quantity supplied, simply how does the market get to this equilibrium? Is this just an accident? No. The market cost volition automatically adapt to a point where supply matches demand. Excess supply or demand in a market will trigger such an adjustment.

To sympathize this equilibrating feature of the market toll, let’s return to our headphones case. Suppose the cost is $l instead of $twoscore. At this price we know from the supply curve that 1500 units will be supplied to the marketplace. Likewise, from the need curve, nosotros know that 800 units will be demanded. Thus there will be an excess supply of 700 units, as shown in Effigy 10.2.3.

Backlog supply
occurs when, at a given price, firms supply more than of a skillful than consumers demand. These are goods that have been produced by the firms that supply the marketplace that have non constitute any willing buyers. Firms volition want to sell these goods and know that by lowering the price more buyers will appear. And so this excess supply of goods will pb to a lowering of the price. The price will continue to fall equally long as the excess supply conditions exist. In other words, toll will go on to autumn until it reaches $40.

Figure ten.2.3: Excess Supply

of Headphones

at a Price of $l

The same logic applies to situations where the toll is below the intersection of supply and demand. Suppose the toll of headphones is $30. We know from the demand bend that at this price, consumers will demand 1200 units. We also know from the supply curve that at this price suppliers will supply 500 units. And so at $30 there will be excess demand of 700 units, as shown in Effigy ten.ii.3.

Excess demand
occurs when, at a given cost, consumers need more of a good than firms supply. Consumers who are not able to detect goods to purchase will offer more money in an effort to entice suppliers to supply more than. Suppliers who are offered more than coin will increment supply and this will continue to happen every bit long as the toll is below $xl and there is backlog demand.

Figure 10.two.three b: Excess Demand

for Headphones

at a Price of $3

Simply at a price of $xl is the pressure for prices to rise or fall relieved and will the toll remain constant.

10.4 Measuring Welfare

and

Pareto Efficiency

LO 10.iv: Calculate consumer surplus, producer surplus, and deadweight loss for a market.

From our written report of markets and so far, information technology is articulate that they can contribute to the economic well-being of both buyers and sellers. The term
welfare, every bit it is used in economics, refers to the economical well-existence of society as a whole, including producers and consumers. We tin can measure out welfare for particular market situations.

To understand the economical concept of welfare—and how to quantify information technology–it is useful to call up about the weekly farmers’ market place in Ithaca, New York. The market is a place where local growers tin sell their produce directly to consumers throughout the summertime. It is very successful and many local residents go to the market to buy produce. Now consider the specific example of tomatoes. What is this market worth to the tomato sellers and buyers that transact in the market place?

Suppose a farmer has a minimum willingness-to-accept toll of $1 for an heirloom tomato. This cost could be based on the farmer’s cost of production or the value she places on consuming the tomato herself. Suppose also that in that location is a consumer who really wants an heirloom tomato to add to his salad that evening and is willing to pay up to $iii for one. If these two people encounter each other at the market place and agree on a price of $2, how much benefit do they each get?

The seller receives $ii and it cost her $1 to provide the tomato, so she is $1 better off, the divergence between what she received and what she would have accepted for the tomato. Too, the buyer pays $ii but receives $3 in benefit from the tomato, since that was his willingness to pay; his net benefit is the deviation, or $ane. The seller and buyer are both $1 better off because they had the opportunity to run across and transact. Without this opportunity the seller would accept stayed at home with the lycopersicon esculentum and been no better or worse off, and the heir-apparent would not take a tomato for his salad simply would exist no better or worse off.

The difference between the price received and the willingness-to-take price is chosen the
producer s
urplus

(

PS

). The divergence betwixt the willingness-to-pay price and the price paid is called the
consumer surplus

(

CS

). The sum of these two surpluses is chosen
total surplus

(

TS

). So the producer surplus in the tomato example is $1, the consumer surplus is $1 and the total surplus is $ii. This is the surplus generated past the one transaction; if we add up all such transactions in the market we get a measure of the consumer and producer surplus from the market place.

Quantifying surplus for an unabridged market is easy to exercise with a graph. Allow’due south return to our previous instance of headphones and discover the consumer and producer surplus.

Figure 10.4.one shows that the consumer surplus is the surface area higher up the equilibrium price and below the demand curve –the green triangle in the figure. Similarly, the producer surplus is the surface area below the equilibrium toll and above the supply curve –the reddish triangle in the figure. The expanse of each surplus triangle is easy to calculate using the formula for the surface area of a triangle: ½bh
,
where
b
is base and
h
is height.

Figure 10.iv.1: Consumer Surplus and Producer Surplus

in the Market for Headphones

In the case of consumer surplus the triangle has a base of yard, the distance from the origin to
Q*, and a peak of $fifty, the divergence between $90, the vertical intercept and
P*, which is $xl.

Consumer surplus = ½(1000)($fifty) = $25,000

Similarly,

Producer surplus = ½(1000)($xx)= $10,000

Total surplus created by this market is the sum of the two or $35,000. This is the measure of how much value the market place creates through its enabling of these transactions. Without the ability to come together in this market place the buyers and sellers would miss out on the opportunity to capture this surplus.

We say that a market is efficient when the entire potential surplus has been created. Such a market is an example of
Pareto efficiency
—
an allocation of goods and services in which no redistribution tin can occur without making someone worse off. Retrieve about the distribution of goods in the headphones case. All of the buyers and sellers that transact are fabricated better off by the transaction because they gain some surplus from it. If they didn’t, they would not voluntarily trade. None of the trades that shouldn’t happen do. For example if at that place were more than 1000 units exchanged it would hateful sellers were selling to buyers who valued the good less than the sellers’ cost of production, where the supply curve is above the demand curve, and ane or both of the parties would be worse off because of the exchange.

Another way to come across that the market equilibrium issue is efficient is if we arbitrarily limit the number of goods exchanged to 900. Allow’southward call this maximum quantity restrictionQ̅, where the bar above the
Q
indicates that information technology is stock-still at that quantity. There are 100 surplus-creating transactions that don’t occur; this cannot be an efficient effect considering the entire potential surplus has non been created. The lost potential surplus has a name,
dead
weight loss (

DWL

):
the loss of total surplus that occurs when there is an inefficient allocation of resources. The blue triangle in Figure 10.4.ii represents this deadweight loss.

Effigy 10.4.2: Deadweight loss from a quantity constraint

We can calculate the value of the deadweight loss precisely, again using the formula for the area of a triangle. Since the demand part is
Q

^D

= 1800 – 20P, the point on the demand curve that results in a need of 900 is a price of $45. Similarly the supply function is given as
Q

^S

= 50P
– 1000, the point on the supply curve that results in a quantity supplied of 900 is a price of $38. Thus the base of the triangle is $45-$38 or $7 and the pinnacle is the deviation between the 1000 units that sold in the absence of a brake and the 900 unit restricted quantity or 100. So
DWL
= ½($7)(100) = $350.

ten.5 Policy Instance
:
Due south
hould Regime Provide Public M
arketplaces?

LO 10.5: Apply the concept of economic welfare to the policy of publicly-supported marketplaces.

The commencement question in determining whether a case can be made for the public provision of marketplaces, such as the Eastern Market place in Washington, D.C., is what would occur in the absence of such a market place. If the buyers and sellers in these markets could hands access other markets and then it would be hard to argue that the marketplace is providing a net benefit. Similarly, if the commercial activity that takes place in this market place is simply a diversion of similar activity that would have taken place elsewhere, then it is likely that there is footling to no internet do good. And then, for the sake of this exercise, nosotros will assume that the marketplace is providing an opportunity to these buyers and sellers that they would not otherwise have.

So, given this assumption, are these marketplaces valuable? The simple answer, as long as transactions are occurring, is yes. We can encounter this from a unproblematic diagram of an private goods market, permit’due south say for fresh apples, that exists within the Eastern Market (Figure 10.five.1).

Figure ten.5.1:

The

Marketplace

for Apples

in

t
he Eastern Market

There is clearly surplus being created by the apple transactions that have place within the market place. This in itself is the main statement for the marketplace. Buyers and sellers are able to transact and become amend off for it. The value to those individuals is measured by surplus.

But a complete answer must compare the value to order of the markets to the toll to society of the market place itself. Does the total surplus created by the marketplace justify the cost?

Permit’southward return now to the key assumption – that a market for fresh apples would not exist without regime support. Is this a reasonable assumption?

In the xix^thursday
and early twenty^thursday
centuries when many public markets were founded, transportation was difficult and bringing fresh food to support urban population centers was something local governments unremarkably did. Today, transportation is not near as difficult or costly. Merely although many areas are well served past grocery stores, where it is reasonable to wait customers will find fresh fruits and vegetables, other locations are characterized by
food deserts:

Food deserts are divers as urban neighborhoods and rural towns without ready access to fresh, salubrious, and affordable nutrient. Instead of supermarkets and grocery stores, these communities may have no food admission or are served simply past fast nutrient restaurants and convenience stores that offering few healthy, affordable food options. The lack of access contributes to a poor diet and tin lead to higher levels of obesity and other diet-related diseases, such equally diabetes and center disease. (U.S. Department of Agriculture (USDA))

The USDA estimates that 23.5 million people in the United states live in food deserts.

Although the Capitol Hill neighborhood experienced some hard times in the past, today it is prosperous and well served by grocery stores. And then the demand for authorities support of the Eastern Market there is less clear. In Section 7 we will explore public goods and externalities in particular and become meliorate equipped to fully explore this issue.

Exploring the Policy Question

1. What other kinds of marketplaces can you remember of that the authorities aids past providing infrastructure?
2. Airports let the marketplace for airline travel to exist in a functional way. Most airports in the United States are run by local governments. Using the topics explored in this module, give a justification for government expenditures on airports.
3. Should the District of Columbia government spend money on a market that primarily serves 1 neighborhood? Requite reasons for and against.

SUMMARY

Review: Topics and Related Learning Outcomes

x.i What is a Market?

Learning Objective 10.i: Identify the characteristics of a market.

x.two Market place Equilibrium – The Supply and Demand Curves Together

Learning Objective 10.2: Determine the equilibrium price and quantity for a market, both graphically and mathematically.

ten.iii Excess Supply and Demand

Learning Objective x.3: Calculate and graph excess supply and excess demand.

10.4 Measuring Welfare and Pareto Efficiency

Learning Objective 10.4:

Calculate consumer surplus, producer surplus, and deadweight loss for a market.

10.5 Policy Example:

Southward
hould Authorities Provide Public M
arketplaces?

LO x.5: Apply the concept of economic welfare to the policy of publicly-supported marketplaces.

Learn: Key Terms and Graphs

Terms

Marketplace Equilibrium

Inverse Demand Curve

Inverse Supply Curve

Equilibrium Price

Equilibrium Quantity

Excess Demand

Excess Supply

Producer Surplus

Consumer Surplus

Full Surplus

Pareto efficiency

Deadweight loss

Graphs

The Supply and Demand Curves and Market Equilibrium

Explicit Supply and Demand Curves

Excess Supply at a Toll of $fifty

Excess Demand at a Price of $30

Consumer Surplus and Producer Surplus

Deadweight loss from a quantity constraint

A Typical Goods Marketplace in The Eastern Market place

Equations

Quantity supplied

Quantity demanded