Economic laws are not made by nature. They are made by human beings.” – Roosevelt, Franklin D.

(1)Introduction.So far, we’ve looked at supply, we’ve looked at demand, and the main question that now arises is, “How do these two opposing forces of supply and demand shape the market?” Buyers want to buy as many goods as possible, as cheaply as possible. Sellers want to sell as many goods as possible, at the highest price possible. Obviously, they can’t both have their way, and some sort of compromise/price agreement should be reached on the price at which buyers are willing to buy the same number of goods that sellers are willing to sell.

(2) The equilibrium market price. In economics, the price at which the quantity demanded exactly equals the quantity supplied is called the equilibrium market price. The equilibrium market price is the “just right price” – a price just high enough and just low enough so that the buyers want to buy just exactly as much as the sellers want to sell. At this price, the quantity of goods flowing into the market from the sellers/being pushed into the market by the sellers is equal to the quantity of goods being pulled out of the market by the buyers. The buyers can buy all that they want, so there is no shortage. The sellers can sell all that they want, so there is no surplus. So, the equilibrium market price is the ONLY price at which the quantity demanded is equal to the quantity supplied (Qs=Qd), and it is the only price that sellers will receive/agree on and buyers will pay at any time in the spotmarket.

(3) The market-clearing price. The equilibrium market price is also referred to as the market-clearing price (MCP) because it clears the market of/clears away any excess supply or excess demand. Note that for everything that is supplied to be consumed and for the market to be “cleared,” price must be equal to or lower than equilibrium price.

(4)Market equilibrium.Markets are where demand meets supply. When the price is just right, so that there is neither excess demand nor excess supply, the market is said to be in (economic) equilibrium.

Microeconomics assumes that market equilibrium is the optimum economic outcome. Under the conditions of market equilibrium every consumer who wishes to purchase the product at the market price is able to do so and the supplier is not left with any unwanted inventory. The result: the market just clears away, and everyone is happy.

(5)Market disturbances and market disequilibrium. However, real life, as always, is different from simple theory, and perfect market equilibrium is ever before reach/is never reached because in reality demand and supply are almost constantly changing, making thus the market adjustment an ever going process. The state of the market that exists when the opposing market forces of demand and supply are not in balance/are out of balance is commonly referred to as market disequilibrium. More specifically, market disequilibrium results if the demand price is not equal to the supply price and the quantity demanded is not equal to the quantity supplied.

(6) Excess demand and supply: effects of being away from the equilibrium point. The result of the imbalance between the opposing market forces of demand and supply is the existence of either a shortage or a surplus, which induces/results in a change in the price.

A shortage exists if the quantity demanded exceeds the quantity supplied at the current market price. This condition emerges/results if the market price is below the equilibrium price. With a market shortage, prices tend to rise. People are unable to buy as much of the good as they would like at the current price. As such, they are willing to pay any price to get the desired but rare/ scarce product and, thus, bid up/raise the current price.

A surplus exists if the quantity supplied exceeds the quantity demanded at the current market price. This condition emerges if the market price is above the equilibrium price. With a market surplus, prices tend to fall. Sellers are unable to sell as much of the good as they would like at the current price. As such, they have to drop the price until people do want to buy all their extra stuff.

The greater the difference (the disparity/discrepancy in numbers) between supply and demand, the greater the tendency for prices to change and bring the market (that is, the quantities supplied and demanded) to a new equilibrium.

(7) Supply-and-demand schedule. Sometimes you have to see it to believe it. The two most common ways to visualize the way how supply and demand interact in a free market are in the form of a table, or in the form of a graph.

If we combine the supply and demand tables discussed earlier in Texts 5.1 and 5.2 onto a single table, we’ll get the table shown/given below. The table thus obtained is a supply-and-demand schedule for a good, which in our case are widgets. It should be obvious that the price of $3.00 is the equilibrium price and the quantity of 70 is the equilibrium quantity. At any other price, sellers would want to sell a different amount than buyers want to buy.

(8)Drawing a supply-and-demand graph. The same information can be shown with a graph. By now, you are familiar with graphs of supply curves showing the price-quantity combinations at which sellers are likely to offer their goods for sale, and with graphs of demand curves showing the price-quantity combinations at which buyers are ready (willing and able) to purchase those goods.

To find the equilibrium price and the equilibrium quantity for a good, it is necessary to combine the respective supply curve and demand curve onto one graph. The point of intersection of supply and demand curves on the graph is referred to as the point of equilibrium. The point of equilibrium marks one price, and one quantity, on which both the buyers and the sellers agree. The price at this point is market equilibrium price, and the quantity is market equilibrium quantity. Points where demand and supply are out of balance are termed points of disequilibrium.

Note once again that in the figures, straight lines are often drawn instead of the more true-to-life curves because the shape of the curve does not change the general relationships and lessons of the supply and demand theory. In any case, the exact shape of the curve is not easy to determine for a given market. It should also be noted that supply and demand curves both are drawn as a function of price. Neither is represented as a function of the other.

(9) Reading a supply-and-demand graph. In the graph below (Fig.5), we see that at the equilibrium price P, buyers want to buy exactly the same amount that sellers want to sell, which means that the quantities demanded and supplied at that price are equal (Qd=Qs).

At prices above the equilibrium point (that is, where Qs>Qd), there is excess supply (oversupply) which creates a surplus of the product, while at prices below

the equilibrium (that is, where Qs<Qd), there is excess demand or undersupply (See Fig.6). The effect of excess supply is to force the price down, while excess demand creates shortages and forces the price up.

The equilibrium price will only change when the conditions of either supply or demand, or both change. These conditions are the “all other things” that we mentally held constant when we stated the law of demand or described the supply response to prices. Changes in the conditions of demand or supply will shift either the demand curve or supply curve, or both. This will cause changes in the equilibrium price and quantity in the market.

(10) Government regulation of the market: price floors and price ceilings. Theoretically, if left alone, a free market will naturally settle into equilibrium. However, the government at times interferes with the market and sets the price for a product in order to protect the interests of either consumers or producers.

If the government sets/installs/introduces a minimum price for a market, then that legal minimum price that can be charged for a good is called the price floor (Qd < Qs). For a price floor to be effective, it must be set above the market equilibrium price. (See Fig.7) Common examples of price floors are found in agricultural markets such as sugar-, wheat-, or milk market. The minimum wage is also a price floor because it sets a minimum level that employers can pay employees. If a price ceiling is set at or above market price, there will be no noticeable effect, and the ceiling is only a preventative measure.

If the government imposes a maximum price for a market, then that legal maximum price that can be charged for a good is called the price ceiling (Qd > Qs). For a price ceiling to be effective, it must be set below the market equilibrium price. (See Fig.8)

The price ceilings cause persistent shortages, while the price floors cause persistent surpluses. This is the cost of imposing these restrictions.

(11) Is price-fixing a “good” or a “bad” thing? It depends. Some groups will benefit/will be helped while others will suffer/will be hurt. Often when price ceilings are binding, and there is a severe market disequilibrium, other methods and ways of dealing with excess demand, or shortages, will appear, such as legal non-price rationing, deterioration in product quality, illegal transactions at prices higher than the ceiling at the black market.

Date: 2015-12-24; view: 1053