A systematic analysis of the factors that determine the prices of different goods is known

as price theory.
• Price refers to the rate at w/c any good can exchange for any other goods.

Good is anything that has some use.

2 kinds of goods:

Economic goods are goods that have some use and are scarce relative to the wants w/c
they can satisfy.

Free goods is one which has a use or a set of uses, but whose supply is unlimited.

Market refers to a situation where buyers and sellers reach a meeting of minds or agree to
make transactions involving certain commodities or services.

• What is needed in order that there can be a market is for the buyers and the sellers
to be able to maintain constant communication with each other.
Ex. Call center.

Supply and demand

From Wikipedia, the free encyclopedia

Jump to: navigation, search

For other uses, see Supply and demand (disambiguation).

The price P of a product is determined by a balance between production at each price

(supply S) and the desires of those with purchasing power at each price (demand D). 2,
along with a consequent increase in price and quantity Q sold of the product.
Supply and demand is an economic model based on price and quantity in a market. It
predicts that in a competitive market, price will function to equalize the quantity
demanded by consumers, and the quantity supplied by producers, resulting in an
economic equilibrium of price and quantity. The model incorporates other factors
changing equilibrium as a shift of demand and/or supply.

Contents
[hide]

• 1 Supply schedule
• 2 Demand schedule
• 3 Changes in market equilibrium
o 3.1 Demand curve shifts
o 3.2 Supply curve shifts
• 4 Elasticity
• 5 Vertical supply curve (Perfectly Inelastic Supply)
• 6 Other markets
• 7 Other market forms
• 8 Positively sloped demand curves?
• 9 Negatively sloped supply curve
• 10 Empirical estimation
• 11 Macroeconomic uses of demand and supply
• 12 Demand shortfalls
• 13 History
• 14 See also
• 15 References

• 16 External links

[edit] Supply schedule

The supply schedule, graphically represented by the supply curve, is most often
expressed by the relationship between market price and amount of goods produced. In
short-run analysis, where some input variables are fixed, a positive slope can reflect the
law of diminishing marginal returns, which states that beyond some level of output,
additional units of output require larger amounts of input. In the long-run, where no input
variables are fixed, a positively-sloped supply curve can reflect diseconomies of scale.

For a given firm in a perfectly competitive industry, if it is more profitable to produce

than to not produce, profit is maximized by producing just enough so that the producer's
marginal cost is equal to the market price of the good.
The law of demand states that when a market demands a high quantity of a good or
service, the price of the good or service will be high, When the market demands a low
quantity the prices will be low

The supply curve of labor is a perfect example of increasing net input(e.g., wages) above
a certain point resulting in decreased net output (hours worked).

Occasionally, supply curves bend backwards. A well known example is the backward
bending supply curve of labour. Generally, as a worker's wage increases, he is willing to
work longer hours, since the higher wages increase the marginal utility of working, and
the opportunity cost of not working. But when the wage reaches an extremely high
amount, the employee may experience the law of diminishing marginal utility. The large
amount of money he is making will make further money of little value to him. Thus, he
will work less and less as the wage increases, choosing instead to spend his time in
leisure.[1] The backwards-bending supply curve has also been observed in non-labor
markets, including the market for oil: after the skyrocketing price of oil caused by the
1973 oil crisis, many oil-exporting countries decreased their production of oil.[2]

The supply curve for public utility production companies is unusual. A large portion of
their total costs are in the form of fixed costs. The supply curve for these firms is often
constant (shown as a horizontal line).

Another postulated variant of a supply curve is that for child labor. Supply will increase
as wages increase, but at a certain point a child's parents will pull the child from the child
labor force due to cultural pressures and a desire to concentrate on education[clarification needed].
The supply will not increase as the wage increases, up to a point where the wage is high
enough to offset these concerns. For a normal demand curve, this can result in two stable
equilibrium points - a high wage and a low wage equilibrium point.[3]

[edit] Demand schedule

The demand schedule, depicted graphically as the demand curve, represents the amount
of goods that buyers are willing and able to purchase at various prices, assuming all other
non-price factors remain the same. The demand curve is almost always represented as
downwards-sloping, meaning that as price decreases, consumers will buy more of the
good.[4]

Just as the supply curves reflect marginal cost curves, demand curves can be described as
marginal utility curves.[5]

The main determinants of individual demand are: the price of the good, level of income,
personal tastes, the population (number of people), the government policies, the price of
substitute goods, and the price of complementary goods.

The shape of the aggregate demand curve can be convex or concave, possibly depending
on income distribution.

As described above, the demand curve is generally downward sloping. There may be rare
examples of goods that have upward sloping demand curves. Two different hypothetical
types of goods with upward-sloping demand curves are a Giffen good (an inferior, but
staple, good) and a Veblen good (a good made more fashionable by a higher price).

[edit] Changes in market equilibrium

Practical uses of supply and demand analysis often center on the different variables that
change equilibrium price and quantity, represented as shifts in the respective curves.
Comparative statics of such a shift traces the effects from the initial equilibrium to the
new equilibrium.

[edit] Demand curve shifts

Main article: Demand curve

An out-ward or right-ward shift in demand increases both equilibrium price and quantity
When consumers increase the quantity demanded at a given price, it is referred to as an
increase in demand. Increased demand can be represented on the graph as the curve
being shifted outward. At each price point, a greater quantity is demanded, as from the
initial curve D1 to the new curve D2. More people wanting coffee is an example. In the
diagram, this raises the equilibrium price from P1 to the higher P2. This raises the
equilibrium quantity from Q1 to the higher Q2. A movement along the curve is described
as a "change in the quantity demanded" to distinguish it from a "change in demand," that
is, a shift of the curve. In the example above, there has been an increase in demand which
has caused an increase in (equilibrium) quantity. The increase in demand could also come
from changing tastes and fads, incomes, complementary and substitute price changes,
market expectations, and number of buyers. This would cause the entire demand curve to
shift changing the equilibrium price and quantity.

If the demand decreases, then the opposite happens: an inward shift of the curve. If the
demand starts at D2, and decreases to D1, the price will decrease, and the quantity will
decrease. This is an effect of demand changing. The quantity supplied at each price is the
same as before the demand shift (at both Q1 and Q2). The equilibrium quantity, price and
demand are different. At each point, a greater amount is demanded (when there is a shift
from D1 to D2).

[edit] Supply curve shifts

An out-ward or right-ward shift in supply reduces equilibrium price but increases

quantity

When the suppliers' costs change for a given output, the supply curve shifts in the same
direction. For example, assume that someone invents a better way of growing wheat so
that the cost of wheat that can be grown for a given quantity will decrease. Otherwise
stated, producers will be willing to supply more wheat at every price and this shifts the
supply curve S1 outward, to S2—an increase in supply. This increase in supply causes the
equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1
to Q2 as the quantity demanded increases at the new lower prices. In a supply curve shift,
the price and the quantity move in opposite directions.
If the quantity supplied decreases at a given price, the opposite happens. If the supply
curve starts at S2, and shifts inward to S1, the equilibrium price will increase, and the
quantity will decrease. This is an effect of supply changing. The quantity demanded at
each price is the same as before the supply shift (at both Q1 and Q2). The equilibrium
quantity, price and supply changed.

When there is a change in supply or demand, there are four possible movements. The
demand curve can move inward or outward. The supply curve can also move inward or
outward.

See also: Induced demand

[edit] Elasticity
Main article: Elasticity (economics)

Elasticity is a central concept in the theory of supply and demand. In this context,
elasticity refers to how supply and demand respond to various factors. One way to define
elasticity is the percentage change in one variable divided by the percentage change in
another variable (known as arc elasticity, which calculates the elasticity over a range of
values, in contrast with point elasticity, which uses differential calculus to determine the
elasticity at a specific point). It is a measure of relative changes.

Often, it is useful to know how the quantity demanded or supplied will change when the
price changes. This is known as the price elasticity of demand and the price elasticity of
supply. If a monopolist decides to increase the price of their product, how will this affect
their sales revenue? Will the increased unit price offset the likely decrease in sales
volume? If a government imposes a tax on a good, thereby increasing the effective price,
how will this affect the quantity demanded?

Another distinguishing feature of elasticity is that it is more than just the slope of the
function. For example, a line with a constant slope will have different elasticity at various
points. Therefore, the measure of elasticity is independent of arbitrary units (such as
gallons vs. quarts, say for the response of quantity demanded of milk to a change in
price), whereas the measure of slope only is not.

One way of calculating elasticity is the percentage change in quantity over the associated
percentage change in price. For example, if the price moves from $1.00 to $1.05, and the
quantity supplied goes from 100 pens to 102 pens, the slope is 2/0.05 or 40 pens per
dollar. Since the elasticity depends on the percentages, the quantity of pens increased by
2%, and the price increased by 5%, so the price elasticity of supply is 2/5 or 0.4.

Since the changes are in percentages, changing the unit of measurement or the currency
will not affect the elasticity. If the quantity demanded or supplied changes a lot when the
price changes a little, it is said to be elastic. If the quantity changes little when the prices
changes a lot, it is said to be inelastic. An example of perfectly inelastic supply, or zero
elasticity, is represented as a vertical supply curve. (See that section below)

Elasticity in relation to variables other than price can also be considered. One of the most
common to consider is income. How would the demand for a good change if income
increased or decreased? This is known as the income elasticity of demand. For example,
how much would the demand for a luxury car increase if average income increased by
10%? If it is positive, this increase in demand would be represented on a graph by a
positive shift in the demand curve. At all price levels, more luxury cars would be
demanded.

Another elasticity sometimes considered is the cross elasticity of demand, which

measures the responsiveness of the quantity demanded of a good to a change in the price
of another good. This is often considered when looking at the relative changes in demand
when studying complement and substitute goods. Complement goods are goods that are
typically utilized together, where if one is consumed, usually the other is also. Substitute
goods are those where one can be substituted for the other, and if the price of one good
rises, one may purchase less of it and instead purchase its substitute.

Cross elasticity of demand is measured as the percentage change in demand for the first
good that occurs in response to a percentage change in price of the second good. For an
example with a complement good, if, in response to a 10% increase in the price of fuel,
the quantity of new cars demanded decreased by 20%, the cross elasticity of demand
would be -2.0.

In a perfect economy, any market should be able to move to the equilibrium position
instantly without travelling along the curve. Any change in market conditions would
cause a jump from one equilibrium position to another at once. So the perfect economy is
actually analogous to the quantum economy. Unfortunately in real economic systems,
markets don't behave in this way, and both producers and consumers spend some time
travelling along the curve before they reach equilibrium position. This is due to
asymmetric, or at least imperfect, information, where no one economic agent could ever
be expected to know every relevant condition in every market. Ultimately both producers
and consumers must rely on trial and error as well as prediction and calculation to find an
the true equilibrium of a market. But supply and demand curves can still serve as an
excellent tool for making those kinds of predictions.

[edit] Vertical supply curve (Perfectly Inelastic Supply)

When demand D1 is in effect, the price will be P1. When D2 is occurring, the price will be
P2. Notice that at both values the quantity is Q. Since the supply is fixed, any shifts in
demand will only affect price.

It is sometimes the case that a supply curve is vertical: that is the quantity supplied is
fixed, no matter what the market price. For example, the surface area or land of the world
is fixed. No matter how much someone would be willing to pay for an additional piece,
the extra cannot be created. Also, even if no one wanted all the land, it still would exist.
Land therefore has a vertical supply curve, giving it zero elasticity (i.e., no matter how
large the change in price, the quantity supplied will not change).

Supply-side economics argues that the aggregate supply function – the total supply
function of the entire economy of a country – is relatively vertical. Thus, supply-siders
argue against government stimulation of demand, which would only lead to inflation with
a vertical supply curve.[6]

[edit] Other markets

The model of supply and demand also applies to various specialty markets.

The model applies to wages, which are determined by the market for labor. The typical
roles of supplier and consumer are reversed. The suppliers are individuals, who try to sell
their labor for the highest price. The consumers of labors are businesses, which try to buy
the type of labor they need at the lowest price. The equilibrium price for a certain type of
labor is the wage.[7]

The model applies to interest rates, which are determined by the money market. In the
short term, the money supply is a vertical supply curve, which the central bank of a
country can influence through monetary policy. The demand for money intersects with
the money supply to determine the interest rate.[8]

[edit] Other market forms

The supply and demand model is used to explain the behavior of perfectly competitive
markets, but its usefulness as a standard of performance extends to other types of
markets. In such markets, there may be no supply curve, such as above, except by
analogy. Rather, the supplier or suppliers are modeled as interacting with demand to
determine price and quantity. In particular, the decisions of the buyers and sellers are
interdependent in a way different from a perfectly competitive market.

A monopoly is the case of a single supplier that can adjust the supply or price of a good at
will. The profit-maximizing monopolist is modeled as adjusting the price so that its profit
is maximized given the amount that is demanded at that price. This price will be higher
than in a competitive market. A similar analysis can be applied when a good has a single
buyer, a monopsony, but many sellers. Oligopoly is a market with so few suppliers that
they must take account of their actions on the market price or each other. Game theory
may be used to analyze such a market.

The supply curve does not have to be linear. However, if the supply is from a profit-
maximizing firm, it can be proven that curves-downward sloping supply curves (i.e., a
price decrease increasing the quantity supplied) are inconsistent with perfect competition
in equilibrium. Then supply curves from profit-maximizing firms can be vertical,
horizontal or upward sloping.

[edit] Positively sloped demand curves?

Standard microeconomic assumptions cannot be used to disprove the existence of
upward-sloping demand curves. However, despite years of searching, no generally agreed
upon example of a good that has an upward-sloping demand curve (also known as a
Giffen good) has been found. Some suggest that luxury cosmetics can be classified as a
Giffen good. As the price of a high end luxury cosmetic drops, consumers see it as an low
quality good compared to its peers. The price drop may indicate lower quality
ingredients, thus consumers would not want to apply such an inferior product to their
face. One example of a Giffen good could be potatoes during the Irish famine.

Lay economists sometimes believe that certain common goods have an upward-sloping
curve. For example, people will sometimes buy a prestige good (eg. a luxury car) because
it is expensive, a drop in price may actually reduce demand. However, in this case, the
good purchased is actually prestige, and not the car itself. So, when the price of the
luxury car decreases, it is actually decreasing the amount of prestige associated with the
good (see also Veblen good). However, even with downward-sloping demand curves, it
is possible that an increase in income may lead to a decrease in demand for a particular
good, probably due to the existence of more attractive alternatives which become
affordable: a good with this property is known as an inferior good.

[edit] Negatively sloped supply curve

There are cases where the price of goods gets cheaper, but more of those goods are
produced. This is usually related to economies of scale and mass production. One
example is computer software where creating the first instance of a given computer
program has a high cost, but the marginal cost of copying this program and distributing it
to many consumers is low (almost zero).

[edit] Empirical estimation

Demand and supply relations in a market can be statistically estimated from price,
quantity, and other data with sufficient information in the model. This can be done with
simultaneous-equation methods of estimation in econometrics. Such methods allow
solving for the model-relevant "structural coefficients," the estimated algebraic
counterparts of the theory. The Parameter identification problem is a common issue in
"structural estimation." Typically, data on exogenous variables (that is, variables other
than price and quantity, both of which are endogenous variables) are needed to perform
such an estimation. An alternative to "structural estimation" is reduced-form estimation,
which regresses each of the endogenous variables on the respective exogenous variables.

[edit] Macroeconomic uses of demand and supply

Demand and supply have also been generalized to explain macroeconomic variables in a
market economy, including the quantity of total output and the general price level. The
Aggregate Demand-Aggregate Supply model may be the most direct application of
supply and demand to macroeconomics, but other macroeconomic models also use
supply and demand. Compared to microeconomic uses of demand and supply, different
(and more controversial) theoretical considerations apply to such macroeconomic
counterparts as aggregate demand and aggregate supply. Demand and supply may also
be used in macroeconomic theory to relate money supply to demand and interest rates.

[edit] Demand shortfalls

A demand shortfall results from the actual demand for a given product being lower than
the projected, or estimated, demand for that product. Demand shortfalls are caused by
demand overestimation in the planning of new products. Demand overestimation is
caused by optimism bias and/or strategic misrepresentation.

[edit] History
The power of supply and demand was understood to some extent by several early Muslim
economists, such as Ibn Taymiyyah who illustrates:

"If desire for goods increases while its availability decreases, its price rises. On the other
hand, if availability of the good increases and the desire for it decreases, the price comes
down."[9]
The phrase "supply and demand" was first used by James Denham-Steuart in his Inquiry
into the Principles of Political Economy, published in 1767. Adam Smith used the phrase
in his 1776 book The Wealth of Nations, and David Ricardo titled one chapter of his 1817
work Principles of Political Economy and Taxation "On the Influence of Demand and
Supply on Price".[10]

In The Wealth of Nations, Smith generally assumed that the supply price was fixed but
that its "merit" (value) would decrease as its "scarcity" increased, in effect what was later
called the law of demand. Ricardo, in Principles of Political Economy and Taxation,
more rigorously laid down the idea of the assumptions that were used to build his ideas of
supply and demand. Antoine Augustin Cournot first developed a mathematical model of
supply and demand in his 1838 Researches on the Mathematical Principles of the Theory
of Wealth.

During the late 19th century the marginalist school of thought emerged. This field mainly
was started by Stanley Jevons, Carl Menger, and Léon Walras. The key idea was that the
price was set by the most expensive price, that is, the price at the margin. This was a
substantial change from Adam Smith's thoughts on determining the supply price.

In his 1870 essay "On the Graphical Representation of Supply and Demand", Fleeming
Jenkin drew for the first time the popular graphic of supply and demand which, through
Marshall, eventually would turn into the most famous graphic in economics.

The model was further developed and popularized by Alfred Marshall in the 1890
textbook Principles of Economics.[10] Along with Léon Walras, Marshall looked at the
equilibrium point where the two curves crossed. They also began looking at the effect of
markets on each other.

Price Elasticity of Demand

A Primer on the Price Elasticity of Demand
By Mike Moffatt, About.com

See More About:

• elasticity formula
• price elasticity of demand
• elasticity

The Price Elasticity of Demand (commonly known as just price elasticity) measures the
rate of response of quantity demanded due to a price change. The formula for the Price
Elasticity of Demand (PEoD) is:

PEoD = (% Change in Quantity Demanded)/(% Change in Price)

Calculating the Price Elasticity of Demand

You may be asked the question "Given the following data, calculate the price elasticity of
demand when the price changes from $9.00 to $10.00" Using the chart on the bottom of
the page, I'll walk you through answering this question. (Your course may use the more
complicated Arc Price Elasticity of Demand formula. If so you'll need to see the article
on Arc Elasticity)

First we'll need to find the data we need. We know that the original price is $9 and the
new price is $10, so we have Price(OLD)=$9 and Price(NEW)=$10. From the chart we
see that the quantity demanded when the price is $9 is 150 and when the price is $10 is
110. Since we're going from $9 to $10, we have QDemand(OLD)=150 and
QDemand(NEW)=110, where "QDemand" is short for "Quantity Demanded". So we
have:

Price(OLD)=9
Price(NEW)=10
QDemand(OLD)=150
QDemand(NEW)=110

To calculate the price elasticity, we need to know what the percentage change in quantity
demand is and what the percentage change in price is. It's best to calculate these one at a
time.

Calculating the Percentage Change in Quantity Demanded

The formula used to calculate the percentage change in quantity demanded is:

[QDemand(NEW) - QDemand(OLD)] / QDemand(OLD)

By filling in the values we wrote down, we get:

[110 - 150] / 150 = (-40/150) = -0.2667

We note that % Change in Quantity Demanded = -0.2667 (We leave this in decimal
terms. In percentage terms this would be -26.67%). Now we need to calculate the
percentage change in price.

Calculating the Percentage Change in Price

Similar to before, the formula used to calculate the percentage change in price is:

[Price(NEW) - Price(OLD)] / Price(OLD)

By filling in the values we wrote down, we get:

[10 - 9] / 9 = (1/9) = 0.1111

We have both the percentage change in quantity demand and the percentage change in
price, so we can calculate the price elasticity of demand.

Final Step of Calculating the Price Elasticity of Demand

We go back to our formula of:

PEoD = (% Change in Quantity Demanded)/(% Change in Price)

We can now fill in the two percentages in this equation using the figures we calculated
earlier.

PEoD = (-0.2667)/(0.1111) = -2.4005

When we analyze price elasticities we're concerned with their absolute value, so we
ignore the negative value. We conclude that the price elasticity of demand when the price
increases from $9 to $10 is 2.4005.

How Do We Interpret the Price Elasticity of Demand?

A good economist is not just interested in calculating numbers. The number is a means to
an end; in the case of price elasticity of demand it is used to see how sensitive the
demand for a good is to a price change. The higher the price elasticity, the more sensitive
consumers are to price changes. A very high price elasticity suggests that when the price
of a good goes up, consumers will buy a great deal less of it and when the price of that
good goes down, consumers will buy a great deal more. A very low price elasticity
implies just the opposite, that changes in price have little influence on demand.

Often an assignment or a test will ask you a follow up question such as "Is the good price
elastic or inelastic between $9 and $10". To answer that question, you use the following
rule of thumb:

• If PEoD > 1 then Demand is Price Elastic (Demand is sensitive to price changes)
• If PEoD = 1 then Demand is Unit Elastic
• If PEoD < 1 then Demand is Price Inelastic (Demand is not sensitive to price
changes)

Recall that we always ignore the negative sign when analyzing price elasticity, so PEoD
is always positive. In the case of our good, we calculated the price elasticity of demand to
be 2.4005, so our good is price elastic and thus demand is very sensitive to price changes.

Next: Price Elasticity of Supply

Data
 Price Quantity Demanded Quantity Supplied
$7 200 50
$8 180 90
$9 150 150
$10 110 210
$11 60 250

Price Elasticity of Supply

A Primer on the Price Elasticity of Supply
By Mike Moffatt, About.com

See More About:

• price elasticity of supply

• elasticity formulas
• elasticity

The Price Elasticity of Supply measures the rate of response of quantity demand due to a
price change. If you've already read The Price Elasticity of Demand and understand it,
you may want to just skim this section, as the calculations are similar. (Your course may
use the more complicated Arc Price Elasticity of Supply formula. If so you'll need to see
the article on Arc Elasticity) We calculate the Price Elasticity of Supply by the formula:

PEoS = (% Change in Quantity Supplied)/(% Change in Price)

Calculating the Price Elasticity of Supply

You may be asked "Given the following data, calculate the price elasticity of supply
when the price changes from $9.00 to $10.00" Using the chart on the bottom of the page,
I'll walk you through answering this question.

First we need to find the data we need. We know that the original price is $9 and the new
price is $10, so we have Price(OLD)=$9 and Price(NEW)=$10. From the chart we see
that the quantity supplied (make sure to look at the supply data, not the demand data)
when the price is $9 is 150 and when the price is $10 is 110. Since we're going from $9 to
$10, we have QSupply(OLD)=150 and QSupply(NEW)=210, where "QSupply" is short
for "Quantity Supplied". So we have:
Price(OLD)=9
Price(NEW)=10
QSupply(OLD)=150
QSupply(NEW)=210

To calculate the price elasticity, we need to know what the percentage change in quantity
supply is and what the percentage change in price is. It's best to calculate these one at a
time.

Calculating the Percentage Change in Quantity Supply

The formula used to calculate the percentage change in quantity supplied is:

[QSupply(NEW) - QSupply(OLD)] / QSupply(OLD)

By filling in the values we wrote down, we get:

[210 - 150] / 150 = (60/150) = 0.4

So we note that % Change in Quantity Supplied = 0.4 (This is in decimal terms. In

percentage terms it would be 40%). Now we need to calculate the percentage change in
price.

Calculating the Percentage Change in Price

Similar to before, the formula used to calculate the percentage change in price is:

[Price(NEW) - Price(OLD)] / Price(OLD)

By filling in the values we wrote down, we get:

[10 - 9] / 9 = (1/9) = 0.1111

We have both the percentage change in quantity supplied and the percentage change in
price, so we can calculate the price elasticity of supply.

Final Step of Calculating the Price Elasticity of Supply

We go back to our formula of:

PEoS = (% Change in Quantity Supplied)/(% Change in Price)

We now fill in the two percentages in this equation using the figures we calculated.

PEoD = (0.4)/(0.1111) = 3.6

When we analyze price elasticities we're concerned with the absolute value, but here that
is not an issue since we have a positive value. We conclude that the price elasticity of
supply when the price increases from $9 to $10 is 3.6.

How Do We Interpret the Price Elasticity of Supply?

The price elasticity of supply is used to see how sensitive the supply of a good is to a
price change. The higher the price elasticity, the more sensitive producers and sellers are
to price changes. A very high price elasticity suggests that when the price of a good goes
up, sellers will supply a great deal less of the good and when the price of that good goes
down, sellers will supply a great deal more. A very low price elasticity implies just the
opposite, that changes in price have little influence on supply.

Often you'll have the follow up question "Is the good price elastic or inelastic between $9
and $10". To answer that, use the following rule of thumb:

• If PEoS > 1 then Supply is Price Elastic (Supply is sensitive to price changes)
• If PEoS = 1 then Supply is Unit Elastic
• If PEoS < 1 then Supply is Price Inelastic (Supply is not sensitive to price
changes)

Recall that we always ignore the negative sign when analyzing price elasticity, so PEoS
is always positive. In our case, we calculated the price elasticity of supply to be 3.6, so
our good is price elastic and thus supply is very sensitive to price changes.

Next: Income Elasticity of Demand

Data

Price Quantity Demanded Quantity Supplied

$7 200 50
$8 180 90
$9 150 150
$10 110 210
$11 60 250

Economic equilibrium
From Wikipedia, the free encyclopedia

Jump to: navigation, search

Price of market balance:

• P - price
• Q - quantity of good
• S - supply
• D - demand
• P0 - price of market balance
• A - surplus of demand - when P<P0
• B - surplus of supply - when P>P0

In economics, economic equilibrium is simply a state of the world where economic

forces are balanced and in the absence of external influences the (equilibrium) values of
economic variables will not change. Market equilibrium, for example, refers to a
condition where a market price is established through competition such that the amount
of goods or services sought by buyers is equal to the amount of goods or services
produced by sellers. This price is often called the equilibrium price or market clearing
price and will tend not to change unless demand or supply change.

Contents
[hide]

• 1 Traits
• 2 Interpretations
• 3 Solving for Equilibrium Price
• 4 Influences changing price
• 5 See also

• 6 References

[edit] Traits
When the price is above the equilibrium point there is a surplus of supply; where the
price is below the equilibrium point there is a shortage in supply. Different supply curves
and different demand curves have different points of economic equilibrium. In most
simple microeconomic stories of supply and demand in a market a static equilibrium is
observed in a market; however, economic equilibrium can exist in non-market
relationships and can be dynamic. Equilibrium may also be multi-market or general, as
opposed to the partial equilibrium of a single market.

As in most usage (say, that of chemistry), in economics equilibrium means "balance,"

here between supply forces and demand forces: for example, an increase in supply will
disrupt the equilibrium, leading to lower prices. Eventually, a new equilibrium will be
attained in most markets. Then, there will be no change in price or the amount of output
bought and sold — until there is an exogenous shift in supply or demand (such as
changes in technology or tastes). That is, there are no endogenous forces leading to the
price or the quantity.

Not all economic equilibria are stable. For an equilibrium to be stable, a small deviation
from equilibrium leads to economic forces that returns an economic sub-system toward
the original equilibrium. For example, if a movement out of supply/demand equilibrium
leads to an excess supply (glut) that induces price declines which return the market to a
situation where the quantity demanded equals the quantity supplied. If supply and
demand curves intersect more than once, then both stable and unstable equilibria are
found.

Most economists (e.g. Samuelson 1947, Chapter 3, p. 52) caution against attaching a
normative meaning (value judgement) to the equilibrium price. For example, food
markets may be in equilibrium at the same time that people are starving (because they
cannot afford to pay the high equilibrium price).

[edit] Interpretations
In most interpretations, classical economists such as Adam Smith maintained that the free
market would tend towards economic equilibrium through the price mechanism. That is,
any excess supply (market surplus or glut) would lead to price cuts, which decrease the
quantity supplied (by reducing the incentive to produce and sell the product) and increase
the quantity demanded (by offering consumers bargains), automatically abolishing the
glut. Similarly, in an unfettered market, any excess demand (or shortage) would lead to
price increases, reducing the quantity demanded (as customers are priced out of the
market) and increasing in the quantity supplied (as the incentive to produce and sell a
product rises). As before, the disequilibrium (here, the shortage) disappears. This
automatic abolition of non-market-clearing situations distinguishes markets from central
planning schemes, which often have a difficult time getting prices right and suffer from
persistent shortages of goods and services.

This view came under attack from at least two viewpoints. Modern mainstream
economics points to cases where equilibrium does not correspond to market clearing (but
instead to unemployment), as with the efficiency wage hypothesis in labor economics. In
some ways parallel is the phenomenon of credit rationing, in which banks hold interest
rates low in order to create an excess demand for loans, so that they can pick and choose
whom to lend to. Further, economic equilibrium can correspond with monopoly, where
the monopolistic firm maintains an artificial shortage in order to prop up prices and to
maximize profits. Finally, Keynesian macroeconomics points to underemployment
equilibrium, where a surplus of labor (i.e., cyclical unemployment) co-exists for a long
time with a shortage of aggregate demand.

On the other hand, the Austrian School and Joseph Schumpeter maintained that in the
short term equilibrium is never attained as everyone was always trying to take advantage
of the pricing system and so there was always some dynamism in the system. The free
market's strength was not creating a static or a general equilibrium but instead in
organising resources to meet individual desires and discovering the best methods to carry
the economy forward.

[edit] Solving for Equilibrium Price

To solve for the equilibrium price, one must either plot the supply and demand curves, or
solve for their equations being equal.

An example may be:

In the diagram, depicting simple set of supply and demand curves, the quantity demanded
and supplied at price P are equal.

At any price above P supply exceeds demand, while at a price below P the quantity
demanded exceeds that supplied. In other words, prices where demand and supply are out
of balance are termed points of disequilibrium, creating shortages and oversupply.
Changes in the conditions of demand or supply will shift the demand or supply curves.
This will cause changes in the equilibrium price and quantity in the market.

Consider the following demand and supply schedule:

Price ($) Demand Supply

8.00 6,000 18,000
7.00 8,000 16,000
6.00 10,000 14,000
5.00 12,000 12,000
4.00 14,000 10,000
3.00 16,000 8,000
2.00 18,000 6,000
1.00 20,000 4,000

• The equilibrium price in the market is $5.00 where demand and supply are equal
at 12,000 units

• If the current market price was $3.00 – there would be excess demand for 8,000
units, creating a shortage.

• If the current market price was $8.00 – there would be excess supply of 12,000
units.

When there is a shortage in the market we see that, in order to correct this disequilibrium,
the price of the good will be increased back to a price of $5.00, thus lessening the
quantity demanded and increasing the quantity supplied thus that the market is in balance.
When there is an oversupply of a good, such as when price is above $6.00, then we see
that producers will decrease the price in order to increase the quantity demanded for the
good, thus eliminating the excess and taking the market back to equilibrium.

[edit] Influences changing price

A change in equilibrium price may occur through a change in either the supply or
demand schedules. For instance, an increase in demand through an increase level of
disposable income may produce a new demand and supply schedule, such as the
following:

Price ($) Demand Supply

8.00 10,000 18,000
7.00 12,000 16,000
6.00 14,000 14,000
5.00 16,000 12,000
4.00 18,000 10,000
3.00 20,000 8,000
2.00 22,000 6,000
1.00 24,000 4,000

Here we see that an increase in disposable income would increase the quantity demanded
of the good by 4,000 units at each price. This has the effect of changing the price at
which quantity supplied equals quantity demanded. In this case we see that the two equal
each other at an increased price of $6.00. This increase in demand would have the effect
of shifting the demand curve rightward. Note that a decrease in disposable income would
have the exact opposite effect on the equilibrium market.

We will also see similar behaviour in price when there is a change in the supply schedule,
occurring through technological changes, or through changes in business costs. An
increase in technology or decrease in costs would have the effect of increasing the
quantity supplied at each price, thus reducing the equilibrium price. On the other hand, a
decrease in technology or increase in business costs will decrease the quantity supplied at
each price, thus increasing equilibrium price.

[edit]