L4 - Equilibrium

Question 1

What is Excess Demand and Excess Supply?

Answer 1

• There is excess demand when quantity demanded exceeds quantity supplied
• There is excess supply when quantity supplied exceeds quantity demanded
• The market clears when there is no excess demand or excess supply

Question 2

What is the Law of price Adjustment?

Answer 2

1- When supply exceeds demand, the price will fall
- When there is excess supply, prices are too HIGH
sellers are frustrated as they cannot sell as much as they would like so there is an incentive to cut prices

2 - When demand exceeds supply, the price will rise
- When there is excess demand, prices are too LOW buyers are frustrated as they cannot buy as much as they would like –> INCENTIVE TO RAISE PRICES

Question 3

What is Equilibrium?

Answer 3

a point where there is no incentive to change

behaviour The market is in equilibrium when it clears

Question 4

What are the assumptions concerning a competitive market?

Answer 4

• The Law of Demand –> demand curves have negative slopes throughout their entire range
• The theory of supply –> supply curves have positive slopes throughout their entire range
• The law of price Adjustment –> price rise when demanded, they remain unchanged when demand and supply are equal.

Question 5

What are the implication of the law of demand, supply and price adjustment?

Answer 5

• there is no more than one price at which quantity demanded equals quantity supplied - equilibrium is unique
• Only at the equilibrium price will the market prices remain constant
• the market is stable in the sense that forces exist to move the price towards its market-clearing level

Question 6

What happens when there is a increase/decrease in demand?

Answer 6

• increase –> increase in equilibrium price and quantity > decrease in the equilibrium price and quality

Question 7

What happens when there is a increase/decrease in supply?

Answer 7

• increase –> decrease in equilibrium price but a increase in equilibrium quantity
• decrease –> a increase in the equilibrium price but a decrease in equilibrium quantity

Question 8

What is the Role of Prices?

Answer 8

• Prices convey information
• Prices ration Scarce Resources
• Prices determine income

Question 9

How do Prices convey information?

Answer 9

Prices are signals that convey all information needed for buyers and sellers
- If flour is even more scarce: no need for Government to advise - less production and consumption of bread
- By signalling what is relatively scarce and what is abundant: price channels
production and consumption

Question 10

How do Prices ration Scarce Resources?

Answer 10

Since resources are limited, need a mechanism to decide who gets what
- Those willing and able to pay get the good

Question 11

how do Prices Determine Income?

Answer 11

Income depends upon the supply & demand of the services you can sell

Question 12

What is Mixed Pricing?

Answer 12

• a mixture between administered and flexible/auction pricing
• cars have a ‘list price’ but can be negotiated down or a trade in price when bringing in an old car

Question 13

What happens if a substitute reduces in price?

Answer 13

people buy more of the
substitute and demand less
of the product

Question 14

What happens if the price to produce a complement rises?

Answer 14

• people buy less of the complement, so demand is less for the product

Question 15

What happens when there is a shortage/surplus of a substitute?

Answer 15

• Shortage –> increase in equilibrium price and quantity

- Surplus –> decrease in equilibrium price and quantity

Question 16

What happens when there is a shortage/surplus of a complement?

Answer 16

• Shortage –> decrease in equilibrium price and quantity

- Surplus –>increase in equilibrium price and quantity

Question 17

What happens when there is a shortage/surplus of an input?

Answer 17

• Shortage –> an increase in equilibrium price but a decrease in equilibrium quantity
• Surplus –> a decrease in equilibrium price but a increase in equilibrium quantity

Question 18

What are some causes of separations in individual markets?

Answer 18

• completely separate products e.g. clothes and TV’s
• large transport costs UK vs US cement markets
• Government -imposed trade restrictions

Question 19

What are some causes of interlinking of individual markets?

Answer 19

• consumer income –> spend more in 1 market, less to spend in another
• even with transport costs similar product markets in different countries may be linked
• people import and export even with tariffs plus trading blocs and other Regional trade agreement remove these all together