ib econ - market equilibrium theory

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Teacher presentation - micro econ - equilibrium

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Market Equilibrium The price mechanisms and Market efficiency IB Economics:

Market Equilibrium The price mechanisms and Market efficiency IB Economics

Learning Objectives:

Learning Objectives At the end of this section you should be able to Explain the concept of equilibrium Explain the effect of changes in demand and supply upon the equilibrium Explain the concepts of excess demand and excess supply HL – calculate the market price and quantity using linear functions Plot changing market equilibriums, identifying new equilibrium points, excess demand and excess supply

Slide 3:

Bringing market demand and supply curves together Bringing buyers (demanders) and sellers (suppliers) together creates what economist call a market When we picture a market in our heads we tend to think of a fruit and veg market but a market does not even have to be physical - it is just where buyers and sellers interact. Transactions can by carried out by phone, mail order or over the internet.

Slide 4:

Equilibrium In order to analyse how a market works we bring the demand and supply curve together and from now on we always draw our diagrams with both curves Equilibrium is when supply satisfies demand and vice versa Everything produced in the market will be sold They are equal, there is balance/stability and there is no tendency for the market to change without external change In theory the price system should produce equilibrium as we will see later Quantity of Coffee D P e Q e The free market equilibrium price is Pe and quantity is Qe S Equilibrium point Market clearing price

Slide 5:

Market disequilibrium and eliminating excess supply Equilibrium is self righting in a free market Lets says the producers increase their price to P1 At this price there will be Q1 demand At this price there will be Q2 supply There is too much supply (excess supply) of Q1 – Q2 The market is said to be in disequilibrium To get rid of the surplus producers will have to supply at a lower price As they do the quantity demanded will increase until once again demand equals supply and there is equilibrium once more Price Q D P Q S P1 Q1 Q2 Excess Supply = Q2 – Q1 O

Slide 6:

Market disequilibrium and eliminating excess demand This time producers tried to lower their price There is too much demand at Q2 and not enough supply at Q1 the market is in disequilibrium because there is excess demand Q2 will be demanded but only Q1 will be supplied which means there will be a shortage (suppliers will sell out) There is a shortage off Q2 – Q1 Excess demand = Q2 – Q1 In order to eliminate the shortage producers have to raise their prices As they do the quantity demanded will fall Eventually demand and supply will be equal again giving equilibrium Quantity D P Q S P1 Q1 Q2

Slide 7:

The effects of changes in demand and supply on the equilibrium Previously we looked at factors that shift the demand curve and supply curve – these are outside disturbances (nothing to do with the price although they will change the price) Now we need to look at what those shifts do to the equilibrium price and quantities In real life lots of things may change at the same time but to make it simple we only deal with single changes and assume that the ceteris paribus condition is met Ceteris paribus is Latin for ‘ all things being equal ’ – in other words nothing else has changed Lets take the example of an increase in income for consumers of foreign holidays When there is an increase in income there will be an increase in the demand for holidays Ceteris paribus there will be a shift of the demand curve to the right Quantity of holidays (days) S1 Q1 D1 Q2 P1 D2 Price of holidays ($)

Slide 8:

The effects of changes in demand and supply on the equilibrium Initially the price remains at the equilibrium price Q1 will be supplied Q2 will be demanded There will be excess demand (a shortage) To get rid of the shortage prices will need to rise Until once again equilibrium is restored but at a higher price of P2 The new equilibrium quantity is Q3 Whenever there is a shift of the demand or supply curve the market (if it is left alone) will adjust to a new equilibrium or market clearing price Complete student workpoint 3.1 P37 Quantity of holidays (days) S1 Q1 D1 Q2 P1 D2 Price of holidays ($) P2 Q3

Slide 9:

The role of the price mechanism Resources are allocated and re-allocated in response to changes in price If there is an increase in the price of a good due to an increase in demand for the good there is a signal to the producers The price signal tells producers that consumers wish to buy this good We assume that producers are rational and wish to maximise their profits There is an incentive for them to produce more Producers allocate more resources to those goods where the demand is highest (they will make more profit) There is not central planning agency Adam Smith said it was like there was an invisible hand moving the factors of production around to produce the goods and services wanted by the buyers in the economy Complete Student workpoint 3.2 Price mechanism = the forces of supply and demand

Slide 10:

Market efficiency – Consumer Surplus Watch the video Consumer surplus = the extra satisfaction (or utility) gained by consumers from paying a price that is lower than that they are prepared to pay Consumer surplus video: http://www.youtube.com/watch?feature=player_detailpage&v=qTxniCLYgok

Slide 11:

Market efficiency – Producer surplus Watch the video Read through page 38 Make notes Ask questions if you don’t understand Producer surplus = the excess of actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to accept for that output Producer surplus video: http://www.youtube.com/watch?v=MinxczZXtKA&feature=player_detailpage

Slide 12:

Allocative efficiency Allocative efficiency means that resources are allocated in the most efficient way from society’s point of view This kind of efficiency is not the same as being efficient at operating like within a firm. This is called productive efficiency and we will learn about that later If we add consumer and producer surplus together this is the community surplus Community surplus is the total benefit to society At the equilibrium community surplus is maximised This is the point of allocative efficiency There is no other combination of price or quantity that could give greater community surplus This is therefore the optimal allocation of resources from the point of view of society as a whole Allocative efficiency = when a market is in equilibrium, with no external influences, it is said to be socially efficient or in a state of allocative efficiency

Slide 13:

Allocative efficiency The supply curve is largely determined by the industry’s costs of production When we assume that the costs of the industry are equal to the costs to society then the supply curve represents the social cost curve When we analyse efficiency we call this the marginal social cost curve (we will learn more about this later) Marginal social costs (MSC) curve = the supply curve represents the marginal social cost curve when the costs to industry are equal to the costs of society

Slide 14:

Allocative efficiency The demand curve is determined by the utility, or benefits, that the consumption of a good or service brings to the consumers If we assume the benefits in the market are equal to the benefits to society we can use the demand curve to represent the social benefits When we analyse efficiency we refer to the demand curve as the marginal social benefit curve (MSB) Marginal social benefits (MSB) curve = the demand curve represents the marginal social benefits curve when the benefits in the market are equivalent to the benefits to society

Slide 15:

Allocative efficiency This is only a brief introduction to allocative efficiency We will come back to it in a lot more detail later In conclusion A free market leads to allocative efficiency Community surplus is maximised so it is the optimum allocation of resources from society’s point of view This occurs when demand is equal to supply or marginal social costs are equal to marginal social benefits

The HL bit!:

The HL bit!

Slide 17:

Calculating and illustrating market equilibrium using linear demand and supply functions If you are given the demand function and the supply function you easily plot the graphs of both and where they cross is the equilibrium Alternatively you can work out the equilibrium using simultaneous equations Work through page 39 to 43 and then complete student workpoint 3.3

Slide 18:

Homework for all Complete the data response question on P44 (copper) Make sure you read the assessment advice In addition, you are going to write a basic commentary Read Assessment advice: internal assessment Read the advice on P34 Complete a basic commentary

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