Transcript The invisible Hand

The Invisible Hand
Market Forces restoring
equilibrium
The Concept of Market Equilibrium
• Consumers aim to pay the lowest possible
price in order to maximise their purchasing
power.
• Producers aim to sell at the highest possible
price so they can maximise their revenue.
• Market equilibrium occurs at the price where
quantity demanded equals quantity supplied.
Equilibrium
Price
($)
S
EQUILIBRIUM
D
Quantity
Equilibrium
Price
80
100
120
140
160
180
Quantity
Demanded
5000
4000
3000
2000
1000
0
Quantity
Supplied
1000
2000
3000
4000
5000
6000
At market equilibrium there will be no surplus or shortage
and there is no incentive for the price or quantity to change.
Changes in Supply
• Four factors that will increase supply (cause a
shift to the right )
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•
•
•
Decrease in costs of production
Decrease in the price of a related good
Increase in productivity
Increase in Technology
Changes in Demand
• The four factors that will increase demand
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Increase in Tastes and preferences
Increase in Incomes
Increase in the price of a substitute
Decrease in the price of a complement
Market reactions to Disequilibrium
When the market is not in equilibrium we call this a
disequilibrium.
When the market is in a disequilibrium, there will be
pressure on the market.
These pressures are from the needs of consumers for
goods and services (demand) and the need of producers to
sell their goods and services (supply)
These pressures are known as
market forces or ‘the invisible hand’.
Market reactions to Disequilibrium
• When the market is in disequilibrium there will
be pressure on market forces to return the
market to equilibrium
• Market forces = Forces of demand and supply
Two Disequilibrium Situations
• Surplus (Excess supply) = Where quantity supplied is
greater than quantity demanded
• Shortage (Excess demand) = Where quantity
demanded is greater than quantity supplied
Disequilibrium
Shortage
Surplus
Market forces restoring equilibrium
Excess Supply ( Surplus)
1. The producer will want to sell their excess stock so will
react by dropping the price of their product
2. Consumers will react to lower prices by buying more as
the goods become more affordable (Law of demand)
3. As prices fall producers decrease their supply as the
good becomes less profitable (Law of supply)
4. QD increases and QS decreases until equilibrium is
restored
Market forces restoring equilibrium
Excess Demand (Shortage )
1. The Consumers want to buy more of the goods so
they are prepared to pay higher prices. Consumers
bid the price up as they don’t want to miss out.
2. Producers will react to higher prices by supplying
more as the good becomes more profitable (Law of
Supply)
3. As prices increase, consumers demand falls as the
good becomes less affordable (Law of demand )
4. QS increases and QD decreases until equilibrium is
regained
Effect of a change in supply or demand
on equilibrium
• A change in market conditions will lead to a
change in demand or supply and the market
will no longer be at equilibrium at the existing
price and quantity.
• The market will adapt to the new conditions
and market forces will return the market to
equilibrium
Decrease in demand
 An decrease in Demand
causes a surplus at the
existing price
S
pe
P1
D
D1
Q1
QD
Qe
QS
Quantity
 Producers will lower
the price to get ride of
excess stock causing
the quantity supplied
to fall and quantity
demanded to increase.
 This continues until a
new equilibrium price
and quantity is
established.
• An increase in Demand will cause a shortage at
the current price
Decrease in Supply
S1
S
 A Decrease in supply causes a
shortage at the existing price
Price
P1
 The price will be bid up causing
the quantity demanded to
decrease and quantity supplied to
increase.
pe
D
Qs
QD Quantity
Q1 Qe
 This continues until a new
equilibrium price and quantity is
established.
• An increase in supply will cause a surplus at the
existing price.
Why markets tend towards
Equilibrium
S’’
S
Price
($)
S’
D’
D’’
D
Quantity
The shift will lead to either a surplus or a shortage depending on
whether demand or supply has increased or decreased
Conclusion
• A market will tend toward equilibrium
• If the price is not at equilibrium then
market forces will work to move the
market back toward equilibrium.