Transcript Document

CHAPTER 16
EQUILIBRIUM
16.1 Supply

Supply curve
 It
measures how much the firm is willing to supply
of a good at each possible market price.
 The supply curve is the upward-sloping part of the
marginal cost curve that lies above the average
cost curve.
16.2 Market Equilibrium

Market supply curve
 Add
up the individual supply curves to get a market supply
curve.

Competitive market
 A market
where each economic agent takes the market
price as given.

Equilibrium price
 The
price where the supply of the good equals the demand.
 The price that clears the market.
D(p*)= S(p*)
16.2 Market Equilibrium

p<p*
 Demand
is greater than supply;
 Charging higher prices will not reduce sales but
increase revenue;
 The price gets bid up.

p>p*
 Demand
is less than supply;
 Firms cut prices to resolve inventory;
 Downward pressure on the price.
16.3 Two Special Cases

Fixed supply
price
Supply
curve
 The
supply curve is
vertical.
 The equilibrium quantity
is determined entirely by
the supply conditions.
 The equilibrium price is
determined entirely by
demand conditions.
p*
Demand
curve
q*
quantity
16.3 Two Special Cases

Perfect elastic supply
price
 The
supply curve is
completely horizontal.
 The equilibrium price is
determined by the supply
conditions
 The equilibrium quantity
is determined by the
demand curve.
Demand
curve
Supply
curve
p*
q*
quantity
16.4 Inverse Demand and Supply
Curves
Inverse supply function PS(q)
 Inverse demand function PD(q)
 Equilibrium is determined by the condition
PS(q)= PD(q)

EXAMPLE: Equilibrium with
Linear Curves
Suppose that both the demand and the supply
curves are linear:
D(p)=a-bp
S(p)=c+dp
 The equilibrium price can be found by solving
the following equation:
D(p)=a-bp=c+dp= S(p)

EXAMPLE: Equilibrium with
Linear Curves
The equilibrium price:
p*=(a-c)/(d+b)
 The equilibrium quantity demanded (and
supplied):
D(p*)=a-bp*
=a-b(a-c)/(d+b)
=(ad+bc)/(d+b)

EXAMPLE: Equilibrium with
Linear Curves
The inverse demand curve:
q=a-bp
PD(q)=(a-q)/b
 The inverse supply curve:
PS(q)=(q-c)/d
 Solving for the equilibrium quantity we have
PD(q)=(a-q)/b=(q-c)/d= PS(q)
q*=(ad+bc)/(b+d)

EXAMPLE: Shifting Both Curves

Demand curve shifts to the
right


D
S’
D’
The equilibrium price and
quantity must both rise.
S
Supply curve shifts to the
right



price
The equilibrium quantity rises,
The equilibrium price must
fall.
p*
Both demand and supply
curves shift to the left by the
same amount

The equilibrium price will
remain unchanged.
q’
q*
quantity
16.6 Taxes
A quantity tax: a tax levied per unit of
quantity bought or sold.
PD=PS+t
 The equilibrium quantity traded:
PD(q*)-t=PS(q*)

16.6 Taxes
S
Supply
Demand
price
pd
price
pd
p*
p*
S’
S
D
ps
ps
D’
quantity
PD(q*)-t=PS(q*)
quantity
PD(q*)=PS(q*)+t
Another way to determine the
impact of a tax

Slide the line segment
along the supply curve
until it hits the demand
curve.
price
demand
supply
pd
Amount
of tax
ps
q*
quantity
EXAMPLE: Taxation with Linear
Demand and Supply
Equilibrium conditions:
a-bpD=c+dpS
pD=pS+t
 From those two equations, we have
PS*=(a-c-bt)/(d+b)
PD*= (a-c-bt)/(d+b)+t
= (a-c+dt)/(d+b)

16.7 Passing Along a Tax

Perfectly elastic
supply
Demand
price
D
 A perfectly horizontal
supply curve.
 The tax gets
completely passed
along to the
consumers.
S’
p*+t
t
p*
S
quantity
16.7 Passing Along a Tax

Perfectly inelastic
supply
Supply
price
S
D’
 A perfectly vertical
supply curve.
 None of the tax gets
passed along.
D
p*
t
p*-t
quantity
16.7 Passing Along a Tax

If the supply curve is
nearly horizontal,
much of the tax can
be passed along.
Demand
price
D
S’
p’
t
S
p*
quantity
16.7 Passing Along a Tax

If the supple curve
is nearly vertical,
very little of the tax
can be passed along.
S’
Demand
price
S
D
t
p’
p*
quantity
16.8 The Deadweight Loss of a Tax

The loss of producers’ and consumers’
surpluses are net costs, and the tax revenue to
the government is a net benefit, the total net
cost of the tax is the algebraic sum of these
areas: the loss in consumers’ surplus, -(A+B),
the loss in producers’ surplus, -(C+D), and the
gain in government revenue, +(A+C).
16.8 The Deadweight Loss of a Tax




The loss in consumers’
surplus: -(A+B)
The loss in producers’
surplus: -(C+D)
The gain in
government revenue:
+(A+C)
Deadweight loss of the
tax: –(B+D).
price
demand
supply
pd
Amount
of tax
A
B
D
C
ps
q*
quantity
EXAMPLE: The Market for Loans

Lenders pay income tax on interests.
 After
tax interest rate: (1-t)r
 Loans supplied: S((1-t)r)

Borrowers receive income tax deductibles on
interest payments.
 Interest
rate with deductible: (1-t)r
 Loans demanded: D((1-t)r)
Equilibrium: S((1-t)r)=D((1-t)r)
 The after-tax interest rate and the amount
borrowed are unchanged.

EXAMPLE: The Market for Loans

If the borrower and
lenders are in the
same tax bracket, the
after-tax interest rate
and the amount
borrowed are
unchanged.
Interest
rate
D’
S’
D
r*/(1-t)
S
r*
q*
loans
16.9 Pareto Efficiency

Pareto Efficiency: there is no way to make
any person better off without hurting anybody
else.
16.9 Pareto Efficiency



Suppose the good were
produced and
exchanged at any price
between pd and ps,
Both the consumer and
the supplier would be
better off.
Any amount less than
the equilibrium amount
cannot be Pareto
efficient.
price
demand
Willing to
buy at this
price pd
supply
pd=ps
Willing to
sell at this
price ps
q*
quantity