Introduction to Economics

Key terms
Market equilibrium
Price mechanism
Market clearing price
Shortage, excess demand
Surplus, excess supply

Equilibrium price and output
Combines analysis of demand and supply
Market clearing – when supply matches demand
Equilibrium is the point where conflicting interests are balanced
Price is determined by the INTERACTION BETWEEN demand and supply in a competitive market

The determination of market equilibrium
(potatoes: monthly)
fig
Quantity (tonnes: 000s)
E
C
B
A
a
b
c
e
Supply
Demand
Price (pence per kg)
D
d

The Determination of Price and Output
Demand and supply curves
effect of price being above equilibrium
price falls
Why does the price fall if above equilibrium?

Change in demand
Determinant other than price changes
Demand curve shifts
Right if demand increases
Left if demand decreases

Change in supply
Determinant other than price changes
Supply curve shifts:
Right if supply increases
Left if supply decreases

Effect of a shift in the demand curve
fig
P
Q
O
Pe1
Qe1
S
D1
g
Initial equilibrium at point g

Effect of a shift in the demand curve
fig
P
Q
O
Pe1
Qe1
S
D1
D2
g

Effect of a shift in the demand curve
fig
P
Q
O
Pe1
Qe1
S
g
D1
D2
Pe2
Qe2
New equilibrium at point i

Movement to a new equilibrium
Shift in one curve means movement along the other
New intersection is the new equilibrium
Changes in more than one determinant means BOTH curves can shift
If both curves move, new equilibrium is where the NEW curves meet

Movement to a new equilibrium

Discussion
Is the following statement true?
‘An increase in demand will cause an increase in price. This increase in price will cause a reduction in demand, until demand is reduced back to its original level’.