Unit 2: Consumer
Choice, Demand,
and Supply
Lecture #3:
Market Pricing: Equilibrium, Price
Ceilings, and Price Floors
EQUILIBRIUM
• When quantity demanded=quantity supplied at the
same price
• There is an equilibrium (market clearing) price
• There is also an equilibrium quantity
• The intersection of the supply and demand curves
shows the equilibrium point
EQUILIBRIUM
• Law of supply and demand
• The claim that the price of any good adjusts to bring the
quantity supplied and the quantity demanded for that good
into balance.
SUPPLY AND DEMAND
TOGETHER
Demand Schedule
Supply Schedule
At $2.00, the quantity demanded
is equal to the quantity supplied!
Figure 8 The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cone
Supply
Equilibrium
Equilibrium price
$2.00
Equilibrium
quantity
0
1
2
3
4
5
6
7
8
Demand
9 10 11 12 13
Quantity of Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
SURPLUS
• A surplus occurs when quantity supplied exceeds
quantity demanded at the market price (the market is
not in equilibrium – also called disequilibrium)
Figure 9 Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream
Cone
Supply
Surplus
$2.50
2.00
Demand
0
4
Quantity
demanded
7
10
Quantity
supplied
Quantity of
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning
SHORTAGE
• A shortage occurs when quantity demanded exceeds
quantity supplied at the market price (the market is
not in equilibrium)
Figure 9 Markets Not in Equilibrium
(b) Excess Demand
Price of
Ice-Cream
Cone
Supply
$2.00
1.50
Shortage
Demand
0
4
Quantity
supplied
7
10
Quantity of
Quantity
Ice-Cream
demanded
Cones
Copyright©2003 Southwestern/Thomson Learning
RATIONING FUNCTION OF
PRICES
• The ability of market forces in a competitive market
to equalize quantity demanded and quantity supplied
and to eliminate shortages and surpluses via changes
in prices
• Results when producers and consumers act according
to their self-interest
QUANTITY DEMANDED AND
SUPPLIED
PRICE
QUANTITY QUANTITY STATE OF
DEMANDED SUPPLIED
THE
MARKET
$5
2
12
SURPLUS OF 10
$4
4
10
SURPLUS OF 6
$3
6
6
EQUILIBRIUM
$2
10
4
SHORTAGE OF
6
$1
12
2
SHORTAGE OF
10
Figure 10 How an Increase in Demand Affects the Equilibrium
Price of
Ice-Cream
Cone
1. Hot weather increases
the demand for ice cream . . .
Supply
New equilibrium
$2.50
2.00
2. . . . resulting
in a higher
price . . .
Initial
equilibrium
D
D
0
7
3. . . . and a higher
quantity sold.
10
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Figure 11 How a Decrease in Supply Affects the Equilibrium
Price of
Ice-Cream
Cone
S2
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
S1
New
equilibrium
$2.50
Initial equilibrium
2.00
2. . . . resulting
in a higher
price of ice
cream . . .
Demand
0
4
7
3. . . . and a lower
quantity sold.
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Three Steps to Analyzing Changes in
Equilibrium
• Shifts in Curves versus Movements along Curves
• A shift in the supply curve is called a change in supply.
• A movement along a fixed supply curve is called a change
in quantity supplied.
• A shift in the demand curve is called a change in demand.
• A movement along a fixed demand curve is called a change
in quantity demanded.
Three Steps to Analyzing Changes in
Equilibrium
1. Decide whether the event shifts the supply or
demand curve (or both).
2. Decide whether the curve(s) shift(s) to the left or to
the right.
3. Use the supply-and-demand diagram to see how the
shift affects equilibrium price and quantity.
Table 4 Supply and Demand Shifts
What happens to the equilibrium price when shifts occur?
Copyright©2004 South-Western
CHANGE SUMMARY
CHANGE IN CHANGE IN EFFECT ON EFFECT ON
DEMAND
SUPPLY
EQ. PRICE
EQ.
QUANTITY
Increase
None
increase
increase
Decrease
None
decrease
decrease
None
Increase
decrease
increase
None
Decrease
increase
decrease
Increase
Increase
depends
increase
Increase
Decrease
increase
depends
Decrease
Increase
decrease
depends
Decrease
Decrease
depends
decrease
PRICE CEILING
• A government regulation that establishes a maximum
price for a product
• The government is trying to make a product more
affordable to the public
• Ceiling must be set BELOW the equilibrium price to
be a binding price ceiling
• Binding price ceilings will result in shortages
Figure 1 A Market with a Price Ceiling
(a) A Price Ceiling That Is Not Binding
Price of
Ice-Cream
Cone
Supply
$4
Price
ceiling
3
Equilibrium
price
Demand
0
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
Figure 1 A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
2
Price
ceiling
Shortage
Demand
0
75
125
Quantity
supplied
Quantity
demanded
Quantity of
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning
Figure 2 The Market for Gasoline with a Price Ceiling
(a) The Price Ceiling on Gasoline Is Not Binding
Price of
Gasoline
Supply, S1
1. Initially,
the price
ceiling
is not
binding . . .
Price ceiling
P1
Demand
0
Q1
Quantity of
Gasoline
Copyright©2003 Southwestern/Thomson Learning
Figure 2 The Market for Gasoline with a Price Ceiling
(b) The Price Ceiling on Gasoline Is Binding
Price of
Gasoline
S2
2. . . . but when
supply falls . . .
S1
P2
Price ceiling
3. . . . the price
ceiling becomes
binding . . .
P1
4. . . .
resulting
in a
shortage.
Demand
0
QS
QD Q1
Quantity of
Gasoline
Copyright©2003 Southwestern/Thomson Learning
PRICE FLOOR
• A government regulation that establishes a minimum
price for a product
• The government is trying to provide a higher price
for the producer
• Floor must be set ABOVE the equilibrium price to
be a binding price floor
• Binding price floors will result in surpluses
Figure 4 A Market with a Price Floor
(a) A Price Floor That Is Not Binding
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
Price
floor
2
Demand
0
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning
Figure 4 A Market with a Price Floor
(b) A Price Floor That Is Binding
Price of
Ice-Cream
Cone
Supply
Surplus
$4
Price
floor
3
Equilibrium
price
Demand
0
Quantity of
Quantity Quantity Ice-Cream
Cones
demanded supplied
80
120
Copyright©2003 Southwestern/Thomson Learning
Figure 5 How the Minimum Wage Affects the Labor Market
Wage
Labor
Supply
Equilibrium
wage
Labor
demand
0
Equilibrium
employment
Quantity of
Labor
Copyright©2003 Southwestern/Thomson Learning
Figure 5 How the Minimum Wage Affects the Labor Market
Wage
Labor surplus
(unemployment)
Labor
Supply
Minimum
wage
Labor
demand
0
Quantity
demanded
Quantity
supplied
Quantity of
Labor
Copyright©2003 Southwestern/Thomson Learning
Graphing Shifts Practice
Graph each situation and state what happens to the equilibrium
price
a) Supply decreases and demand is constant.
b) Demand decreases and supply is constant.
c) Supply increases and demand is constant.
d) Demand increases and supply increases.
e) Demand increases and supply is constant.
f) Supply increases and demand decreases.
g) Demand increases and supply decreases.
h) Demand decreases and supply decreases.