Market Equilibrium

… a core concept in Economic Analysis

Concept description

Alex Tabarrok (reference below and video to right) explains how prices reach equilibrium and how the market works like an invisible hand coordinating economic activity.

“At equilibrium, the price is stable and gains from trade are maximized. When the price is not at equilibrium, a shortage or a surplus occurs. The equilibrium price is the result of competition amongst buyers and sellers.”

Tabarrok notes that buyers do not compete with sellers, but with other buyers, and vice versa.

In his second lesson video on the subject (above left), Tabarrok further explores the dynamics of market equilibrium and produces the following summary graph:

and describes what this means as:

1. The supply of goods is bought by buyers with the highest willingness to pay
2. The supply of goods is sold by the sellers with the lowest costs
3. Between buyers and sellers, there are no unexploited gains from trade or any wasteful trades.

Does the equilibrium model work?

In another lesson video (right) Tabarrok reviews the work of Nobel prize winner, Vernon Smith, and experimental support for the equilibrium model.

MRU practice questions

See http://www.mruniversity.com/equilibrium-price-supply-demand-example-practice-questions and http://www.mruniversity.com/node/179642, and http://www.mruniversity.com/courses/principles-economics-microeconomics/does-equilibrium-model-work, accessed 20 April 2016.

1. If the price in a market is above the equilibrium price, this creates ___________.
   1. a shortage
   2. a surplus
   3. neither a shortage nor a surplus
2. When the price is above the equilibrium price, greed (in other words, self-interest) tends to _________.
   1. push the price down
   2. push the price up
   3. have no effect on price
3. Jon is on eBay, bidding for a first edition of the influential Frank Miller graphic novel Batman: The Dark Knight Returns. In this market, who is Jon competing with?
   1. The seller of the graphic novel
   2. The other bidders 
   3. eBay’s stakeholders
4. Now, Jon is in Japan, trying to get a job as a full-time translator; he wants to translate English TV shows into Japanese and vice versa. He notices that the wage for translators is very low. Who is the “competition” that is pushing the wage down?
   1. Businesses who hire translators
   2. Other translators
   3. Prospective clients
5. Jules wants to purchase a Royale with cheese from Vincent. Vincent is willing to offer this tasty burger for $3. The most Jules is willing to pay for the tasty burger is $8 (after all, his girlfriend is a vegetarian, so he doesn’t get many opportunities for tasty burgers). How large are the potential gains from trade if Jules and Vincent agree to make this trade? In other words, what is the sum of producer and consumer surplus if the trade happens?
   1. $3
   2. $4
   3. $5
6. If the trade takes place at $4, how much producer surplus goes to Vincent? How much consumer surplus goes to Jules?
   1. $1 goes to Vincent, $4 goes to Jules
   2. $4 goes to Vincent, $1 goes to Jules
   3. $2 goes to Vincent, $3 goes to Jules
7. If the trade takes place at $7, how much producer surplus goes to Vincent? How much consumer surplus goes to Jules?
   1. $1 goes to Vincent, $4 goes to Jules
   2. $4 goes to Vincent, $1 goes to Jules
   3. $2 goes to Vincent, $3 goes to Jules
8. What happened in Vernon Smith’s lab?
   1. The price and quantity were close to equilibrium but gains from trade were far from the maximum.
   2. The price and quantity were far from equilibrium and gains from trade were far from the maximum.
   3. The price and quantity were far from equilibrium but gains from trade were close to the maximum.
   4. The price and quantity were close to equilibrium and gains from trade were close to the maximum.
9. When demand increases, what happens to price and quantity in equilibrium?
   1. Price increases and quantity decreases
   2. Price decreases and quantity increases
   3. Price and quantity both increase
   4. Price and quantity both decrease
10. When supply increases, what happens to price and quantity in equilibrium?
    1. Price increases and quantity decreases
    2. Price decreases and quantity increases
    3. Price and quantity both increase
    4. Price and quantity both decrease
11. When supply decreases, what happens to price and quantity in equilibrium?
    1. Price increases and quantity decreases
    2. Price decreases and quantity increases 
    3. Price and quantity both increase
    4. Price and quantity both decrease
12. When demand decreases, what happens to price and quantity in equilibrium?
    1. Price increases and quantity decreases
    2. Price decreases and quantity increases
    3. Price and quantity both increase
    4. Price and quantity both decrease
13. What’s the best way to think about the rise in oil prices in the 1970s, when wars and oil embargoes wracked the Middle East?
    1. A rise in demand
    2. A fall in demand
    3. A rise in supply
    4. A fall in supply
14. What’s the best way to think about the rise in oil prices in the last 10 years, as China and India have become richer: Was it a rise in demand, a fall in demand, a rise in supply, or a fall in supply?
    1. A rise in demand
    2. A fall in demand
    3. A rise in supply
    4. A fall in supply

Source

Alex Tabarrok, The Equilibrium Price, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/equilibrium-price-supply-demand-example, accessed 19 April 2016.

Alex Tabarrok, Exploring Equilibrium, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/equilibrium-supply-demand, accessed 20 April 2016.

Alex Tabarrok, Does the Equilibrium Model Work, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/does-equilibrium-model-work, accessed 20 April 2016.

Atlas topic and subject

Supply, Demand, and Equilibrium (core topic) in Economic Analysis.

Page created by: Ian Clark, last modified on 20 April 2016.

Image: Minute 0.37 of MRU Video, at http://www.mruniversity.com/courses/principles-economics-microeconomics/equilibrium-price-supply-demand-example, accessed 19 April 2016.