IGCSE Economics

2.2 Market Equilibrium

Learning Outcomes

• Describe the causes of changes in demand and supply conditions and analyse such changes to show effects in the market

What is Market Equilibrium?

• When demand and supply are combined there is a tendency for them to reach an equilibrium state

• Market Equilibrium is defined as:‘The state in which the quantity supplied is

equal to the quantity demanded’The price level at which this happens is

called the market clearing price

Task

• Draw a fully labelled diagram which shows a supply curve AND a demand curve

Market Equilibrium

Quantity

Pric

e S

D

Pe

Qe

DISEQUILIBRIUM

Disequilibrium

• Disequilibrium is a situation where demand doesn’t equal supply

Question…

• What would happen if the price was set ABOVE the equilibrium price?

Show this in a diagram…..

Excess Supply

Quantity

Pric

e S

D

Pe

Qe

P1

Excess Supply(Surplus)

There is now an excess of supplyWhat is likely to

happen?

What will happen?

• Producers now have too much stock (Excess of supply/surplus))

• The only way they can sell this is to reduce the price

• As they do this demand will increase• The gap will be narrowed until the surplus

is reduced to zero and the equilibrium price is reached

Prices will fall until equilibrium is reached

Quantity

Pric

e S

D

Pe

Qe

P1

Excess Supply(Surplus)

Question…

• What would happen if the price was set BELOW the market price

Excess Demand

Quantity

Pric

e S

D

Pe

Qe

P1

Excess Demand(Shortage)

There is now an excess of demand

What is likely to happen?

What will happen?

• Suppliers realise that they can charge a higher price

• They will produce more but will increase the price gradually

• As they do this, consumers start to drop out of the market and demand is gradually lowered

• The gap will be narrowed until the surplus demand is reduced to zero and the equilibrium price is reached

Prices will increase until equilibrium is reached

Quantity

Pric

e S

D

Pe

Qe

P1

Excess Demand(Shortage)

Video

• Watch the Video• Episode 14 – Market Equilibrium

CHANGES IN SUPPLY AND DEMAND

Introduction

• The tendency towards market equilibrium is strong

• When the markets are in balance it usually requires some external force to change them

• Shifts in supply or demand will change the market equilibrium

• There will be a new equilibrium price and equilibrium quantity

LOOKING AT SHIFTS IN DEMAND AND SUPPLY – FILL IN YOUR TABLES AS WE GO THROUGH THEM

There has been a decrease in consumers incomes. How will this affect the new car

market?

• Will the demand or the supply curve be affected?

• Will this be a shift to the left or a shift to the right?

• What will happen to the equilibrium price and quantity?

A Decrease in DemandPrice

Quantity 0

S

p

q

DD1

p1

q1

A shift to the left of the demand curve will decrease equilibrium price and decrease equilibrium quantity

Explanation…..

• The demand curve will shift to the left from D to D1 as cars are a normal/luxury good

• As a result the market price will decrease from P to P1

• Suppliers will now be less willing to supply at this new price so there will be a contraction of supply

• The market quantity will decrease from Q to Q1

Discovery of synthetic rubber makes the production of rubber ducks much cheaper

• Will the demand or the supply curve be affected?

• Will this be a shift to the left or a shift to the right?

• What will happen to the equilibrium price and quantity?

An Increase in SupplyPrice

Quantity 0

S

p

q

D

S1

p1

q1

A shift to the right of the supply curve will decrease equilibrium price and increase equilibrium quantity

Explanation

• The supply curve will shift to the right from S to S1 as costs of production are decreased

• The market price will decrease from P to P1

• As a result there will be an extension of demand

• The market quantity will increase from Q to Q1

Bad weather in Greece and Cyprus damage orange crops

• Will the demand or the supply curve be affected?

• Will this be a shift to the left or a shift to the right?

• What will happen to the equilibrium price and quantity?

A Decrease in SupplyPrice

Quantity 0

S

p

q

D

S1

p1

q1

A shift to the left of the supply curve will increase equilibrium price and decrease equilibrium quantity

Explanation

• The supply curve will shift to the left from S to S1 as the supply of oranges is restricted

• The market price will increase from P to P1

• As a result there will be a contraction of demand

• The market quantity will decrease from Q to Q1

It is reported that pomegranate juice contains high levels of healthy antioxidants

• Will the demand or the supply curve be affected?

• Will this be a shift to the left or a shift to the right?

• What will happen to the equilibrium price and quantity?

An Increase in DemandPrice

Quantity 0

S

p

q

D D1

p1

q1

A shift to the right of the demand curve will increase equilibrium price and increase equilibrium quantity

Explanation

• The demand curve will shift to the right from D to D1 as customers will want to buy more of the healthy drink

• The market price will increase from P to P1

• As a result there will be an extension of supply

• and market quantity will increase and from Q to Q1

For each of the headlines below explain the change in equilibrium price and quantity with the aid of a diagram

Peer marking• Use the grids to give a mark out of 6

3 marks Correctly labelled diagram• Axis and curves are correctly labelled• Correct shift/change is shown• Original and new equilibrium price and quantity labelled

Up to 3 marks

• All – 3 marks• Most – 2 marks• Some – 1 mark

• Inappropriate/incorrect answer – 0 marks

Explanation• Refers to diagram • Correctly identifies and explains how the market price

will change• Correctly identifies and explains how the market quantity

will change• Uses subject specific terminology

Extension Activity

• Read the article

• Explain with the aid of a diagram why the price of coffee has increased

Coffee prices expected to rise as a result of poor harvests and growing demand Coffee bean prices top $3 a pound for first time in 34 years

Thursday 21 April 2011 15.33 BST

Coffee picking in Costa Rica. Global stocks of coffee are declining. Photograph: Juan Carlos Ulate/ Reuters/Corbis

The price of a cup of coffee is likely to go up further as coffee prices have topped $3 a pound for the first time in more than 34 years. Poor harvests of high-grade arabica coffee beans and a growing taste for gourmet coffee among burgeoning middle classes in China, Brazil, Indonesia and India are behind the sharp rise.

Coffee prices have more than doubled in the past seven months. Supplies are running low because heavy rain led to worse than expected harvests in Colombia, the second-largest producer of arabica beans after Brazil, Indonesia, Mexico and Vietnam.

"We expect prices to hit further highs on production downgrades, the decline in global stocks and supply tightness that should keep markets fearful of any disruptions," said Sudakshina Unnikrishnan, commodities analyst at Barclays Capital. "This is likely to be reflected in higher retail prices which operate with a lag."

Supermarket coffee prices have been going up around the world. In Britain, a 227g bag of ground filter coffee cost £2.60 in March, compared with £2.28 a year ago, according to the Office for National Statistics. A 100g bag of instant coffee was £2.47, up from £2.27. Most of the coffee drunk in Britain is instant.