• Solving for the competitive equilibrium price
  To find the equilibrium price, one must either plot the supply and demand curves, or solve for the expressions for supply and demand being equal.

• Influences changing price
  A change in equilibrium price may occur through a change in either the supply or demand schedules.

• When there is a shortage in the market we see that, to correct this disequilibrium, the price of the good will be increased back to a price of $5.00, thus lessening the quantity demanded and increasing the quantity supplied thus that the market is in balance.

• Likewise where the price is below the equilibrium point (also known as the “sweet spot”[3]) there is a shortage in supply leading to an increase in prices back to equilibrium.

• Consider the following demand and supply schedule:
  The equilibrium price in the market is $5.00 where demand and supply are equal at 12,000 units
  If the current market price was $3.00 – there would be excess demand for 8,000 units, creating a shortage.

• Demand is chosen to maximize utility given the market price: no one on the demand side has any incentive to demand more or less at the prevailing price.

• Then, there will be no change in price or the amount of output bought and sold — until there is an exogenous shift in supply or demand (such as changes in technology or tastes).

• For example, in the neoclassical growth model, starting from one dynamic equilibrium based in part on one particular saving rate, a permanent increase in the saving rate leads to a new dynamic equilibrium in which there are permanently higher capital per worker and productivity per worker, but an unchanged growth rate of output; so it is said that in this model the comparative dynamic effect of the saving rate on capital per worker is positive but the comparative dynamic effect of the saving rate on the output growth rate is zero.

• This price is often called the competitive price or market clearing price and will tend not to change unless demand or supply changes, and quantity is called the “competitive quantity” or market clearing quantity.

• Equilibrium can change if there is a change in demand or supply conditions.

• We will also see similar behaviour in price when there is a change in the supply schedule, occurring through technological changes, or through changes in business costs.

• For example, since a rise in consumers’ income leads to a higher price (and a decline in consumers’ income leads to a fall in the price — in each case the two things change in the same direction), we say that the comparative static effect of consumer income on the price is positive.

• Likewise supply is determined by firms maximizing their profits at the market price: no firm will want to supply any more or less at the equilibrium price.

• Similarly, in models of inflation a dynamic equilibrium would involve the price level, the nominal money supply, nominal wage rates, and all other nominal values growing at a single common rate, while all real values are unchanging, as is the inflation rate.

• As Dixon argues: “The crucial weakness is that, at each step, the firms behave myopically: they choose their output to maximize their current profits given the output of the other firm, but ignore the fact that the process specifies that the other firm will adjust its output…”.

• This is another way of saying that the total derivative of price with respect to consumer income is greater than zero.

• [1]

  Market equilibrium in this case is a condition where a market price is established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers.

• Modern mainstream economics points to cases where equilibrium does not correspond to market clearing (but instead to unemployment), as with the efficiency wage hypothesis in labor economics.

• When there is an oversupply of a good, such as when price is above $6.00, then we see that producers will decrease the price to increase the quantity demanded for the good, thus eliminating the excess and taking the market back to equilibrium.

• A decrease in disposable income would have the exact opposite effect on the market equilibrium.

• [4] Both firms produce a homogenous product: given the total amount supplied by the two firms, the (single) industry price is determined using the demand curve.

• This is the same case when the price is above the equilibrium and the shortage in supply leads the monopolist to decrease the supply to return to the profit-maximizing quantity.

• P1 is satisfied since the payoff function ensures that the market price is consistent with the outputs supplied and that each firms profits equal revenue minus cost at this output.

• On the other hand, a decrease in technology or increase in business costs will decrease the quantity supplied at each price, thus increasing equilibrium price.

• An increase in technological usage or know-how or a decrease in costs would have the effect of increasing the quantity supplied at each price, thus reducing the equilibrium price.

• Because the monopolist’s profit-maximizing quantity is different from the socially-maximizing quantity, consumers have an incentive to demand more at the equilibrium price.

• Best response dynamics involves firms starting from some arbitrary position and then adjusting output to their best-response to the previous output of the other firm.

• This will cause changes in the equilibrium price and quantity in the market.

• The reaction function for each firm gives the output which maximizes profits (best response) in terms of output for a firm in terms of a given output of the other firm.

• This increase in demand would have the effect of shifting the demand curve rightward.

• In most simple microeconomic stories of supply and demand a static equilibrium is observed in a market; however, economic equilibrium can be also dynamic.

• For instance, starting from the above supply-demand configuration, an increased level of disposable income may produce a new demand schedule, such as the following:
  Here we see that an increase in disposable income would increase the quantity demanded of the good by 2,000 units at each price.

• In economics, economic equilibrium is a situation in which the economic forces of supply and demand are balanced, meaning that economic variables will no longer change.

• [7]
  Interpretations
  In most interpretations, classical economists such as Adam Smith maintained that the free market would tend towards economic equilibrium through the price mechanism.

• When there is an excess in supply, monopolists will realize that the equilibrium is not at the profit-maximizing quantity and will put upward pressure on the price to make it return to equilibrium.

 

Works Cited

[‘1. Varian, Hal R. (1992). Microeconomic Analysis (Third ed.). New York: Norton. ISBN 0-393-95735-7.
2. ^ Dixon, H. (1990). “Equilibrium and Explanation”. In Creedy (ed.). The Foundations of Economic Thought. Blackwells. pp. 356–394. ISBN 0-631-15642-9. (reprinted in Surfing Economics).
3. ^ Finding the sweet spot: how to get the right staffing for variable workloads Bryce, Christensen; Healthcare Financial Management 2011 Mar;65(3):54-60
4. ^ Augustin Cournot (1838), Theorie mathematique de la richesse sociale and of recherches sur les principles mathematiques de la theorie des richesses, Paris
5. ^ Dixon (1990), page 369.
6. ^ Paul A. Samuelson (1947; Expanded ed. 1983), Foundations of Economic Analysis : Ch.3, p.52 , Harvard University Press. ISBN 0-674-31301-1
7. ^ See citations at Great Famine (Ireland): Food exports to England, including Cecil Woodham-Smith The Great Hunger; Ireland 1845–1849, and Christine Kinealy, ‘Irish Famine: This Great Calamity and A Death-Dealing Famine’
8. ^ Smith, Adam (1776), Wealth of Nations Archived 2013-10-20 at the Wayback Machine, Penn State Electronic Classics edition, republished 2005, Chapter 7: p.51-58
9. ^ Turnovsky, Stephen J. (2000). Methods of Macroeconomic Dynamics. MIT Press. ISBN 0-262-20123-2.
10. ^ O’Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey: Pearson Prentice Hall. p. 550. ISBN 0-13-063085-3.
Photo credit: https://www.flickr.com/photos/mikaelmiettinen/3630246240/’]