CHAPTER 16 EQUILIBRIUM
16.1 Supply
Supply curveIt measures how much the firm is willing to supply
of a good at each possible market price.The supply curve is the upward-sloping part of the
marginal cost curve that lies above the average cost curve.
16.2 Market Equilibrium
Market supply curve Add up the individual supply curves to get a market supply
curve. Competitive market
A market where each economic agent takes the market price as given.
Equilibrium price The price where the supply of the good equals the demand. The price that clears the market.
D(p*)= S(p*)
16.2 Market Equilibrium
p<p*Demand is greater than supply;Charging higher prices will not reduce sales but
increase revenue;The price gets bid up.
p>p*Demand is less than supply;Firms cut prices to resolve inventory;Downward pressure on the price.
16.3 Two Special Cases
Fixed supply The supply curve is
vertical. The equilibrium quantity
is determined entirely by the supply conditions.
The equilibrium price is determined entirely by demand conditions.
16.3 Two Special Cases
Perfect elastic supply The supply curve is
completely horizontal. The equilibrium price is
determined by the supply conditions
The equilibrium quantity is determined by the demand curve.
16.4 Inverse Demand and Supply Curves
Inverse supply function PS(q)
Inverse demand function PD(q)
Equilibrium is determined by the condition
PS(q)= PD(q)
EXAMPLE: Equilibrium with Linear Curves Suppose that both the demand and the supply
curves are linear:D(p)=a-bpS(p)=c+dp
The equilibrium price can be found by solving the following equation:
D(p)=a-bp=c+dp= S(p)
EXAMPLE: Equilibrium with Linear Curves The equilibrium price:
p*=(a-c)/(d+b) The equilibrium quantity demanded (and
supplied):D(p*)=a-bp*
=a-b(a-c)/(d+b) =(ad+bc)/(d+b)
EXAMPLE: Equilibrium with Linear Curves The inverse demand curve:
q=a-bp
PD(q)=(a-q)/b The inverse supply curve:
PS(q)=(q-c)/d Solving for the equilibrium quantity we have
PD(q)=(a-q)/b=(q-c)/d= PS(q)q*=(ad+bc)/(b+d)
EXAMPLE: Shifting Both Curves
Demand curve shifts to the right The equilibrium price and
quantity must both rise. Supply curve shifts to the
right The equilibrium quantity
rises, The equilibrium price must
fall. Both demand and supply
curves shift to the left by the same amount The equilibrium price will
remain unchanged.
16.6 Taxes
A quantity tax: a tax levied per unit of quantity bought or sold.
PD=PS+t
The equilibrium quantity traded:
PD(q*)-t=PS(q*)
Another way to determine the impact of a tax
Slide the line segment along the supply curve until it hits the demand curve.
EXAMPLE: Taxation with Linear Demand and Supply Equilibrium conditions:
a-bpD=c+dpS
pD=pS+t From those two equations, we have
PS*=(a-c-bt)/(d+b)
PD*= (a-c-bt)/(d+b)+t= (a-c+dt)/(d+b)
16.7 Passing Along a Tax
Perfectly elastic supply A perfectly horizontal
supply curve. The tax gets
completely passed along to the consumers.
16.7 Passing Along a Tax
Perfectly inelastic supply A perfectly vertical
supply curve. None of the tax gets
passed along.
16.7 Passing Along a Tax
If the supply curve is nearly horizontal, much of the tax can be passed along.
16.7 Passing Along a Tax
If the supple curve is nearly vertical, very little of the tax can be passed along.
16.8 The Deadweight Loss of a Tax
The loss of producers’ and consumers’ surpluses are net costs, and the tax revenue to the government is a net benefit, the total net cost of the tax is the algebraic sum of these areas: the loss in consumers’ surplus, -(A+B), the loss in producers’ surplus, -(C+D), and the gain in government revenue, +(A+C).
16.8 The Deadweight Loss of a Tax
The loss in consumers’ surplus: -(A+B)
The loss in producers’ surplus: -(C+D)
The gain in government revenue: +(A+C)
Deadweight loss of the tax: –(B+D).
EXAMPLE: The Market for Loans
Lenders pay income tax on interests.After tax interest rate: (1-t)rLoans supplied: S((1-t)r)
Borrowers receive income tax deductibles on interest payments.Interest rate with deductible: (1-t)rLoans demanded: D((1-t)r)
Equilibrium: S((1-t)r)=D((1-t)r) The after-tax interest rate and the amount
borrowed are unchanged.
EXAMPLE: The Market for Loans
If the borrower and lenders are in the same tax bracket, the after-tax interest rate and the amount borrowed are unchanged.
16.9 Pareto Efficiency
Pareto Efficiency: there is no way to make any person better off without hurting anybody else.