Market equilibrium, the price mechanism and market efficiency (1.3)

Revision cards for section 1.3 (chapter 3) in the International Baccalaureate economics course

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Equilibrium

The market equilibrium is very important to consider when setting the price of a product. The equilibrium is the point where supply and demand meets each other. A product priced at the equilibrium point is the place where a producer is able to sell the most, given their current production. In the graph Pe shows the market equilibrium

(http://i45.tinypic.com/2vjd16o.png)

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Equilibrium

When a producer sells a product higher or lower than the equilibrium price it can lead to a shortage or surplus of the good. If the product is at a higher price than equilibrium, the supply would be greater than the demand for the product at this price, leading to a surplus of the product. If the producer sells the product below equilibrium price, the producer will face a shortage of the product, as the demand at the given price will be higher than the supply he is willing to create. The graph to the left shows a product sold over the equilibrium price and the right graph shows the product sold under equilibrium price

 (http://i46.tinypic.com/358c56x.png)(http://i46.tinypic.com/2emlfkk.png)

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The effect of changes in demand and supply upon th

When the demand or supply curve moves to either the right or the left, the equilibrium will also be moved, in order to match the new demand or supply. For example, if there is a rise in income consumers are more likely to purchase normal goods, such as shoes. This leads to an increase in demands for shoes, moving the demand curve and equilibrium to the right

(http://i47.tinypic.com/c5gr6.png)

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The role of price mechanism

The forces of supply and demand is also known as 'price mechanisms'

When the price increases due to an increase in demand of a certain product in a location, the producers may want to allocate their resources to these places in order to maximize their supply

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Market efficiency - consumer and producer surplus

As the consumers usually pays for a product at the equilibrium price, they are said to gain the surplus of what they haven't paid.

For example, if we look at hats, at an equilibrium price of $10, a producer is able to sell 10 hats and at a price of $15 the producer is able to sell 5 hats. This means that there are 5 consumers willing to pay $15 for a hat, but they purchase them at the equilibrium price of $10 instead, therefore, they have paid less than they were willing to. In the graph, the area labeled green is the consumer surplus.

The producer also gets a surplus, which is the amount of money that the consumer is willing to pay for a certain good, the producer surplus is labeled yellow in the graph

The graph is on the next slide

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Market efficiency - consumer and producer surplus

(http://i48.tinypic.com/rck2o2.png)

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Market efficiency - allocative efficiency

The allocative efficiency is the consumer surplus and the producer surplus added together This means that the larger the area is the more allocative efficient the product is. Therefore, the larger the area is, the more allocative efficient the product is, in order to reach maximum allocative efficiency, the product needs to be sold at the equilibrium price, fully using the surplus and creating efficiency

(http://i47.tinypic.com/2n74kus.png)

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Calculating and illustrating market equilibrium us

In order to find the equilibrium price of a product, you can set up the equations of supply and demand against each other, for example:

Qd = 500 - 100P

Qs = -600 + 300P

Then you can set them up as an equation

500 - 100P = -600 + 300P

Then simplify the equation by adding 100P on both sides

500 = -600 + 400P

Then adding 600 to both sides

1100 = 400P

Divide the 400 P on both sides

Pe = 1100/400 = $2.75

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Calculating and illustrating market equilibrium us

With the equilibrium price, we can find the equilibrium supply and demand

Qd = 500 - 100*2.75 = 225 units

Qs = -600 + 300*2.75 = 225 units

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