Chapter

4: Demand & Supply

An Equilibrium Analysis

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Demand and Supply Aggrega:on

Sum the Supply curves HORIZONTALLY!

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Demand and Supply Aggrega:on

Sum the Demand curves HORIZONTALLY!

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Demand and Supply Aggrega:on

DeniGons:
The Aggregate Demand (or Supply) represents
the horizontal sum of the individual Demand (or
Supply) curves.


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Market Equilibrium
How much gets traded in the market & at what price?

1. In one graph, plot both

Aggregate Demand & Aggregate Supply
2. Find the point (Q*, P*) where
Quan:ty Demand = Quan:ty Supplied

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Market Equilibrium
DeniGons:
Excess Supply depicts a situa:on where the
quan/ty supplied is larger than the quan/ty
demanded.
Excess Demand depicts a situa:on where the
quan/ty demanded is larger than the quan/ty
supplied.

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Market Equilibrium

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Market Equilibrium
DeniGon:
The Equilibrium Price (QuanGty) represents the
price (quan:ty) such that the quanGty supplied
equals the quanGty demanded.




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Market Equilibrium
Perfectly compeGGve market
Buyers & Sellers are Price Accepters (Takers)

# ReservaGon
Price

Seller 1
Seller 2
Seller 3
Seller 4
Seller 5
Seller 6

Buyer 1
Buyer
2


Buyer 3
Buyer
4


Buyer
5


Buyer 6

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# ReservaGon
Price

Market Equilibrium
DeniGons:

The ReservaGon Price of a Buyer is the highest

price a buyer is willing to pay for a given good.
The ReservaGon Price of a Seller is the lowest
price a seller is willing to accept for a given
good.
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Market Equilibrium

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Market Equilibrium
RaGoning Rule:
The RaGoning Rule states that buyers who value
the good more will be the rst to buy it.




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Market Equilibrium

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Market Equilibrium
DeniGons:

The Consumer Surplus represents the

dierence between what a consumer pays for a
good or service and what she is willing to pay
for that good or service (her reserva:on price).
The Producer Surplus represents the dierence
between the price a seller receives for a good or
service and what he is willing to receive for that
good or service (her reserva:on price).
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Market Equilibrium

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Market Equilibrium

-$2
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Market Equilibrium

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Market Equilibrium

NOPE!! Perfectly compeGGve market:
If agents try to change price away
from P*, they wouldnt be able to buy
(sell) anything
(equilibrium) price-takers!
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Market Equilibrium

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Consumer and Producer Surplus

DeniGons:
The Total Consumer Surplus represents the sum of
the economic surplus of all consumers.
The Total Producer Surplus represents the sum of
the economic surplus of all producers.
The Total Surplus is the sum of the total consumer
surplus and total producer surplus.

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Consumer and Producer Surplus

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Consumer and Producer Surplus

In a perfectly compeGGve market,
Total Surplus is maximized exactly at the
equilibrium price P*!!

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Consumer and Producer Surplus

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A (Clever) Toy Model

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A (Clever) Toy Model

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A (Clever) Toy Model

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C Compe::ve Markets:
Pareto Eciency (Short Run)
Pareto Eciency:
Pareto Eciency is a situa:on in which it is

impossible to make any individual be^er o

without making at least one other individual
worse o.

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C Compe::ve Markets:
Pareto Eciency (Short Run)
A perfectly compeGGve markets Equilibrium
is Pareto Ecient!

There is
= no
possible transac:on that would make someone
be^er o
harming someone else.
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C Compe::ve Markets:
Pareto Eciency (Short Run)
DeniGon:
A Pareto Improving TransacGon is a transac:on
where all par:es involved are be^er o.

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C Compe::ve Markets:
Pareto Eciency (Short Run)
How about Equity & Society Wellbeing?

Eciency
Equality of Resources & OpportuniGes

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C Compe::ve Markets:
The Invisible Hand (Long Run)
The Invisible Hand Principle:
The Invisible Hand Principle states that
individuals independent eorts to maximize
their gains (prots for sellers; u:lity for buyers)
will generally be benecial for society and result
in the socially op:mal alloca:on of resources.

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C Compe::ve Markets:
The Invisible Hand (Long Run)
In the long run,

exis:ng rms can adjust all their factors of produc:on

(and perhaps exit) its the long run!
new rms can enter the market (as long as produc:on>0)
S curve shihs to right P*
produc:on
produc:on = 0
rms produce Q* such that ATC is minimized

P*LR = min(ATC) !!!

what if ini:ally produc:on < 0 ?

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C Compe::ve Markets:
The Invisible Hand (Long Run)

Entry

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C Compe::ve Markets:
The Invisible Hand (Long Run)

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C Compe::ve Markets:
The Invisible Hand (Long Run)

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The Long Run Supply Curve

All rms
- produce with the same technology ( same cost curves)
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- sell at P* = min(ATC)

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The Long Run Supply Curve

P* doesnt change !!
But Q* does !!
In the LR, Supply is
more elas/c!

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