10
3. Equilibrium Price and Quantity
Question:
1. Define the equilibrium price and quantity of a consumer good and describe a
process that causes the price to adjust to equilibrium.
2. Define the equilibrium wage and quantity of labor and describe a process
that causes the wage to adjust to equilibrium.
Diagrams and Problems:
3. Given supply and demand functions, illustrate with spreadsheets, algebra,
and diagrams. Illustrate an economy that has only one type of labor and one
type of consumer good with a circular flow.
Equilibrium Price for a Consumer Good
Hint: Never say "demand" in place of "quantity demanded" or "supply" in place
of "quantity supplied."
The equilibrium price is the price where the quantity demanded is equal
to the quantity supplied for a particular good or service. That implies that
the equilibrium quantity is both the quantity supplied and the quantity
demanded.
The equilibrium price and quantity is the only price and quantity were
the planned actions of the buyers are consistent with the planned actions of
the sellers. At any other price and quantity some or all of either the buyers
or the sellers must be frustrated, and unable to complete planned purchases or
sales.
If price is greater than equilibrium price, quantity supplied is greater
than quantity demanded. Some sellers are frustrated because they sell less
than planned. They shave their ask prices to try to increase sales. As all
sellers gradually cut prices, quantity demanded increases and quantity
supplied decreases. Eventually, price and quantity are equal to equilibrium
price and quantity.
If price is less than equilibrium price, quantity supplied is less than
quantity demanded. Some buyers are frustrated because they buy less than
planned. Sellers increase prices knowing that they can still sell all they
produce. As all sellers gradually increase prices, quantity demanded
decreases and quantity supplied increases. Eventually, price and quantity are
equal to equilibrium price and quantity.
The equilibrium price can be found using algebra by setting the demand and
supply functions equal to one another and solving for the price.
Qd = Qs
2000k – 100k P = -500k + 400k P
2000k – 100k P + 500k = -500k +400k P + 500k
2500k –100k P + 100k P = 400k P + 100k P
2500k = 500k P
2500k/500k = 500k P/ 500k (the “k”s cancel)
5 = P
Pe = 5 <-- this is $5 per unit.
The equilibrium quantity can be found using algebra by substituting the
equilibrium price into either the demand or the supply function. The result
must be same--assuming the equilibrium price is used.
Qd = 2000k – 100k P Qs = -500k + 400k P
= 2000k – 100k (5) = -500k + 400k (5)
11
= 2000k –500k = -500k + 2000k
= 1500k = 1500k
Qe = 1500k <-- this is 1500 thousand units -- 1,500,000
The equilibrium price and quantity can be illustrated using a supply and
demand diagram. Generally, these are not drawn to scale. If you are asked
to draw one using paper and pencil, it should look something like the one
below:
P S
P – Price
Q- Quantity
5 Pe
D
Qe Q
1500k
Equilibrium Wage
The equilibrium wage is the wage where the quantity of labor demanded is
equal to the quantity of labor supplied for a specific type of labor. The
equilibrium quantity of labor is both the quantity supplied and the quantity
demanded. The equilibrium wage is the only wage where the plans of firms to
hire workers is just matched by the plans of workers to obtain employment. At
any other wage, either the firms or workers are frustrated.
If the wage is below equilibrium, quantity supplied is less than quantity
demanded. Some firms cannot find enough suitable employees. Each firm offers
higher wages to attract worker. As all firms gradually increase wages, the
quantity demanded decreases and the quantity supplied increases. Eventually
the wage and quantity of labor employed is equal to the equilibrium wage and
quantity of labor.
If the wage is above equilibrium, quantity supplied is greater than
quantity demanded. Some workers can not find employment. Each firm can offer
lower wages and still find enough workers. As all firms gradually decrease
wages, the quantity demanded increases and the quantity supplied decreases.
Eventually the wage and quantity of labor is equal the equilibrium wage and
quantity of labor.
The equilibrium wage can be calculated using algebra. First set the
supply and demand functions equal and solve for the wage rate.
Ld = Ls
1250m – 50m W = -50m + 80m W
1250m – 50m W + 50m = -50m + 80m W + 50m
1300b - 50b W = 80b W
1300m – 50m W + 50m W = 80m W + 50m W
1300m = 130m W
1300m/130m = 130m W/130m
10 = W
We = 10
Now, substitute the equilibrium wage into the supply or demand function and
12
solve for labor.
Ld = 1250m – 50m W Ls = -50m + 80m W
= 1250m – 50m (10) = -50m + 80m (10)
= 1250m – 500m = -50m + 800m
= 750m = 750m
This equilibrium can be illustrated using a supply and demand for labor
diagram. Generally, these are drawn on paper and pencil like the one below:
S
W
W – Wage
L- Labor
10 We
D
Le
750b
13