Market Equilibrium Pt. 1

A competitive market of many buyers and many sellers possessing complete information about alternatives results in a single, market-clearing price at which there is neither surplus or shortage.

In fact, the very existence of surpluses and shortages work automatically to bring about the market-clearing price. This can be called the "horizontal perspective" of our supply and demand graph. (Explain this process.)

Competitive markets automatically move toward market-clearing equilibrium. Actions of market participants force the price toward the market-clearing level. (P_E and Q_E–equilibrium price and quantity)

This process is automatic–nobody has to see to it that it happens! "Market forces" bring it about! (What does this mean?)

Now focus your attention not on the movement along the price axis to P_E but instead along the quantity axis to Q_E. Suppose that some other quantity than Q_E is being produced (along the supply curve) and bought (along the demand curve). Compare what price the buyer is willing to pay for that unit of output versus what price the seller must receive as inducement to produce that unit. This is the "vertical perspective" on the supply and demand curves.

To society, the unit Q₁ should definitely be produced because Q₁ is worth more to the marginal buyer than it costs the marginal seller to produce it. How about the next unit? And the next?

But what about unit Q₂? Should it be produced? Is Q₂ worth more to the marginal buyer than it costs the marginal seller to produce it? Clearly, it is not to society’s benefit to produce Q₂.

But no one has to be concerned with the production of such an "excessive" amount of the good, nor does anyone have to be concerned about an "insufficient" amount of the good. The automatic market-clearing mechanism will ensure that exactly Q_E will be produced. This is the result of having a competitive market with many buyers and sellers who have complete ("perfect") information about alternatives.

Class Notes | Clint Johnson |  Economics & Finance | Departments & Majors
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