Chapter

4: Demand & Supply

An Equilibrium Analysis

Playconomics, LHS 1
Demand and Supply Aggrega:on
Sum the Supply curves HORIZONTALLY!

Playconomics, LHS 2
Demand and Supply Aggrega:on
Sum the Demand curves HORIZONTALLY!

Playconomics, LHS 3
 Demand and Supply Aggrega:on

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

Playconomics, LHS 4
 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

Playconomics, LHS 5
 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.

Playconomics, LHS 6
Market Equilibrium

Playconomics, LHS 7
 Market Equilibrium

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



Playconomics, LHS 8
 Market Equilibrium
Perfectly compeGGve market
Buyers & Sellers are Price Accepters (Takers)

Seller 1 Buyer 1
Seller 2 Buyer 2
# ReservaGon Seller 3 Buyer 3 # ReservaGon
Price Seller 4 Buyer 4 Price

Seller 5 Buyer 5
Seller 6 Buyer 6
Playconomics, LHS 9
 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.

Playconomics, LHS 10
Market Equilibrium

Playconomics, LHS 11
 Market Equilibrium

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




Playconomics, LHS 12
Market Equilibrium

Playconomics, LHS 13
 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).
Playconomics, LHS 14
Market Equilibrium

Playconomics, LHS 15
Market Equilibrium

-$2
Playconomics, LHS 16
Market Equilibrium

Playconomics, LHS 17
 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!
Playconomics, LHS 18
Market Equilibrium

Playconomics, LHS 19
 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.

Playconomics, LHS 20
Consumer and Producer Surplus

Playconomics, LHS 21
 Consumer and Producer Surplus

In a perfectly compeGGve market,

Total Surplus is maximized exactly at the
equilibrium price P*!!

Playconomics, LHS 22
Consumer and Producer Surplus

Playconomics, LHS 23
A (Clever) Toy Model

Playconomics, LHS 24
A (Clever) Toy Model

Playconomics, LHS 25
A (Clever) Toy Model

Playconomics, LHS 26
 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.

Playconomics, LHS 27
 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.

Playconomics, LHS 28
 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.

Playconomics, LHS 29
 C Compe::ve Markets:
Pareto Eciency (Short Run)

How about Equity & Society Wellbeing?

Eciency
Equality of Resources & OpportuniGes

Playconomics, LHS 30
 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.

Playconomics, LHS 31
 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 ?
Playconomics, LHS 32
 C Compe::ve Markets:
The Invisible Hand (Long Run)

Entry

Playconomics, LHS 33
 C Compe::ve Markets:
The Invisible Hand (Long Run)

Playconomics, LHS 34
 C Compe::ve Markets:
The Invisible Hand (Long Run)

Playconomics, LHS 35
 The Long Run Supply Curve

All rms
- produce with the same technology ( same cost curves)
- sell at P* = min(ATC) Playconomics, LHS 36
The Long Run Supply Curve
P* doesnt change !!
But Q* does !!

In the LR, Supply is

more elas/c!

Playconomics, LHS 37