Market Equilibrium and

Govermnet Policies
 Input Markets and Output Markets
Output, or product, markets
are the markets in which
goods and services are
exchanged.

Input markets are the

markets in which
resources—labor, capital,
and land—used to produce
Payments flow in the opposite products, are exchanged
direction as the physical flow of
resources, goods, and services
(counterclockwise).
 Input Markets
• The labor market, in which households supply
work for wages to firms that demand labor.

• The capital market, in which households supply

their savings, for interest or for claims to future
profits, to firms that demand funds to buy capital
goods.

• The land market, in which households supply

land or other real property in exchange for rent.
 Market Equilibrium
 The operation of the market
depends on the interaction
between buyers and sellers.
 An equilibrium is the condition
that exists when quantity
supplied and quantity
demanded are equal.
 At equilibrium, there is no
tendency for the market price
to change.

 Only in equilibrium is quantity supplied equal to quantity

demanded.
 At any price level other than Po, the wishes of buyers and
sellers do not coincide.
 Market Disequilibra
 Excess demand, or shortage,
when quantity demanded
exceeds quantity supplied at the
current price.
 As a consequence, price tends to
rise until equilibrium is restored.

 Excess supply, or surplus, when

quantity supplied exceeds
quantity demanded at the
current price.
 As a consequence, price tends
to fall until equilibrium is
restored.
 Change in demand

Higher demand leads to

higher equilibrium price
and higher equilibrium
quantity.

Lower demand leads to

lower price and lower
quantity exchanged.
 Change in supply
 Higher supply leads to  Lower supply leads
lower equilibrium price to higher price and
and higher equilibrium lower quantity
quantity. exchanged.
 Relative Magnitude of Change

The relative magnitudes of change in supply and demand

determine the outcome of market equilibrium.
 Controls on prices: Price Ceiling
• Price Ceiling
A legal maximum on the price at which a good can
be sold.
• Two possible outcomes:
1) The price ceiling is not binding if set above the
equilibrium price.
2) The price ceiling is binding if set below the
equilibrium price, leading to a shortage.
 Outcomes of Price Ceiling
D S D S

Price ceiling

Price ceiling

Quantity Quantity Quantity Quantity

demanded supplied demanded supplied

surplus shortage

Price ceiling that is not binding Price ceiling that is binding

 Controls on prices: Price floor
• Price Floor
A legal minimum on the price at which a good can
be sold.

• Two possible outcomes:

1) The price floor is not binding if set below the
equilibrium price.
2) The price floor is binding if set above the
equilibrium price, leading to a surplus.
 Outcomes of Price Floor
D S D S

Price floor

Price floor

Quantity Quantity Quantity Quantity

demanded supplied demanded supplied

surplus
Price floor that is not binding
Price ceiling that is binding
 How Price Floors Affect Market Outcomes
• A price floor prevents supply and demand from moving
toward the equilibrium price and quantity.
• When the market price hits the floor, it can fall no
further, and the market price equals the floor price.

• A binding price floor causes:

– a surplus because QS > QD.
– nonprice rationing is an alternative mechanism for
rationing the good, using discrimination criteria.

• Examples: The minimum wage, agricultural price

supports.
 Alternative Rationing Mechanisms
• Queuing is a nonprice rationing system that uses waiting in
line as a means of distributing goods and services.

• Favored customers are those who receive special

treatment from dealers during situations when there is
excess demand.

• Ration coupons are tickets or coupons that entitle

individuals to purchase a certain amount of a given product
per month.

• The problem with these alternatives is that excess demand

is created but not eliminated.
 Black Market

A black market is a market

in which illegal trading takes
place at market-determined
prices.
Execise: how do taxes on buyer (seller)
affect maekert outcomes ?
Prices and the allocation of resources
• Price changes resulting from shifts of demand in
output markets cause profits to rise or fall.
• Profits attract capital but losses lead to
disinvestment.
• Higher wages attract labor and encourage
workers to acquire skills.
• At the core of the system, supply, demand, and
prices in input and output markets determine
the allocation of resources and the ultimate
combinations of things produced