Lecture_13_Equilibrium - Lecture 13 Equilibrium c 2008...

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Lecture 13: Equilibrium c ° 2008 Je/rey A. Miron Outline 1. Introduction 2. Supply 3. Market Equilibrium 4. Special Cases 5. Inverse Demand and Supply Curves 6. Comparative Statics 7. Taxes 8. The Incidence of a Tax 9. The Deadweight Loss from Taxation 10. Pareto E¢ ciency 1 Introduction So far, we have constructed individual demand curves by using information about preferences, prices, and income. We have also seen that we can add up these individual demand curves to get market demand curves In this lecture, we use the market demand curves to determine the equi- librium market price. This will involve two core principles of economics: optimization and equilibrium. Until now, we have only focused on opti- mization; we will apply this principle again when we examine °rms. Before moving on to that, however, it is useful to consider some aspects of equilib- rium analysis. To do so, we need to look brie±y at supply. 1
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2 Supply We have already seen examples of supply, such as consumers being net sup- pliers of the goods they own. We have also seen labor supply decisions. In these examples, the supply curve measures how much the consumer is willing to supply of a certain good at each possible market price. This is in fact the de°nition of supply: for each p , we determine how much of the good will be supplied, S ( p ) . We derive this formally later. For now we accept this intuitive de°nition to develop other insights. 3 Market Equilibrium Suppose we have a number of consumers of a good. We can obtain a market demand curve by adding up their individual demand curves. Likewise, if we have a number of suppliers, we can obtain the market supply curve by adding up their individual supply curves. For now we assume all individual suppliers and demanders take prices as given and determine their best response given those market prices. This is known as a competitive market. No individual agent can determine the market price; rather, the actions of all agents together determine the market price. The equilibrium price is the price such that the supply of goods equals the demand. Geometrically this is where the demand and supply curves cross. To state this more explicitly, let D ( p ) be the market demand curve and S ( p ) be the market supply curve. Then the equilibrium price solves D ( p ° ) = S ( p ° ) Why is this an equilibrium? An equilibrium is a situation where all agents are doing the best they can and every agent²s actions are consistent with 2
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everyone else²s actions. The price that solves the equation above satis°es these conditions. At any other price, by contrast, someone would have an incentive to change behavior. If, for example, the price were greater than the equilibrium price, the quanatity demanded would be less than the quantity supplied. The sellers would therefore have unsold inventories and want to cut back on production.
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