Market Equilibrium
The intersection of the demand and supply curves defines the market equilibrium.
Combination of a “market price” (P) and a “aggregate traded quantity” (Q) where:
- Buyers want to buy precisely Q given P
- Sellers want to sell precisely Q given P
Adjustment to Equilibrium
Market Efficiency
Demand Curve
Supply Curve
Efficiency Properties
Consumer Surplus
- Represents the difference between what consumers are willing to pay and the actual market price
- Forms a triangular area above the equilibrium price point and below the demand curve
- Indicates the monetary gain when consumers pay less than their maximum willingness to pay
Producer Surplus
- Represents the difference between the market price and the minimum price producers would accept
- Forms a triangular area below the equilibrium price point and above the supply curve
Competitive markets realize the potential for mutually beneficial exchange:
- maximizes total surplus for buyers and sellers
- achieves allocative efficiency: those with MWP>P consume, those with MC<P produce
They rely on minimum information
- own valuation
- market price
Invisible hand leads self-interested market participants to a socially desirable outcome
Caveat
The result that markets deliver efficient outcomes relies on strong assumption and breaks down in the following cases:
- Market power: when markets are less than fully competitive
- Externalities: when the actions of one directly affects the well-being of others
- Imperfect information: when the properties of the traded goods are not observable