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- [Alex Tabarrok] In this video, 
I want to review

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just a little bit equilibrium 
and the adjustment process.

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Ordinarily, we won't be doing 
much review in this class

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since you can always go back 
and re-watch a video.

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But in this case I want to emphasize 
a few points

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and the material is very important.

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Let's review 
but we'll do so quickly.

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Okay, here's the equilibrium price,

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the price where 
the quantity demanded

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is equal to the quantity supplied.

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Why is that the equilibrium price?

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Because at any other price,
forces are put into play

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which push the price towards 
the equilibrium price.

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So at a price of $80 per barrel
for example,

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we would have a surplus.

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The quantity supplied would be 
greater than the quantity demanded.

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Sellers have more goods 
than they have customers

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and because of that they had 
incentive to push the price down

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towards the equilibrium price.

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What if the price is less than 
the equilibrium price?

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Well, in this case 
the quantity demanded

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will exceed the quantity supply.

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Buyers will want the good

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but there won't be enough
of the good to go around.

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In other words, 
there'll be a shortage

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because the buyers have to compete 
to obtain the good,

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they're going 
to push the price up again

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towards the equilibrium price.

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The equilibrium price 
is the only stable price.

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There is similar kind of argument 
we can show why this quantity,

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the quantity such that 
quantity demanded

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is equal to quantity supply

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by this quantity 
is the equilibrium quantity.

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Namely, choose any other quantity 


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and let's show that 
that can't be an equilibrium.

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So suppose that the quantity 
bought and sold

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was 50 million barrels 
of oil per day.

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Notice that for this last barrel of oil

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which is being bought and sold,

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buyers are willing to pay up to $90
for that barrel of oil

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where for one more barrel of oil 
they're willing to pay $90.

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On the other hand, 
sellers are willing to sell

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that barrel of oil or one more 
barrel of oil for just $50.

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So there's a big potential gain
from trade here of $40.

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Indeed, for any quantity below 
the equilibrium quantity

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there are unexploited gains 
from trade.

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Now in economics we assume that 
if you put a potential gain

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from trade in front of people, 
they're going to find it.

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They're going to be able to realize

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that if only they bought and sold 
a little bit more,

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both the buyers and the sellers 
could be better off.

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So that's why we assume that 
the quantity bought and sold

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will be pushed 
to the equilibrium quantity

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because it's only 
at the equilibrium quantity

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that all the gains from trade 
have been exploited.

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In a free market, could the quantity 
bought and sold

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be greater than 
the equilibrium quantity?

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Well not for any significant 
period of time.

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Imagine for example that 
90 million barrels of oil

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were being bought and sold.

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Well, for this last barrel of oil 
the suppliers are willing to sell

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that barrel of oil for $90, 
that's their cost.

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They require at least $90

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to stay in business 
and sell that barrel of oil.

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On the other hand, buyers are
willing to pay

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for that barrel of oil only $50.

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So there's a lot of waste going on here.

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Suppliers are spending more 
to produce the barrel

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than the barrel is worth to buyers.

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Indeed at any quantity above 
the equilibrium quantity

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there is waste.

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And we don't expect waste

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to last very long 
in this market precisely

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because if without any intervention
suppliers are not going to be able

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to sell a product to buyers 
for more than the buyers

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are willing to pay for that product,

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for more than the product 
is worth to the buyers.

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So for this reason

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we don't expect waste 
to last in a free market either.

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So a free market maximizes 
the gains from trade.

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Remember also that 
the gains from trade

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can be broken down into two parts,

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the consumer surplus 
and of course the producer surplus.

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Couple of other points 
just to finish this off.

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Notice that the equilibrium price

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splits the demand curve 
into two parts.

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The goods are bought by the buyers 
who value them the most,

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the buyers with 
the highest demands.

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These are therefore the buyers 
and these are the non-buyers

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and goods are sold by the sellers 
with the lowest costs.

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So these are the sellers

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and these with the higher cost 
are the non-sellers.

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Okay, let's summarize this whole thing.

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Free market maximizes 
the gains from trade

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or the gain from trade 
are maximized

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at the equilibrium 
price and quantity.

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And what this means is that 
the supply of goods is bought

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by the buyers with 
the highest willingness to pay.

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The supply of goods are sold by 
the suppliers with the lowest costs.

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And between the buyers 
and the sellers,

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there are no unexploited gains 
from trade and no wasteful trades.

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Okay, that concludes our review 
on to some new material.

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- [Announcer] If you want 
to test yourself,

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click Practice Questions

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or if you're ready to move on, 
just click "Next Video."

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