Exploring Equilibrium

{'type': u'plain'}

♪ [music] ♪

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

just a little bit equilibrium
and the adjustment process.

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

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

But in this case I want to emphasize
a few points

and the material is very important.

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

Okay, here's the equilibrium price,

the price where
the quantity demanded

is equal to the quantity supplied.

Why is that the equilibrium price?

Because at any other price,
forces are put into play

which push the price towards
the equilibrium price.

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

we would have a surplus.

The quantity supplied would be
greater than the quantity demanded.

Sellers have more goods
than they have customers

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

towards the equilibrium price.

What if the price is less than
the equilibrium price?

Well, in this case
the quantity demanded

will exceed the quantity supply.

Buyers will want the good

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

In other words,
there'll be a shortage

because the buyers have to compete
to obtain the good,

they're going
to push the price up again

towards the equilibrium price.

The equilibrium price
is the only stable price.

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

the quantity such that
quantity demanded

is equal to quantity supply

by this quantity
is the equilibrium quantity.

Namely, choose any other quantity

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

So suppose that the quantity
bought and sold

was 50 million barrels
of oil per day.

Notice that for this last barrel of oil

which is being bought and sold,

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

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

On the other hand,
sellers are willing to sell

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

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

Indeed, for any quantity below
the equilibrium quantity

there are unexploited gains
from trade.

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

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

They're going to be able to realize

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

both the buyers and the sellers
could be better off.

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

will be pushed
to the equilibrium quantity

because it's only
at the equilibrium quantity

that all the gains from trade
have been exploited.

In a free market, could the quantity
bought and sold

be greater than
the equilibrium quantity?

Well not for any significant
period of time.

Imagine for example that
90 million barrels of oil

were being bought and sold.

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

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

They require at least $90

to stay in business
and sell that barrel of oil.

On the other hand, buyers are
willing to pay

for that barrel of oil only $50.

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

Suppliers are spending more
to produce the barrel

than the barrel is worth to buyers.

Indeed at any quantity above
the equilibrium quantity

there is waste.

And we don't expect waste

to last very long
in this market precisely

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

to sell a product to buyers
for more than the buyers

are willing to pay for that product,

for more than the product
is worth to the buyers.

So for this reason

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

So a free market maximizes
the gains from trade.

Remember also that
the gains from trade

can be broken down into two parts,

the consumer surplus
and of course the producer surplus.

Couple of other points
just to finish this off.

Notice that the equilibrium price

splits the demand curve
into two parts.

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

the buyers with
the highest demands.

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

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

So these are the sellers

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

Okay, let's summarize this whole thing.

Free market maximizes
the gains from trade

or the gain from trade
are maximized

at the equilibrium
price and quantity.

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

by the buyers with
the highest willingness to pay.

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

And between the buyers
and the sellers,

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

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

- [Announcer] If you want
to test yourself,

click Practice Questions

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

♪ [music] ♪