Exploring Equilibrium

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- 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 had been exploited. Okay.
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

is 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

gains 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.

- If you want to test yourself,
click Practice Questions or if you're

ready to move on, just click Next Video.