Microeconomics extra flashcards

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Flip-Modus

Discuss the following statement: “Since supply and demand curves are always shifting, markets never actually reach an equilibrium. Therefore, the concept of equilibrium is useless.”

While the claim that markets never reach an equilibrium is probably debatable, even if markets do not ever reach equilibrium, the concept is still of central importance. The concept of equilibrium is important because it provides a simple way to predict how market prices and quantities will change as exogenous variables change. Thus, while we may never reach a particular equilibrium price, say because a supply or demand schedule shifts as the market moves toward equilibrium, we can predict with relative ease, for example, whether prices will be rising or falling when exogenous market factors change as we move toward equilibrium. As exogenous variables continue to change we can continue predict the direction of change for the endogenous variables, and this is not “useless.”

The supply of aluminum in the United States depends on the price of aluminum and the average price of electricity (a critical input in the production of aluminum). Assume that an increase in the price of electricity shifts the supply curve for aluminum to the left (i.e., a higher average price of electricity decreases the supply of aluminum). The demand for aluminum in the United States depends on the price of aluminum and income shifts the demand curve for aluminum to the right (i.e., higher income increases the demand for aluminum). In 2004, national income in the United States increased, while the price of electricity fell, as compared to 2003. How would the equilibrium price of aluminum in 2004 compare to the equilibrium price in 2003? How would the equilibrium quantity in 2004 compare to the equilibrium quantity in 2003?

In 2003, the initial equilibrium is at price P₁and quantity Q₁. As national income increased, demand for aluminum shifted to the right, as depicted in the graph below by the shift from D₁ to D₂. The fall in the price of electricity shifted the supply curve to the right, from S₁ to S₂. Both shifts have the effect of increasing the equilibrium quantity, from Q₁ to Q₂. However, it is unclear whether price will rise or fall – if the demand shift dominates, price would rise; if the supply shift dominates, price would fall.

The price of gasoline in the United States depends on the supply of gasoline and the demand for gasoline. Gasoline is supplied by oil companies that sell it on several markets. Hence the supply of gasoline in the United States depends on the price of gasoline in the United States and its price on other markets. When the price of gasoline outside the United States increases, the U.S. supply decreases because firms prefer to sell the gasoline elsewhere. How would an increase in the price of gasoline abroad affect the equilibrium price of gasoline in the United States?

When the price of gasoline abroad goes up, the supply on the domestic market decreases. Firms are willing to supply less gasoline for the same price as before. At that price the domestic demand exceeds the supply and therefore the equilibrium price in the US has to increase. When this is followed by increase in the demand – consumers are willing to buy more gasoline then before – supply would again be smaller than the demand. Hence the equilibrium price of the gasoline would increase even more.