MODULE 6: SUPPLY AND EQUILIBRIUM

The purpose of this module is to introduce students to the supply half of the model and to bring demand and supply together to illustrate the concept of equilibrium in the competitive market.

Student learning objectives:

Learn what the supply curve is.

The difference between movements along a supply curve and changes in supply.

The factors that shift a supply curve.

How supply and demand curves determine a market's equilibrium price and equilibriumquantity.

In the case of a shortage or surplus, how price moves the market back to equilibrium.

Key Economic Concepts For This Module:

The first key concept and graph in this module is the upward sloping supply curve for good X. A movement along a supply curve shows how a change in the price of good X causes a direct change in quantity of good X supplied (a to b). A shift outward (b to c), or inward, in the entire supply curve is caused by an external factor (not the price of good X).

The second key concept, and graph, in this module is market equilibrium. Stress to the students that equilibrium is a state where there is no tendency for anything to change. Consumers won’t change their buying patterns, and producers won’t change their production patterns. In other words, the market comes to equilibrium at the only price where the quantity consumers wish to buy (Qd) is equal to the quantity that producers wish to supply (Qs).

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Common Student Difficulties:

Students are very often confused by the movement along a supply curve and how it differs from a shift in the entire supply curve.

The precise use of language is important. Correct: “A decrease in the price of trucks causes a decrease in the quantity of trucks supplied.” Incorrect: “A decrease in the price of trucks causes a decrease in the supply of trucks.”

Students can shift the supply curve upward (vertically) when they really need to shift it outward (horizontally). When we say “supply has increased,” we need to emphasize to students that this is an increase in quantity (horizontal), not increase in price (vertical).

46Section 2: Supply and Demand

In-Class Presentation of Module and Sample Lecture

Suggested time: This module should be completed in two to three one hour-long classes.

  1. The Supply Curve
  1. The Supply Schedule and Supply Curve
  2. Understanding Shifts of the Supply Curve
  3. Changes in input prices
  4. Changes in the price of related goods or services
  5. Changes in technology
  6. Changes in expectations
  7. Changes in the number of producers
  1. Supply, Demand, and Equilibrium
  1. Finding the Equilibrium Price and Quantity
  2. Why Does the Market Price Fall if it is Above the Equilibrium Price?
  3. Why Does the Market Price Rise if it is Below the Equilibrium Price?
  1. The Supply Curve
  1. Supply Schedule and Supply Curve

Supply is a schedule, which shows amounts of a product a producer is willing and able to produce and sell at each of a series of possible prices during a specified time period.

A supply schedule portrays this in the hypothetical cans of soda example.

Price per Soda / Quantity supplied per week
$5 / 250
4 / 200
3 / 150
2 / 100
1 / 50

The schedule shows what quantities will be offered at various prices or what price will be required to induce various quantities to be offered.

The supply schedule shows that when the price is high, the quantity of sodas supplied is high. This relationship is known as the Law of Supply.

The Law of supply is believed to hold true for most products.

  1. All else equal, as the price rises, quantity supplied rises.
  1. Restated: There is a direct relationship between price and quantity supplied.
  2. Note the “all else equal” assumption refers to a handful of other factors that affect the supply of a good. These will be covered shortly.

Plot the five prices and quantities supplied in a graph. This is the supply curve of cans of soda (per week).

The supply curve illustrates the positive relationship between price and quantity supplied.

The upward slope indicates lower quantity (horizontal axis) at lower price (vertical axis), higher quantity at higher price.

Module 6: Supply and Equilibrium47

Show what happens when the price falls from $3 per can to $2 per can. Quantity supplied decreases from 150 cans per week to 100 cans per week. This is a movement down the supply curve.

  1. Understanding Shifts of the Supply Curve

There are several “shifters” of supply or the “other things,” besides price, which affect supply. Changes in a shifter cause changes in supply.

If supply has increased, it has shifted to the right. At any price, firms wish to produce more. If supply has decreased, it has shifted to the left. At any price, firms with to produce less.

  1. Input (Resource) prices

A rise in an input price will cause a decrease in supply or leftward shift in supply curve; a decrease in an input price will cause an increase in supply or rightward shift in the supply curve. An increase in theprice of fertilizer would cause a decrease in supply of corn.

  1. Prices of related goods or services

If the price of a substitute production good rises, producers might shift production toward the higher priced good causing a decrease in supply of the original good. An increase in the price of soybeansmay cause a farmer to decrease the supply of corn.

  1. Technology

A technological improvement means more efficient production and lower costs, so an increase in supply or rightward shift in the curve results. Genetically improved seeds will increase supply of corn.

  1. Expectations

Expectations about the future price of a product can cause producers to increase or decrease current supply.

Expectations of higher corn prices (next month) may cause farmers to decrease supply to the market today.

  1. Number of sellers

Generally, the larger the number of sellers the greater the supply.

48Section 2: Supply and Demand

  1. Supply, Demand, and Equilibrium

One way to think about equilibrium is like a stopped pendulum. Once a pendulum has started, it should continue to swing back and forth, never stopping. If you stop it, it will never restart the swinging. That’s equilibrium in the market. There are no changes in price, quantity demand, or quantity supply.

Think stability.

  1. Finding the Equilibrium Price and Quantity

It is time to bring back the demand half of this table that summarizes soda demand and supply at five possible prices.

Note: At first, do not complete the last column of this table.

Price per Soda / Quantity demanded / Quantity supplied / Shortage or
per week / per week / Surplus =
$5 / 50 / 250 / Surplus = 200
4 / 100 / 200 / Surplus = 100
3 / 150 / 150 / 0
2 / 200 / 100 / Shortage = 100
1 / 250 / 50 / Shortage = 200

The equilibrium, or market-clearing, price is the only price where Qd =Qs. At this price, there is no tendency for the price to rise or fall. In other words, the market is in a state of balance.

It’s often easier to explain why P=$3 is the equilibrium price if you discuss what is happening at prices above and below $3.

  1. Why Does the Market Price Fall if it is Above the Equilibrium Price?

Ask the students what happens to the price of many items (like sweaters) right after Christmas. Most will agree that there are widespread “after Christmas” sales on clothes, electronics, and even cars.

Why?

Because the store has too many items that went unsold prior to Christmas. In other words, they have a surplus of sweaters, and the best way to get rid of a surplus of sweaters, is to lower the price.

Surplus = Qs – Qd

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Complete the last column of the table at prices above $3.

When the surplus is gone, there is no reason to further decrease the price.

  1. Why Does the Market Price Rise if it is Below the Equilibrium Price?

Imagine an auction where there is only one thing up for sale (like a valuable painting) and many people who wish to buy it.

What happens? The auctioneer begins to raise the price and the number of bidders begins to fall. Eventually all but one bidder has been eliminated because the price got so high that all others dropped out.

When you have a shortage of something, the best way to eliminate the shortage is to increase the price.

Shortage = Qd – Qs

Complete the last column of the table at prices below $3.

In-Class Activities and Demonstrations

Deriving a Supply Curve

While it is very easy for people to imagine themselves as consumers (demanders), it’s difficult for most people to imagine themselves as producers (suppliers), so the supply curve is less intuitive.

Ask the students if they have ever had a job. For those who say “yes,” you can tell them that they have been a supplier: of labor.

Pick a job that involves a high degree of manual labor (raking leaves, eg). Ask students to write down how many hours they are willing to rake leaves at the following hourly wage rates: $16.00, $12.00, $10.00, $8.00, $6.00.

Repeat for a job that involves very little manual labor (a cashier, eg). Again, ask students to write down how many hours they are willing to work at the cash register at the following hourly wage rates: $16.00, $12.00, $10.00, $8.00, $6.00.

Then for each job, ask three students to report their responses. Add up the hours at each wage, and derive the upward-sloping supply curve.

Note: A few students may choose to work fewer hours as the wage rises, but generally the overall response produces an upward sloping supply curve.

Mathematical Practice at Solving for Equilibrium

If you would like to entertain the math sensibilities of your students, provide them with an opportunity to practice their algebra and graphing skills.

Give the students two linear equations, one for demand and one for supply. Then ask them to solve for the equilibrium price and quantity, and sketch the market in a graph.

Example

Demand equation: P = 100 – 2Qd

Supply equation: P = 10 + Qs

Equilibrium requires that Qd=Qs=Qe and, at this quantity, the price is the same on the vertical axis. Solve for equilibrium by setting these equations equal to each other.

100 – 2Qe = 10 + Qe 90 = 3Qe

Qe= 30, Pe= $40

50Section 2: Supply and Demand