2.
3 Competitive market equilibrium
Learning objectives
2.3 Competitive market equilibrium Depth Diagrams and calculations
Demand and supply curves forming a market equilibrium AO4 Diagram: market equilibrium
Shifting the demand and supply curves to produce a new AO2 Diagram: showing changes in
market equilibrium, with reference to excess demand and AO4 equilibrium/role of price
excess supply mechanism
Functions of the price mechanism AO2
• Resource allocation (Signalling, Incentive)
• Rationing
Learning objectives
2.3 Competitive market equilibrium Depth Diagrams and calculations
Consumer and producer surplus AO2 Diagram: showing consumer
AO4 surplus and producer surplus
Social/ community surplus AO2 (social / community surplus) –
AO4 maximized at competitive market
Allocative efficiency at the competitive market equilibrium: AO2 equilibrium
• Social/community surplus maximized at equilibrium AO4
• Marginal benefit (MB) equals marginal cost (MC) Calculation (HL) only:
Consumer surplus and producer
surplus from a diagram
Real world example
How might the Uber market be related to
demand, supply, and market equilibrium?
Market equilibrium introduction
Market equilibrium occurs at the price where quantity demanded equals to quantity supplied. At
this point, the market is cleared of any shortage or surplus.
Price Market for Uber Rides
($/km) S
Q Quantity of rides
Market equilibrium – activity
The market demand and supply of Uber rides is displayed below.
Quantity Quantity 1. Plot the demand and supply curves.
Price of
demanded supplied
rides ($/km) 2. Identify the equilibrium price & quantity.
(Riders) (Drivers)
3. What happens if the price is $10/km?
25 2,000 10,000
4. What happens if the price is $25/km?
20 4,000 8,000
15 6,000 6,000
10 8,000 4,000
5 10,000 2,000
Market equilibrium – activity
1. Plot the demand and supply curves.
Market for Uber Rides
30
Quantity Quantity
Price of Market
demanded supplied
rides ($/km) 25 equilibrium
(Riders) (Drivers)
Price of rides ($/km)
S
20
25 2,000 10,000
20 4,000 8,000 15
15 6,000 6,000 10 D
10 8,000 4,000
5
5 10,000 2,000
0
2000 4000 6000 8000 10000
Quantity of rides
Market equilibrium – activity
Quantity Quantity 2. Identify the equilibrium price and quantity.
Price of
demanded supplied Equilibrium price = $15
rides ($/km)
(Riders) (Drivers)
Equilibrium quantity = 6,000 rides
25 2,000 10,000
3. What happens if the price is $10/km?
20 4,000 8,000
Market shortage of 4,000 drivers.
15 6,000 6,000
4. What happens if the price is $25/km?
10 8,000 4,000
Market surplus of 8,000 drivers.
5 10,000 2,000
Market equilibrium
Quantity Quantity Market for Uber Rides
Price of
demanded supplied 30
rides ($/km)
(Riders) (Drivers) Market S
25 equilibrium
25 2,000 10,000
Price of rides ($/km)
20
20 4,000 8,000
15 6,000 6,000 15
10 8,000 4,000 10
5 10,000 2,000 D
5
At the market equilibrium, there are no surpluses
0
or shortages. The market “clears” where every 2000 4000 6000 8000 10000
Quantity of rides
rider is matched with a driver and vice versa.
Shortage – excess demand
Quantity Quantity Market for Uber Rides
Price of
demanded supplied 30
rides ($/km)
(Riders) (Drivers) S
25
25 2,000 10,000
Price of rides ($/km)
20
20 4,000 8,000
15 6,000 6,000 15
10 8,000 4,000 10
5 10,000 2,000
5 D
If the price is lower than the equilibrium price, the Shortage
0
quantity demanded is greater than quantity 2000 4000 6000 8000 10000
Quantity of rides
supplied, resulting in excess demand (shortage).
Surplus – excess supply
Quantity Quantity Market for Uber Rides
Price of
demanded supplied 30
rides ($/km)
(Riders) (Drivers)
25 S
25 2,000 10,000
Price of rides ($/km)
20
20 4,000 8,000
15 6,000 6,000 15
10 8,000 4,000 10
5 10,000 2,000
5 D
If the price is higher than the equilibrium price, the Surplus
0
quantity supplied is greater than quantity 2000 4000 6000 8000 10000
Quantity of rides
demanded, resulting in excess supply (surplus).
Key terms
Market equilibrium: occurs at a price where quantity demanded equals its quantity supplied. The
market has no shortages or surpluses.
Equilibrium price: Price at which quantity demanded equals quantity supplied.
Equilibrium quantity: Quantity at which quantity demanded equals quantity supplied.
Surplus (Excess supply): When quantity supplied exceeds quantity demanded.
Shortage (Excess demand): When quantity demanded exceeds quantity supplied.
Over to you…
Hoang, Wray, & Chakraborty (2020)
Economics for the IB Diploma Programme
• Page 70-71
• Paper 2 and 3 Exam Practice Question 5.1
• [4 marks]
• Paper 2 and 3 Exam Practice Question 5.2
• [2 marks]
• Paper 2 and 3 Exam Practice Question 5.3
• [5 marks]
Real World Example - Price Mechanism
Uber’s surge pricing is an example of how the
price mechanism reallocates resources.
The price mechanism uses signals and
incentives to allocate resources via the forces of
demand and supply in competitive markets.
Real world example – price mechanism
Using the example of Uber, explain how the price mechanism allows a market to reach equilibrium
following an increase in demand.
Real World Example - Price mechanism
1. During peak periods, more people may demand
Uber as a means of transport, increasing demand
Market for Uber Rides
from D1 to D2. Price
($/km)
2. Hence, at the regular Uber pricing of P1, excess D1 D2 S
demand (shortage) of Q3 - Q1 occurs.
3. Some consumers are willing and able to pay prices
higher than P1 to secure an Uber ride. This exerts P1
an upward pressure on price.
Shortage
4. A higher price acts as a signal to producers (Uber
drivers) and informs them that there are consumers Q1 Q3 Quantity
of rides
(riders) who wish to get a ride at higher prices.
Real World Example - Price mechanism
5. As price increases from P1, suppliers (Uber
drivers) are incentivized to increase quantity Market for Uber Rides
supplied beyond Q1 due to the law of supply. Price
($/km)
D1 D2 S
More Uber drivers come to the area to provide
their services. c
6. Hence there is an upward movement along the a b
P1
supply curve from point a towards point c.
Shortage
Q1 Q3 Quantity
of rides
Real World Example - Price mechanism
7. At the same time, as price increases from P1,
some consumers (riders) are disincentivized to Market for Uber Rides
Price
purchase rides, so quantity demanded falls from ($/km)
D1 D2 S
Q3 due to the law of demand. Some riders may
c
opt for alternative forms of transport.
8. Hence there is an upward movement along the a b
P1
demand curve from point b towards point c. Shortage
Q1 Q3 Quantity
of rides
Real World Example - Price mechanism
9. The increase in price from P1 continues until
quantity supplied equals to quantity demanded, Market for Uber Rides
at point c. A new market equilibrium forms at P2 Price
($/km)
D1 D2 S
and Q2. At this point, the market clears.
c
10. The price mechanism successfully rations P2
resources to consumers who are willing to pay a a b
P1
higher price. Thus, it addresses the basic
Shortage
economic question of “to whom to produce for?”
Q1 Q2 Q3 Quantity
of rides
Price mechanism – signals and incentives
Signaling function: price conveys market information to producers
and consumers for making production and consumption decisions,
in order to allocate resources.
Incentive function: price provides incentives for producers and
consumers to change their behaviors to maximize their own
benefits, in order to allocate resources.
Price mechanism - rationing
The rationing function serves to allocate scarce
resources, by increasing the market price to
deter some consumers from buying the good.
An increase in price by the price mechanism
helps to reduce quantity demanded, which is
useful to eliminate shortages.
Over to you…
Hoang, Wray, & Chakraborty (2020)
Economics for the IB Diploma Programme
• Page 71
• Paper 2 and 3 Exam Practice Question 5.4
• [4 marks]
• Page 73
• Paper 1 Exam Practice Question 5.5
• [10 marks]
Real World Example - Essay
Video: 2 New Low-Cost Airlines Launch as Americans Return To The Skies
Using the airline industry as an example, explain how the price mechanism works to reallocate
resources in a market following an increase in market supply.
Producer surplus
Producer surplus is the positive difference between the price that a producers receive from
selling a good and the minimum amount they prepare to sell the good at.
Price
($) S
Producer surplus is identified by the area
below the selling price and above the
supply curve for the quantities sold.
P
(HL only)
Producer surplus can be calculated by the area of
Producer D the triangle below P and above the supply curve.
surplus
Q Quantity
Producer surplus
Calculate the producer surplus in the Uber market. Market for Uber Rides
30
S
Market
25 equilibrium
$"# $ $%.# × (,***
Producer surplus =
Price of rids ($/km)
% 20
15
Producer surplus = $37,500
10
5 D
0
2000 4000 6000 8000 10000
Quantity of rides
Consumer surplus
Consumer surplus is the positive difference between the amount that a consumer is willing and
able to pay for a good and the amount they actually pay.
Price Consumer surplus is identified by the area
Consumer
($) surplus
S
above the buying price & below the demand
curve for the quantities purchased.
P (HL only)
Consumer surplus can be calculated by the area of
the triangle above P and below the demand curve.
D
Q Quantity
Producer surplus
Calculate the consumer surplus in the Uber market. Market for Uber Rides
30
S
Market
25 equilibrium
$%+.# $ $"# × (,***
Consumer surplus =
Price of rids ($/km)
% 20
15
Consumer surplus = $37,500
10
5 D
0
2000 4000 6000 8000 10000
Quantity of rides
Social surplus (Community surplus) and allocative efficiency
Social surplus is the sum of consumer surplus and producer surplus at a particular price and
quantity.
Price
($) Consumer S
surplus
Producer D Social surplus is maximized at the
surplus
market equilibrium.
Q Quantity
Social surplus (Community surplus) and allocative efficiency
Allocative efficiency is the socially optimum outcome where resources are allocated such that
the sum of consumer and producer surplus are maximized.
Price In other words, no one can be better-off
($) Consumer S
surplus without making someone else worse-off.
This is attained at the competitive market
equilibrium.
P
How would social surplus be shown if
producers charged a price above the
Producer D
surplus equilibrium?
Q Quantity
Marginal benefits and marginal costs
The demand curve can also be considered the
Price marginal benefit curve.
($) S = MC
Consumer
surplus
Why does marginal benefit decrease as
quantity increase?
Pe
The supply curve can also be considered the
marginal cost curve.
Producer D = MB
surplus Why does marginal cost increase as
Qe quantity increase?
Quantity
Marginal benefits and marginal costs
Price Marginal cost: The additional cost
($) S = MC
Consumer
surplus incurred by producers when they
produce an additional unit.
Pe
Marginal benefit: The additional
benefit enjoyed by consumers when
Producer D = MB
they consume an additional unit.
surplus
Qe Quantity Allocative efficiency is attained when MC = MB
Over to you…
Hoang, Wray, & Chakraborty (2020)
Economics for the IB Diploma Programme
• Page 76
• Paper 3 Exam Practice Question 5.6
• [12 marks]
• Paper 3 Exam Practice Question 5.7
• [10 marks]
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