Demanders and suppliers have different views of price. Demanders pay the price and suppliers receive it. Thus, a higher price is bad news for consumers but good news for producers. As the price rises, consumers reduce their quantity demanded along the demand curve and producers increase their quantity supplied along the supply curve. How is this conflict between producers and consumers resolved?
Markets
Markets sort out differences between demanders and suppliers. For example, suppose you are looking for a summer job. One approach might be to go from employer to employer looking for openings. But this could have you running around for days or weeks. A more efficient strategy would be to pick up a copy of the local newspaper or go online and look for openings. Classified ads and Web sites, which are elements of the job market, reduce the transaction costs of bringing workers and employers together.
The coordination that occurs through markets takes place not because of some central plan but because of Adam Smith’s “invisible hand.” For example, auto dealers in your community tend to locate together, usually on the outskirts of town, where land is cheaper. The dealers congregate not because they all took an economics course or because they like one another’s company but because grouped together they become a more attractive destination for car buyers. A dealer who makes the mistake of locating away from the others misses out on a lot of business. Similarly, stores locate together so that more shoppers will be drawn by the call of the mall. From Orlando theme parks to Broadway theaters to Las Vegas casinos, suppliers in a particular market tend to congregate to attract demanders. Some groupings can be quite specialized. For example, shops in Hong Kong that sell dress mannequins cluster along Austin Road. And diamond merchants in New York City congregate within the same few blocks.
Market Equilibrium
To see how a market works, let’s bring together market demand and market supply. Exhibit 5 shows the market for pizza, using schedules in panel (a) and curves in panel (b). Suppose the price initially is $12. At that price, producers supply 24 million pizzas per week, but consumers demand only 14 million, resulting in an excess quantity supplied, or a surplus, of 10 million pizzas per week. Producers compete by dropping the price. Suppliers don’t like getting stuck with unsold pizzas. Competition among producers puts downward pressure on the price, as shown by the arrow pointing down
Markets
Markets sort out differences between demanders and suppliers. For example, suppose you are looking for a summer job. One approach might be to go from employer to employer looking for openings. But this could have you running around for days or weeks. A more efficient strategy would be to pick up a copy of the local newspaper or go online and look for openings. Classified ads and Web sites, which are elements of the job market, reduce the transaction costs of bringing workers and employers together.
The coordination that occurs through markets takes place not because of some central plan but because of Adam Smith’s “invisible hand.” For example, auto dealers in your community tend to locate together, usually on the outskirts of town, where land is cheaper. The dealers congregate not because they all took an economics course or because they like one another’s company but because grouped together they become a more attractive destination for car buyers. A dealer who makes the mistake of locating away from the others misses out on a lot of business. Similarly, stores locate together so that more shoppers will be drawn by the call of the mall. From Orlando theme parks to Broadway theaters to Las Vegas casinos, suppliers in a particular market tend to congregate to attract demanders. Some groupings can be quite specialized. For example, shops in Hong Kong that sell dress mannequins cluster along Austin Road. And diamond merchants in New York City congregate within the same few blocks.
Market Equilibrium
To see how a market works, let’s bring together market demand and market supply. Exhibit 5 shows the market for pizza, using schedules in panel (a) and curves in panel (b). Suppose the price initially is $12. At that price, producers supply 24 million pizzas per week, but consumers demand only 14 million, resulting in an excess quantity supplied, or a surplus, of 10 million pizzas per week. Producers compete by dropping the price. Suppliers don’t like getting stuck with unsold pizzas. Competition among producers puts downward pressure on the price, as shown by the arrow pointing down
in the graph. As the price falls, producers reduce their quantity supplied and consumers increase their quantity demanded. The price continues to fall as long as quantity supplied exceeds quantity demanded. Alternatively, suppose the price initially is $6. You can see from Exhibit 5 that at that price consumers demand 26 million pizzas but producers supply only 16 million, resulting in an excess quantity demanded, or a shortage, of 10 million pizzas per week. Consumers compete to buy the product, which is in short supply. Consumer competition forces the price higher. Profit-maximizing producers and eager consumers create market pressure for a higher price, as shown by the arrow pointing up in the graph. As the price rises, producers increase their quantity supplied and consumers reduce their quantity demanded. The price continues to rise as long as quantity demanded exceeds quantity supplied.
Thus, a surplus creates downward pressure on the price, and a shortage creates upward pressure. As long as quantity demanded differs from quantity supplied, this difference forces a price change. Note that a shortage or a surplus depends on the price. There is no such thing as a general shortage or a general surplus, only a shortage or a surplus at a particular price. To repeat, buyers prefer a lower price and sellers prefer a higher price. A market reaches equilibrium when the quantity demanded equals quantity supplied. In equilibrium, the independent plans of buyers and sellers exactly match, so market forces exert no pressure for change. In Exhibit 5, the demand and supply curves intersect at the equilibrium point, identified as point c. The equilibrium price is $9 per pizza, and the equilibrium quantity is 20 million per week. At that price and quantity, the market clears. Because there is no shortage or surplus, there is no pressure for the price to change. The demand and supply curves form an “x” at the intersection. The equilibrium point is found where “x” marks the spot.
Markets indicate the price and variety of goods available to you from the latest social network to the smartest phone. You should be interested in equilibrium prices because that’s what you pay for the thousands of goods and services you consume. A market finds equilibrium through the independent actions of thousands, or even millions, of buyers and sellers. In one sense, the market is personal because each consumer and each producer makes a personal decision about how much to buy or sell at a given price. In another sense, the market is impersonal because it requires no conscious communication or coordination among consumers or producers. The price does all the talking. Impersonal market forces synchronize the personal and independent decisions of many individual buyers and sellers to achieve equilibrium price and quantity. Prices reflect relative scarcity. For example, to rent a 26-foot truck one-way from San Francisco to Austin, U-Haul recently charged $3,236. Its one-way charge for that same truck from Austin to San Francisco was just $399. Why the difference? Far more people wanted to move from San Francisco to Austin than vice versa, so U-Haul had to pay its own employees to drive the empty trucks back from Texas. Rental rates reflected that extra cost.
Thus, a surplus creates downward pressure on the price, and a shortage creates upward pressure. As long as quantity demanded differs from quantity supplied, this difference forces a price change. Note that a shortage or a surplus depends on the price. There is no such thing as a general shortage or a general surplus, only a shortage or a surplus at a particular price. To repeat, buyers prefer a lower price and sellers prefer a higher price. A market reaches equilibrium when the quantity demanded equals quantity supplied. In equilibrium, the independent plans of buyers and sellers exactly match, so market forces exert no pressure for change. In Exhibit 5, the demand and supply curves intersect at the equilibrium point, identified as point c. The equilibrium price is $9 per pizza, and the equilibrium quantity is 20 million per week. At that price and quantity, the market clears. Because there is no shortage or surplus, there is no pressure for the price to change. The demand and supply curves form an “x” at the intersection. The equilibrium point is found where “x” marks the spot.
Markets indicate the price and variety of goods available to you from the latest social network to the smartest phone. You should be interested in equilibrium prices because that’s what you pay for the thousands of goods and services you consume. A market finds equilibrium through the independent actions of thousands, or even millions, of buyers and sellers. In one sense, the market is personal because each consumer and each producer makes a personal decision about how much to buy or sell at a given price. In another sense, the market is impersonal because it requires no conscious communication or coordination among consumers or producers. The price does all the talking. Impersonal market forces synchronize the personal and independent decisions of many individual buyers and sellers to achieve equilibrium price and quantity. Prices reflect relative scarcity. For example, to rent a 26-foot truck one-way from San Francisco to Austin, U-Haul recently charged $3,236. Its one-way charge for that same truck from Austin to San Francisco was just $399. Why the difference? Far more people wanted to move from San Francisco to Austin than vice versa, so U-Haul had to pay its own employees to drive the empty trucks back from Texas. Rental rates reflected that extra cost.
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