Study guide: Competitive Market Equilibrium and Failures

📋 Course Outline

1. Demand Determinants and Elasticity
2. Supply Determinants and Elasticity
3. Market Equilibrium and Price Signals
4. Surplus and Optimal Allocation
5. Exogenous Shocks and Disequilibrium
6. Self-Regulation and Market Taxes
7. Information Asymmetries
8. Public Responses to Information Failures

📖 1. Demand Determinants and Elasticity

🔑 Key Concepts & Definitions

• Demand: the quantity of resources that consumers are willing to buy at a given price

★ Must-know

📌 According to the law of demand, when the price of a good or service decreases, the quantity demanded increases, and when the price increases, the quantity demanded decreases.

Further detail

📌 Demand is relatively insensitive to price for essential and difficult-to-replace goods such as eggs or fuel, but it is more sensitive for non-essential and easily substitutable services such as restaurant meals.

💡 Memory Hook

Essential eggs and fuel are relatively inelastic, whereas restaurant meals are more price-sensitive.

📖 2. Supply Determinants and Elasticity

🔑 Key Concepts & Definitions

• Supply: the quantity of resources that sellers are willing to sell at a given price

★ Must-know

📌 According to the law of supply, when the price of a good or service increases, the quantity supplied increases, and when the price decreases, the quantity supplied decreases.

Further detail

• Supply also depends on:
  • production costs
  • the stock of productive resources
  • natural hazards
  • expected demand

💡 Memory Hook

Higher prices → higher expected profit → greater quantity supplied.

📖 3. Market Equilibrium and Price Signals

🔑 Key Concepts & Definitions

• Equilibrium price: the price at which supply and demand are equal

★ Must-know

📌 In a perfectly competitive market, flexible prices spontaneously balance supply and demand because individual buyers and sellers are price takers.

Further detail

• In the cocoa market, the equilibrium price is 3 thousand dollars per tonne and the equilibrium quantity is 6 tonnes.

💡 Memory Hook

The upward supply curve and downward demand curve cross at one equilibrium point.

📖 4. Surplus and Optimal Allocation

🔑 Key Concepts & Definitions

• Consumer surplus: the difference between the maximum price a consumer was willing to pay and the equilibrium price
• Producer surplus: the difference between the equilibrium price and the minimum price at which a producer was willing to sell

📝 Essential Points

📐 Formula - Collective surplus is measured graphically as the area of a triangle, calculated with $\frac{base \times height}{2}$; in one example, consumer surplus and producer surplus are each 140 €, giving a total surplus of 280 €.

💡 Memory Hook

Surplus is a gain from exchange, whereas overproduction means supply exceeds demand.

📖 5. Exogenous Shocks and Disequilibrium

🔑 Key Concepts & Definitions

• Exogenous shock: an external, often unpredictable event or public-policy action that immediately changes quantities supplied and/or demanded

📝 Essential Points

📌 A positive supply or demand shock increases the affected quantity and shifts its curve to the right, whereas a negative shock decreases the quantity and shifts its curve to the left.

📌 When supply is lower than demand, the market experiences a shortage or underproduction, whereas when supply is higher than demand, it experiences a surplus or overproduction.

💡 Memory Hook

Positive shocks shift a curve right, whereas negative shocks shift it left.

📖 6. Self-Regulation and Market Taxes

★ Must-know

• A surplus leads to lower prices, which increases demand and reduces supply until supply equals demand.

• A shortage leads to higher prices, which reduces demand and increases supply until supply equals demand.

Further detail

📌 A tax on sodas increases the price paid by consumers, reduces the amount received by producers when the tax is not fully passed on, and decreases the quantity exchanged.

💡 Memory Hook

Shortage → price rises → demand falls and supply rises → new equilibrium.

📖 7. Information Asymmetries

🔑 Key Concepts & Definitions

• Information asymmetry: a market situation in which buyers or sellers do not have access to all information about the goods, services or conditions of exchange
• Adverse selection: Adverse selection occurs before a contract when poorly informed buyers choose low-quality goods because they cannot observe quality, discouraging sellers of high-quality goods.
• Moral hazard: Moral hazard occurs after a contract when an agent takes risks or changes behaviour because the agent does not bear the full costs of those actions.

💡 Memory Hook

Selection adverse occurs before the contract, whereas moral hazard occurs after it.

📖 8. Public Responses to Information Failures

📝 Essential Points

• Public responses include:

  • controls
  • sanctions
  • information
  • prevention

• Labour inspection can sanction undeclared or hidden work with fines while protecting workers' rights and limiting unfair competition between firms.

📌 Insurance can increase moral hazard because being well insured may encourage individuals to behave less cautiously.

💡 Memory Hook

Controls, sanctions, information and prevention → fewer abuses and fairer exchanges.

📊 Synthesis Tables

Supply, demand and market outcomes