DP Economics HL 2.3 Competitive Market Equilibrium

DP Economics HL 2.3 Competitive Market Equilibrium - Full notes

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DP Economics HL | 2.3 Competitive Market Equilibrium

DP ECONOMICS · UNIT 2: MICROECONOMICS

2.3

Competitive Market Equilibrium

Full notes for HL · IB-style

Contents

1	Market equilibrium
2	Disequilibrium: excess demand and excess supply
3	Changes in equilibrium
4	The price mechanism and the allocation of resources
5	Consumer surplus, producer surplus and allocative efficiency
6	Equilibrium in the real world: commodity markets
7	Equilibrium and surplus from linear functions (HL only)
8	Equilibrium from demand and supply functions
9	Excess demand and excess supply
10	Changes in equilibrium: one curve shifts
11	Changes in equilibrium: both curves shift
12	Calculating new equilibria
13	The functions of the price mechanism
14	Consumer and producer surplus at equilibrium
15	Allocative efficiency
16	Real-world markets and equilibrium
17	Mixed review: worked problems
18	Additional exam-style practice
19	Price volatility
20	Diagram skills checklist
21	Common misconceptions and links
22	Exam-style question with markscheme
23	Check your understanding
24	Summary and topic map

These are full teaching notes. Read each section in order, try the Think about it question before you read on, and do every Quick check before moving to the next section.

Before you start

Rate yourself on each statement now, and again after you've worked through the notes. Shade R (not yet), A (getting there) or G (confident).

I can…	R	A	G
explain how equilibrium price and quantity are determined
explain how excess demand and excess supply are eliminated
analyse the effects of shifts in demand, supply or both on equilibrium
explain the signalling, incentive and rationing functions of price
identify consumer and producer surplus on a diagram
explain why a competitive equilibrium is allocatively efficient (MB = MC)
calculate equilibrium price and quantity from linear functions
calculate consumer surplus, producer surplus and excess demand or supply from functions

Section 7 is Additional Higher Level content. Every other section is common to SL and HL.

Guiding questions

How do buyers and sellers who never meet agree on a price? What happens when the price is 'wrong'? Why do economists say that a competitive market can allocate resources efficiently?

How this topic is examined

Equilibrium is the core of microeconomics: almost every Paper 1 and Paper 2 question on a market asks you to show a change in equilibrium on a demand and supply diagram and explain it.

Expect diagram questions that combine shifts with the price mechanism, and evaluation questions about whether markets allocate resources well. Consumer and producer surplus are the tools you will use later to measure welfare losses from taxes, price controls and market failure. At HL, Paper 3 regularly asks you to solve for equilibrium from functions and to calculate surplus areas.

Command term	What the examiner wants
Define	the precise meaning, ideally in the IB wording, in one or two sentences
Draw / Sketch	a fully labelled diagram with every axis, curve, equilibrium and change labelled
Explain	a causal chain linked to economic theory, usually supported by a diagram
Analyse	break a situation into its parts and trace the effects of each
Evaluate / Discuss	weigh up arguments, question assumptions and reach a justified conclusion using real-world examples
Calculate	solve the functions step by step, show each substitution and give units

How to use these notes

Each section teaches one part of the syllabus in full. You'll see these boxes throughout; each has one job:

Box	What it's for
Think about it	a question to get you thinking before a section; the answer comes in the section
Key point	the one idea you must not forget
Common mistake	an error examiners see every year, and how to avoid it
In the real world	where the economics shows up outside the classroom
Try this	something quick you can do yourself to test the idea
Worked example	full solutions with IB-style marks (M1 method, A1 answer, R1 reasoning)
Quick check	short questions to test yourself at the end of each section

1 Market equilibrium

Equilibrium is where buyers' plans and sellers' plans match.

Think about it

At a car-boot sale, a seller starts by asking $20 for an old lamp and nobody buys. By the end of the day she sells it for $8. What was happening during the day?

In 2.1 and 2.2 you studied buyers and sellers separately. Now we put them together. When the demand and supply curves are drawn on the same diagram, they cross at one point. At that point, the quantity consumers want to buy exactly equals the quantity producers want to sell.

Market equilibrium is the situation in which quantity demanded equals quantity supplied, so that there is no tendency for the price to change. The price at which this happens is the equilibrium price (or market-clearing price), and the quantity bought and sold is the equilibrium quantity.

The word 'equilibrium' means balance. At the equilibrium price every buyer who is willing and able to pay that price can buy, and every seller who is willing and able to sell at that price can sell. Nobody has a reason to change their behaviour, so the price stays where it is until something shifts demand or supply.

Figure 1. Equilibrium where demand and supply intersect: price Pe and quantity Qe.

P ($)	Quantity demanded	Quantity supplied	Situation
8	36	76	excess supply of 40
7	44	64	excess supply of 20
6	52	52	equilibrium
5	60	40	excess demand of 20
4	68	28	excess demand of 40

The schedule above shows the market for concert tickets. At $6, quantity demanded and quantity supplied are both 52: this is the equilibrium. At every other price the quantities differ, and the market is in disequilibrium.

Key point

Equilibrium is a state of rest: Qd = Qs and there is no pressure on price to change. It is not 'the best' or 'the fair' price, only the one at which plans match.

Quick check

1. Define equilibrium price.

2. In the table, what is the equilibrium quantity?

3. Why is there no pressure for price to change at equilibrium?

Answers: 1. the price at which quantity demanded equals quantity supplied 2. 52 3. every willing buyer and seller can trade; plans match

2 Disequilibrium: excess demand and excess supply

If the price is wrong, the market pushes it back.

Think about it

Tickets for a famous band are sold at a price far below what fans would pay. What happens next?

2.1 Excess supply (a surplus)

If the price is above equilibrium, quantity supplied exceeds quantity demanded. The difference is called excess supply or a surplus. In the ticket market at $8, firms want to sell 76 tickets but buyers only want 36, leaving 40 unsold.

Sellers with unsold goods have an incentive to cut their prices. As the price falls, two things happen: quantity demanded extends (more buyers come in) and quantity supplied contracts (some sellers withdraw). The surplus shrinks until the price reaches equilibrium.

2.2 Excess demand (a shortage)

If the price is below equilibrium, quantity demanded exceeds quantity supplied: excess demand or a shortage. At $4, buyers want 68 tickets but only 28 are offered, a shortage of 40.

Buyers who cannot get the good compete for it and are willing to pay more; sellers notice queues and sell-outs and raise their prices. As the price rises, quantity supplied extends and quantity demanded contracts, until the shortage disappears at equilibrium.

Figure 2. At a price below equilibrium, quantity demanded exceeds quantity supplied: excess demand of Qd − Qs.

Notice how the price moves along both curves during this process. Nothing shifts. The demand and supply curves stay where they are; only the price and the quantities demanded and supplied adjust. This is why the movement/shift distinction from 2.1 and 2.2 is so important.

Common mistake

Showing excess demand as a vertical distance on the diagram. Excess demand and excess supply are horizontal distances: the gap between Qd and Qs at a given price.

Quick check

1. What exists when price is above equilibrium?

2. How is a shortage eliminated?

3. Do the curves shift when the market moves back to equilibrium?

Answers: 1. excess supply (surplus) 2. price rises; Qs extends, Qd contracts 3. no: movements along both curves

3 Changes in equilibrium

A shift in one curve creates disequilibrium at the old price; the price then moves to a new equilibrium.

Think about it

Two things happen in the market for coffee in the same year: a health study boosts demand, and frost damages crops. What can you say for certain about the price?

3.1 A change in demand

Suppose incomes rise and coffee is a normal good. Demand shifts right from D1 to D2. At the old equilibrium price there is now excess demand. The price rises, quantity supplied extends along the supply curve, and a new equilibrium is reached at a higher price and higher quantity. A decrease in demand does the opposite: lower price and lower quantity.

3.2 A change in supply

Suppose a new technology lowers costs. Supply shifts right from S1 to S2. At the old price there is excess supply, so the price falls, quantity demanded extends along the demand curve, and the new equilibrium has a lower price and higher quantity. A decrease in supply gives a higher price and lower quantity.

Figure 3. Shifts of demand and supply and the new equilibrium.

3.3 Changes in both demand and supply

Often both curves shift at once. When this happens, the direction of change of one variable is certain, and the other depends on the relative size of the shifts.

If demand and supply both increase, quantity definitely rises (both shifts raise it), but the effect on price is uncertain: the demand shift pushes price up and the supply shift pushes it down. If demand rises by more than supply, price rises; if supply rises by more, price falls.

If demand increases and supply decreases, price definitely rises, but the effect on quantity is uncertain. Work through each case by asking what each shift does on its own and whether the effects reinforce or oppose each other.

Change	Price	Quantity
Demand up	rises	rises
Demand down	falls	falls
Supply up	falls	rises
Supply down	rises	falls
Demand up, supply up	uncertain	rises
Demand down, supply down	uncertain	falls
Demand up, supply down	rises	uncertain
Demand down, supply up	falls	uncertain

WORKED EXAMPLE 1 Two shifts at once

In the coffee market, a health study increases demand and frost reduces supply in the same year. Explain the effect on equilibrium price and quantity.

Solution

Demand shifts right: on its own this raises both price and quantityR1

Supply shifts left: on its own this raises price and lowers quantityR1

Both shifts raise price, so the price definitely risesA1

The effects on quantity oppose each other, so the change in quantity is uncertain and depends on the relative size of the shiftsA1

Common mistake

Drawing both curves shifting by exactly the same amount and then claiming the result is certain. If the effect on one variable depends on the sizes of the shifts, say so explicitly.

Quick check

1. What happens to price and quantity when supply falls?

2. Demand and supply both rise. What is certain?

3. Demand falls and supply rises. What is certain?

Answers: 1. price rises, quantity falls 2. quantity rises 3. price falls

4 The price mechanism and the allocation of resources

Prices do three jobs at once, without anyone planning them.

Think about it

Nobody tells farmers how many tomatoes to grow next year. How do they decide?

In a market economy, nobody coordinates millions of buying and selling decisions. Prices do it. The price mechanism is the system in which the interaction of demand and supply determines prices, and those prices guide how resources are allocated. Prices perform three functions.

The signalling function. Prices give information to buyers and sellers. A rising price signals that a good is becoming scarcer relative to demand; a falling price signals that it is becoming more plentiful. Producers and consumers respond without needing to know why the price changed.

The incentive function. Prices create incentives. A higher price makes producing the good more profitable, encouraging existing firms to produce more and new firms to enter. For consumers, a higher price is an incentive to buy less or look for substitutes.

The rationing function. When a good is scarce, rising prices ration it among buyers. Only those willing and able to pay the higher price obtain it. This is how a market allocates goods that are in short supply without queues or official rationing.

Together, these functions answer the basic economic questions from 1.1. Resources move towards the goods consumers value most (what to produce), firms use the cheapest methods to maximize profit (how to produce), and goods go to those willing and able to pay (for whom). Adam Smith's 'invisible hand' is the price mechanism at work.

Function	What it does	Example: rising demand for electric cars
Signalling	tells producers and consumers about scarcity	higher prices show that demand exceeds supply
Incentive	encourages producers to supply more	car makers switch factories to electric models
Rationing	allocates scarce goods to those willing to pay	only buyers willing to pay the higher price get a car now

Key point

The price mechanism allocates resources through signals and incentives, without central planning. Its weakness, explored in Unit 2's market failure topics, is that it responds only to willingness and ability to pay.

Quick check

1. Name the three functions of price.

2. How does the price mechanism answer the question 'for whom to produce?'

3. Explain the incentive function with an example.

Answers: 1. signalling, incentive, rationing 2. goods go to those willing and able to pay 3. higher prices raise profits, so firms produce more

5 Consumer surplus, producer surplus and allocative efficiency

The areas between the curves measure the gains from trade.

Think about it

You were willing to pay $15 for a concert ticket, but it cost only $6. Did you gain anything from the purchase? How could you measure it?

5.1 Consumer surplus

The demand curve shows how much consumers are willing to pay for each unit. Many consumers would pay more than the market price. Consumer surplus is the difference between the total amount consumers are willing to pay for a good and the amount they actually pay. On a diagram it is the area below the demand curve and above the price, up to the quantity bought.

If you would pay $15 for a ticket and the price is $6, you gain $9 of consumer surplus. Adding up these gains for every buyer gives total consumer surplus: the triangle above the price line.

5.2 Producer surplus

The supply curve shows the minimum price at which producers are willing to supply each unit, which reflects their costs. Producer surplus is the difference between the price producers receive and the minimum price they would accept. On a diagram it is the area above the supply curve and below the price, up to the quantity sold.

Figure 4. Consumer surplus (blue) and producer surplus (red) at the competitive equilibrium.

5.3 Allocative efficiency

Social surplus (or community surplus) is consumer surplus plus producer surplus: the total benefit society gains from producing and consuming the good. At the competitive equilibrium, social surplus is maximized.

To see why, think of the demand curve as showing the marginal benefit (MB) to consumers of each unit, and the supply curve as showing the marginal cost (MC) of producing it. For every unit up to the equilibrium quantity, the benefit to consumers exceeds the cost of producing it, so producing it adds to social surplus. Beyond the equilibrium, MC exceeds MB, so producing more would reduce surplus.

Allocative efficiency is achieved when resources are allocated so that society gets the goods and services it values most: the quantity where MB = MC. A competitive market, with no market failures, achieves allocative efficiency at equilibrium. If output is below or above this quantity, some surplus is lost. That lost surplus is called a welfare loss (or deadweight loss), and you will use it to analyse taxes, price controls and market failure later in the course.

Key point

At competitive equilibrium MB = MC, social surplus is maximized, and the market is allocatively efficient. Any other quantity creates a welfare loss.

Common mistake

Shading consumer surplus below the price line. Consumer surplus is above the price and below demand; producer surplus is below the price and above supply.

Quick check

1. Define consumer surplus.

2. Where is producer surplus on the diagram?

3. Why is social surplus maximized at equilibrium?

4. What is a welfare loss?

Answers: 1. willingness to pay minus price actually paid 2. above supply, below price 3. every unit with MB > MC is produced, none with MC > MB 4. the loss of social surplus when output is not at the efficient level

6 Equilibrium in the real world: commodity markets

Commodity prices swing because demand and supply both move, often at once.

Markets for commodities such as oil, coffee, wheat and copper are close to the competitive model: many buyers and sellers trade a fairly standard product, and prices are set by demand and supply every day on world markets.

In 2022, wheat prices rose sharply. On the supply side, war in Ukraine, a major exporter, disrupted harvests and shipping, shifting supply left. On the demand side, demand remained strong. The result was a sharp rise in price. In the following year, as exports resumed and other producers expanded output, supply recovered and prices fell back.

The price mechanism worked as the model predicts: high prices signalled scarcity, gave farmers elsewhere an incentive to plant more wheat, and rationed the available supply. The same rationing, however, meant that poor households in import-dependent countries struggled to afford bread, which shows why governments sometimes intervene (2.7).

In the real world

Commodity exchanges, such as the Chicago Board of Trade, publish prices that change minute by minute as traders react to news about weather, harvests and demand. Each price change is a small step towards a new equilibrium.

7 Equilibrium and surplus from linear functions (HL only)

Set Qd = Qs, solve for P, then substitute back.

HL only

This section is Additional Higher Level content. SL students do not need it.

With linear functions, equilibrium is found by setting quantity demanded equal to quantity supplied and solving for P. Substituting P into either function gives the equilibrium quantity. Excess demand or supply at another price is found by calculating Qd and Qs at that price and subtracting.

Consumer and producer surplus are triangles, so their areas are ½ × base × height. The base is the equilibrium quantity. For consumer surplus the height is the gap between the choke price (where Qd = 0) and the equilibrium price; for producer surplus it is the gap between the equilibrium price and the price at which supply begins (where Qs = 0).

WORKED EXAMPLE 2 Equilibrium from functions

Qd = 100 − 8P and Qs = −20 + 12P. (a) Find equilibrium price and quantity. (b) Calculate excess demand at $4.

Solution

(a) 100 − 8P = −20 + 12PM1

120 = 20P, so P = $6A1

Q = 100 − 8(6) = 52A1

(b) at $4: Qd = 100 − 32 = 68; Qs = −20 + 48 = 28M1

excess demand = 68 − 28 = 40A1

WORKED EXAMPLE 3 Consumer and producer surplus

Using the same functions, calculate consumer surplus, producer surplus and social surplus at equilibrium.

Solution

Choke price: 0 = 100 − 8P gives P = $12.50M1

CS = ½ × 52 × (12.50 − 6) = $169A1

Supply starts where 0 = −20 + 12P, P = $1.67M1

PS = ½ × 52 × (6 − 1.67) = $112.7A1

Social surplus = 169 + 112.7 = $281.7A1

WORKED EXAMPLE 4 A shift in demand

Demand increases to Qd = 140 − 8P. Find the new equilibrium and the change in consumer surplus.

Solution

140 − 8P = −20 + 12P, so 160 = 20P and P = $8; Q = 140 − 64 = 76A1 A1

New choke price 140 ÷ 8 = $17.50; CS = ½ × 76 × (17.50 − 8) = $361M1 A1

Consumer surplus rises by $192A1

Common mistake

Using the price-axis intercept of the wrong curve for consumer surplus. Consumer surplus uses the demand curve's choke price; producer surplus uses the price at which supply begins.

Quick check

1. Qd = 60 − 5P, Qs = −12 + 4P. Find equilibrium P and Q.

2. Calculate consumer surplus for these functions.

3. Calculate producer surplus.

Answers: 1. P = $8, Q = 20 2. ½ × 20 × (12 − 8) = $40 3. ½ × 20 × (8 − 3) = $50

8 Equilibrium from demand and supply functions

Setting Qd = Qs.

At equilibrium, quantity demanded equals quantity supplied. With linear functions, set Qd = Qs, solve for P, then substitute to find Q.

WORKED EXAMPLE 5 Solving (standard)

Qd = 100 − 5P and Qs = −20 + 3P. Find the equilibrium price and quantity.

Solution

100 − 5P = −20 + 3P: 8P = 120M1

P = $15, Q = 25A1 A1

Quick check

1. Qd = 80 − 2P, Qs = 10 + 5P. Find equilibrium.

2. In the first example, find the excess at P = $10.

Answers: 1. P = $10, Q = 60 2. Qd = 50, Qs = 10: excess demand of 40

9 Excess demand and excess supply

How markets adjust.

Above equilibrium, quantity supplied exceeds quantity demanded (excess supply, surplus): firms cut prices. Below equilibrium, quantity demanded exceeds quantity supplied (excess demand, shortage): prices are bid up. The price mechanism moves the market towards equilibrium.

Figure 5. Market equilibrium where demand meets supply.

WORKED EXAMPLE 6 Adjustment (exam level)

Explain how a shortage of concert tickets is eliminated in a free market.

Solution

Excess demand at current priceR1

Buyers bid up prices; quantity demanded falls and quantity supplied risesR1

Until Qd = Qs at the new equilibriumR1

10 Changes in equilibrium: one curve shifts

Predicting outcomes.

An increase in demand raises equilibrium price and quantity; a decrease lowers both. An increase in supply lowers price and raises quantity; a decrease raises price and lowers quantity.

Figure 6. An increase in demand raises equilibrium price and quantity.

WORKED EXAMPLE 7 Supply shock (standard)

Explain the effect of a frost destroying coffee crops on the coffee market.

Solution

Supply decreases (leftward shift)R1

Equilibrium price rises; quantity fallsR1

11 Changes in equilibrium: both curves shift

Indeterminate outcomes.

If both curves shift, the effect on one variable is certain and on the other depends on the relative size of the shifts. If demand and supply both increase, quantity rises but price may rise, fall or stay the same.

Demand	Supply	Price	Quantity
increase	increase	?	increase
increase	decrease	increase	?
decrease	increase	decrease	?
decrease	decrease	?	decrease

WORKED EXAMPLE 8 Both shift (exam level)

In winter, demand for heating oil increases while a refinery closure reduces supply. Predict the effects.

Solution

Price definitely risesR1

Quantity change depends on the relative size of the shiftsR1

12 Calculating new equilibria

Functions after a shift.

When a determinant changes, update the intercept of the demand or supply function and solve again.

WORKED EXAMPLE 9 New equilibrium (standard)

In the first example, a rise in income changes demand to Qd = 140 − 5P. Find the new equilibrium.

Solution

140 − 5P = −20 + 3P: P = 20M1 A1

Q = 40A1

13 The functions of the price mechanism

Signalling, incentives, rationing.

Prices signal information about scarcity; they create incentives for producers to supply more when prices rise; and they ration scarce goods to those willing and able to pay. Together these allocate resources without central planning.

WORKED EXAMPLE 10 Functions (standard)

Explain the signalling and incentive functions of a rise in avocado prices.

Solution

Signal: avocados are scarcer relative to demandR1

Incentive: farmers plant more avocadosR1

14 Consumer and producer surplus at equilibrium

Measuring welfare.

Total surplus (community surplus) = consumer surplus + producer surplus. In a competitive market at equilibrium, total surplus is maximized: allocative efficiency, where marginal benefit equals marginal cost.

WORKED EXAMPLE 11 Surplus calculation (exam level)

For Qd = 100 − 5P and Qs = −20 + 3P (equilibrium P = 15, Q = 25), calculate consumer and producer surplus.

Solution

Max price 20: CS = ½ × 25 × (20 − 15) = $62.50M1 A1

Min price 20/3 = 6.67: PS = ½ × 25 × (15 − 6.67) = $104.17M1 A1

15 Allocative efficiency

MB = MC.

Allocative efficiency occurs when resources produce the combination of goods most wanted by society: marginal benefit (demand) equals marginal cost (supply). Producing more or less than equilibrium creates a welfare loss (deadweight loss).

Quick check

1. Why does producing above equilibrium reduce total welfare?

Answers: 1. extra units cost more to make (MC) than they are worth to consumers (MB)

16 Real-world markets and equilibrium

Prices in the news.

Many markets show equilibrium adjustments: oil prices rising after supply cuts by OPEC+; housing prices rising when demand outpaces new building; chip shortages in 2021 raising prices of cars and electronics.

WORKED EXAMPLE 12 Chip shortage (exam level)

Explain why used car prices rose during the chip shortage.

Solution

Fewer new cars produced (supply of new cars fell)R1

Demand shifted to used cars (substitutes), raising their priceR1

In the real world

During the 2021 semiconductor shortage, used car prices in the United States rose by over 40% as new car supply fell.

17 Mixed review: worked problems

Bringing the ideas together.

WORKED EXAMPLE 13 Mixed problem (exam level)

Qd = 60 − 2P, Qs = 3P − 15. (a) Find equilibrium. (b) Calculate excess demand at P = $12.

Solution

(a) 60 − 2P = 3P − 15: P = 15, Q = 30M1 A1

(b) Qd = 36, Qs = 21: excess demand 15A1

18 Additional exam-style practice

Paper 1 and Paper 3.

WORKED EXAMPLE 14 Paper 1 part (b) (exam level)

Using real-world examples, evaluate the view that the price mechanism always allocates resources efficiently. [15]

Solution

Explains signalling, incentives, rationing with diagramR1 R1

Market failures: externalities, public goods, information asymmetryR1 R1

Equity concerns; conclusion with justified judgementR1

19 Price volatility

Why some prices swing.

Markets with inelastic demand and supply (oil, agricultural goods) show large price swings when either curve shifts. Speculation can amplify changes. Volatility creates uncertainty for producers and consumers.

Quick check

1. Why are agricultural prices more volatile than prices of manufactured goods?

Answers: 1. supply changes with weather; both demand and supply are inelastic

20 Diagram skills checklist

Scoring diagram marks.

Label axes (Price, Quantity), curves (D, S, D1, S1), equilibrium points (P1, Q1, P2, Q2), use arrows for shifts, and refer to the diagram in your explanation. Diagrams should be large and clear.

WORKED EXAMPLE 15 Checklist (standard)

List four features of a full-mark supply and demand diagram.

Solution

Labelled axesA1

Labelled curves, equilibria, and shift arrowsA1

21 Common misconceptions and links

Students often think…	Actually…
equilibrium is the fairest price	it is only the price at which plans match
excess demand is a vertical gap	it is the horizontal gap Qd − Qs
curves shift as the market returns to equilibrium	price adjusts along unchanged curves
when both curves shift, both outcomes are certain	one outcome depends on the size of the shifts
consumer surplus is below the price line	it is above the price and below demand

How 2.3 connects to the rest of the course

Topic	Connection
2.1 and 2.2	demand and supply shifts
2.5 and 2.6 Elasticity	how much price and quantity change after a shift
2.7 Role of government	taxes and price controls cause welfare losses
2.8 to 2.12 Market failure	when the market equilibrium is not allocatively efficient
4.2 Trade protection	tariff analysis uses consumer and producer surplus

22 Exam-style question with markscheme

Try this under exam conditions (about 18 minutes) before reading the markscheme.

Figure 7. Average price of coffee beans.

Text A. In 2021 frost destroyed part of Brazil's coffee crop, while demand from China grew steadily. Coffee farmers in Vietnam and Colombia responded by expanding their plantations.

(a) Define the term equilibrium price. [2]

(b) Calculate the percentage increase in the price of coffee beans between 2020 and 2022. [2]

(d) Explain how the price mechanism may lead to an increase in coffee supply in future. [4]

(e) Demand for coffee in one market is Qd = 300 − 40P and supply is Qs = −60 + 80P. Calculate equilibrium price and quantity, and consumer surplus. [4]

Markscheme

Part	Answer	Marks
(a)	the price at which quantity demanded equals quantity supplied	A1
	so there is no tendency for price to change	A1
(b)	(3.4 − 1.9) ÷ 1.9 × 100	M1
	= 78.9%	A1
(c)	diagram: supply shifts left and demand shifts right; higher price	A1
	frost reduced supply	R1
	rising demand from China increased demand	R1
	both raise price; effect on quantity uncertain	R1
(d)	higher price signals scarcity	R1
	incentive: higher profits for farmers	R1
	farmers plant more / new producers enter	R1
	supply increases over time, moving the price back down	R1
(e)	300 − 40P = −60 + 80P, so P = $3	M1 A1
	Q = 180	A1
	CS = ½ × 180 × (7.5 − 3) = $405	A1

Examiner's comments. In (c), many answers shifted only one curve. The text describes two changes; both must appear. In (d), the best answers named all three functions of price. In (e), the most common error was using the wrong intercept for consumer surplus.

23 Check your understanding

Section A: multiple choice

1. Equilibrium occurs where

A. quantity demanded equals quantity supplied B. price is highest C. demand is greatest D. supply is zero

2. If price is above equilibrium there is

A. excess demand B. equilibrium C. excess supply D. a shortage

3. An increase in demand with supply unchanged causes

A. lower price and quantity B. higher price and quantity C. higher price, lower quantity D. lower price, higher quantity

4. If both demand and supply increase, equilibrium quantity

A. definitely falls B. is unchanged C. is uncertain D. definitely rises

5. Consumer surplus is

A. producers' profit B. the difference between willingness to pay and price paid C. government revenue D. total revenue

6. Allocative efficiency occurs where

A. marginal benefit equals marginal cost B. price is lowest C. profit is maximized D. demand is elastic

7. The rationing function of price means

A. prices fall to zero B. goods are shared equally C. government allocates goods D. higher prices limit demand to the available supply

8. Social surplus is

A. consumer surplus minus producer surplus B. government revenue C. consumer surplus plus producer surplus D. total revenue

9. If Qd = 100 − 8P and Qs = −20 + 12P, equilibrium price is

A. $4 B. $5 C. $8 D. $6

10. Using the same functions, equilibrium quantity is

A. 40 B. 52 C. 60 D. 68

Section B: structured

11. Explain how the price mechanism eliminates excess supply. [4]

12. Using a diagram, explain the effect of a simultaneous fall in demand and rise in supply. [4]

13. Explain the three functions of price. [3]

14. Explain why a competitive equilibrium is allocatively efficient. [4]

15. Qd = 60 − 5P and Qs = −12 + 4P. Calculate equilibrium price, quantity and producer surplus. [3]

Answers

1. A 2. C 3. B 4. D 5. B 6. A 7. D 8. C 9. D 10. B

11. Sellers cut prices; Qd extends and Qs contracts until Qd = Qs.

12. Price definitely falls; effect on quantity uncertain and depends on the relative shifts; diagram.

13. Signalling (information), incentive (encourages supply), rationing (allocates scarce goods).

14. D = MB and S = MC; at equilibrium MB = MC; social surplus maximized; no welfare loss.

15. P = $8, Q = 20, PS = ½ × 20 × 5 = $50.

24 Summary and topic map

Idea	Remember
Equilibrium	Qd = Qs; no pressure on price
Excess supply	price above equilibrium; price falls
Excess demand	price below equilibrium; price rises
Two shifts	one outcome certain, the other depends on relative sizes
Functions of price	signalling, incentive, rationing
Consumer / producer surplus	above price below D / below price above S
Allocative efficiency	MB = MC; social surplus maximized
HL	set Qd = Qs; CS and PS are triangles

Before the exam, make sure you…

•show excess demand and supply as horizontal gaps
•keep curves fixed while price adjusts to equilibrium
•state which outcome is uncertain when two curves shift
•name all three functions of price
•shade surplus areas correctly

Competitive Market Equilibrium on one page

Cover this page with a sheet of paper and try to rebuild it from memory. Whatever you can't recall is what to revise next.

Figure 8. Topic map for Competitive Market Equilibrium.

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