Market Equilibrium

CFA Level I Economics
#1

Consider a Market where quantity supplied = 1500 - 3 x price, and quantity demanded = 2000 - 5 x price. With respect to equlibrium price and quantity, there is:

A) No Market Equilibrium

B) Stable Market Equilibrium

C) Unstable Market Equlibrium

Answer: (B)

Explanation:

There is a Market Equlibrium at a price of 250 where Qs= 750 and Qd= 750. Although the supply curve is downward sloping, the Equlibrium is stable because the supply curve intersects the demand curve from above- the slope of the supply curve (-1/3) is steeper than the slope of the demand curve (-1/5).

Question:

  1. My algebra must be awlful because I cannot get the calculation for the Market Equlibrium price of 250 and Qs= 750 and Qd= 750, and how to get the slope of the supply and and demand curve

  2. I am under the assumption that in the reverse (if the demand curve slope is steeper than the supple curve) it would be unstable. Correct?

#2

Set both curves equal (=intersection) and solve for P:

Qs=Qd <=> 1,500 - 3 x P = 2,000 - 5 x P II -1,500 and +5 x P <=> 2 x P = 500 <=> P = 250

That’s the equilibrium price. If you enter this price into the demand and supply curves you will get the respective quantities.

Note that if there wouldn’t be an algebraic solution to the equation there wouldn’t also be an equilibrium at all. Best, Oscar

#3

Set Qd=Qs: 2000 - 5X = 1500 - 3X and solve for X : 500 = 2X —> X = 250

As a check Qd = 2000 - 5(250) = 2000 - 1250 = 750

Qs = 1500 - 3(250) = 1500 - 750 = 750

#4

Follow up question, if the slope of either Qs or Qd is positive (ex: slope of Qs was 1/3) is the market still in equilibrium?

Thanks in advance

#5

Oscar nailed this one.

Correct.

In a stable equilibrium,

  • at a price below the equilibrium price there is excess demand, driving the price up (toward the equilibrium price)
  • at a price above the equilibrium price there is excess supply, driving the price down (toward the equilibrium price)

In an unstable equilibrium,

  • at a price below the equilibrium price there is excess supply, driving the price down (away from the equilibrium price)
  • at a price above the equilibrium price there is excess demand, driving the price up (away from the equilibrium price)
#6

At the end you could insert e.g. P=300 (price above the equilibrium, 300>250)

You would get:

S = 1500-3*300=600

D = 2000-5*300=500

So, we can see excess supply when the price is above the equilibrium (S-D=600-500=100), therefore we have stable market equilibrium