Equilibrium - Balance in a Busy World

Himalaya.
You're listening to Think like an Economist, a Humalaya learning production.
For exclusive content like bonus episodes and supplemental materials for
this podcast and others like it, go to Himalaya dot com,
slash econ and enter promo code econ eco and a
checkout to get your first fourteen days free. It's time
to think like an economist.
It's four dollars right now. I'm gonna go out by
twenty cents. Submit bid. You're the first bidder.
Good luck.
I think if I put down a bit of five dollars,
I could be the highest bidder. So getting in early.
Oh, I've already been out of bed.
I want to win while spending as little money as possible.
Katie and Chris both want this rare watch stripes vinyl,
which they've seen in an auction.
But who will win this auction, Well, that depends on
who's willing to pay the most for it.
That's another way of saying who wants it the most.
And we're going to explore how praises are set on
this week's episode of Think Like an Economist. I'm Betty Stevenson.
And I'm just a Wolphus.
We're going to teach you the tools of economics so
you can make the best decisions for you.
Thinking like an economist will change your life. So let's
dig in. NaSTA and Tabacoli far joins us.
So we're bringing demand and supply together on this episode.
Yes, it's finally happening. It's a special economics style meet up.
Equilibrium is making me think of science experiments and letting
fluids or gas particles even out or something. So what
are economists talking about when they use the term equilibrium.
It's basically the same concept as scientists refer to equilibrium.
It's a stable situation with no tendency to change. This
occurs when competing force and balance each other. The same
idea applies in economics.
In economics, demand and supply are the competing forces. Equilibrium
occurs when they're in balance. That happens when demand is
equal to supply in a market. The price changes to
bring demand and supply into balance.
In fact, there's only one point at which the quantity
that buyers want to buy is equal to the quantity
that sellers want to sell. Prices adjust until we hit
what we call the equilibrium price. At this price, every
seller who wants to sell an item can find a buyer,
and every buyer who wants to make a purchase can
find a willing seller.
So if supply equals demand and they balance out in
this way, that's how we get the equilibrium price exactly.
We've talked about your demand for coffee, Betsy, and I
remember that obey to the law of demand, So if
price goes up, you'll buy less.
My logic is that when the price is higher, it's
not really worth buying because an expensive coffee will cost
me more than the marginal benefit I'll get from it.
Also, last episode we talked about the supply of coffee.
When we spoke to Samer in California. He follows the
law of supply, which says that the higher the price,
the more cups of coffee he'll want to sell.
Yeah, when the price is higher, it's more likely to
be profitable to produce more because to be able to
cover the marginal cost of producing more coffee.
So today we're going to look at what happens when
buyers like Betsy and sellers like Samit come together.
That's today's big question. Of course, in a real market,
there are many, many buyers and many many sellers, the buyers,
It's pretty likely they're all going to act a bit
like Betsy and the sellers, they're all going to act
a bit like Samir. Equilibrium is what happens when all
these folks interact.
The equilibrium we're going to analyze today applies if there's
something called perfect competition. This is when many people are
buying and selling identical goods. So a perfectly competitive market
for coffee would have a lots of different shops selling
identical coffees, which then gives me lots of options of
where to buy this uniform cup of coffee. It also
involves lots of people looking to buy coffee. Under perfect competition,
no individual buyer or seller is really a big enough
deal that they'll get any kind of special treatment. The
real world, well, it's a little bit messier, and we'll
come to that in later episodes.
The coffee market is very competitive, though, and that affects
how Samir is going to set his price. When you're
in a perfectly competitive market and it's in equilibrium, your
best strategy is to charge pretty much the same price
as your competitors.
And why is this the case?
Well, Sami could try charging a bit more than his rivals,
But if the other coffee shops on your block sell
a pretty much identical product for less, you'll quickly lose
all your customers. Alternatively, Sami could charge a bit less
than these competitors, but this doesn't make sense either. If
he's the only shop on his block charging that lower price,
he'll get all the customers from all the other coffee shops,
which sounds great until you realize there's no way he
could serve that many customers.
Okay, so what does all of this mean for equilibrium,
which is today's topic.
It means that it's the market that determines the equilibrium price,
not individual managers. So managers in perfectly competitive markets don't
spend a lot of time strategizing about price. The best
choice for any individual supplier is to simply follow the market,
charging the typical market price. So our task for today
is figuring out where this market price comes from.
Buyers like me, you want to buy more coffee if
the price is lower, but sellers like Samir will then
supply fewer cups of coffee at this price. So therefore,
buyers want more coffee than sellers want to produce. That's
not an equilibrium.
And if the price is too high, suppliers will want
to sell a lot more coffee, then buyers will want
to purchase. That's also not an equilibrium.
I feel like there's a Goldilocks moment that's about to happen.
So somewhere between a price that's too low and a
price that's too high, there's got to be a price
that's just right.
There is equilibrium is the point where the quantity demanded
is exactly equal to the quantity supplied. And at this
point Goldilocks would declare the price just right. We call
it the equilibrium price.
Let's really hone in and get into the details of
how we actually get to an equilibrium.
On either side of equilibrium, there are two things that
can happen, a shortage or a surplus, and when these happen,
they set off a series of price changes that'll push
us towards the equilibrium. For example, at three dollars a cup,
I'm willing to go to a coffee shop several times
a day, but Samir isn't willing to open it all. Remember,
when the price is too low, more people want to
buy coffee than there are sellers wanting to make it
for them. So there's a shortage of coffee.
Now, sells like Samir pretty savvy. Remember he told us
that he wouldn't be in business at three dollars a cup.
But if he sees long lines out the door at
other coffee houses, he might spot an opportunity. Perhaps it's
worth opening and charging four bucks a cup. Some of
the folks who couldn't get coffee because of the shortage
will be happy to pay Samir's higher price than to
do without.
And how about other sellers, what will they do?
Well, those folks charging three dollars will see that they
can charge four dollars and still have more customers that
they can handle, So they'll all raise their price a
bit too. That higher price might scare away a few buyers,
and it might lead a few coffee shops to try
to supply more coffee.
But what if there's still a shortage.
Though, then the process continues. As long as there's still
a shortage. The coffee shops will still find that they're
overrun with customers. So folks like Samir wor think why
not raise my prise a bit more? And they'll keep
doing this as long as the demand for coffee outstrips
the supply.
So whenever there's a shortage, market forces will push the
price up yep.
And they'll keep pushing prices up until those shortages have
been eliminated, which occurs when the quantity demanded is equal
to the quantity supplied. That is, market forces will push
the price up until it gets to the equilibrium price.
And exactly what does this mean?
Though?
That there are as many people wanting to buy coffee
at five dollars a cup as there are people wanting
to sell it to them at five dollars a cup.
At this price, there's no pressure for the price to change.
And how about the opposite? What happens if the price
is higher than that? I remember that Betsy, you said
you're not willing to go for coffee every day if
coffee costs eight dollars a cup, But Samir said he'd
open his shop for a few more hours if prices
are going to be that high.
In that case, we have what we call a surplus
of coffee, which is basically the opposite of a shortage.
When coffee is really expensive, Coffee shop owners like to
me and want to sell loads of coffee, but they're
going to be disappointed to discover that not many people
come to their sh to pay, say eight bucks a cup.
To get more people like me to buy coffee, they're
gonna have to drop their prices. As the price goes down,
more people are willing to buy coffee. This process of
coffee shops cutting their prices to try to lure customers
to buy their surplus will continue until we get to
our equilibrium price.
Have five dollars, so whenever there's a surplus, market forces
push the price down, and whenever there's a shortage, market
forces push the price up. So basically things adjust both
ways until five dollars is a stable price.
Yes, the bottom line is that shortages lead the price
to rise and surpluses lead the price to fall. The
equilibrium is the only stable point because the quantity demanded
is equal to the quantity supplied, so there's no competing
force trying to move the price in a different direction,
no shortage or surplus.
Hi. I'm Katie, I'm in Seattle.
Hello, I'm Chris. I'm in Toronto.
And I'm about to bid on a vinyl. I'm about
to bid on the white stripes Icky Thump seven inch
white vinyl.
This is really cool. I've loved this band for a
long time. I think this would be a cool thing
to have.
It's four dollars right now, I'm going to go out
by twenty cents.
Submit bid. You're the first bidder. Good luck.
I think if I put down a bit of five dollars,
I could be the highest bidder. So I'm getting in early.
You can see what's happening here. Katie and Chris both
really want this red vinyl, so the reach pushing the
price up.
Oh, I've already been out bid.
I want to win while spending as little money as possible.
I'm checking back in on my vinyl here and now
we've got ten minutes and forty seconds left. I put
my maximums dollars and we're currently at five fifty. All right,
let's see what happens.
I see I'm no longer the highest bid I'm gonna
put in a bid for seven dollars. Fifty cents sent. Okay,
I'm the highest bidder again. This is exciting.
Okay, says I've been outbid. Okay, so someone else is
definitely looking at this.
I see there's a couple bidders in the.
Mix now counting down and I'm still the highest bidder
at eight.
Fifty are almost at one minute left. Twelve is the
highest bid I've been.
Not bid, Well, let's try thirteen.
Bid thirteen. Somebody's ahead of me. I'm going to get
a bid ready for fifteen, and I'm going to put
it in at the last possible second.
Oh, they've already been out bid. Okay, fourteen is my
highest we've been O bid. Okay, let's put Oh that's
what Fifteen is my highest i've been. Okay, I'm gonna
put seventeen and go.
This is nerve racking. I'm really nervous.
Chris is only willing to go so far.
Auction is almost over it. We've got six seconds. They're
gonna do it again. I've already gone over what I wanted.
To pay four three two one.
Ah no, and so Katie wouldn't see auction.
I won the auction. Exciting Yes, Oh I lost.
I can't believe this. That is very frustrated.
Okay, I paid sixteen dollars. That's only one dollar over
what I wanted to pay.
Yay auctions are an interesting example the use only one
of the item that people want to buy. In this case,
there's only one record, which both Katie and Chris want,
so they basically need to battle it out to see
who wants it more.
It's just as well we don't buy ceps of coffee.
This way, Thank goodness.
I don't beat you any typeat no way.
We've looked at how we get to an equilibrium price.
Once we're there, would it just stay like that forever?
No?
If other things change, the market price will change too.
Okay, so one depends on the other, and that sounds
a bit like the interdependence principle.
You bet, Remember your best choice depends on your other choices,
the choices that others make, developments in other markets, and
expectations about the future. If any of these things happen,
demand and supply will change too.
I think I remember this. So a rise in income
might cause a coffee lover who's earning more money to
buy more coffees. Or say, if tea becomes more expensive,
people might start buying coffee instead of buying tea. Preferences
might shift. I mean, I think coffee has become more
popular over the past decade or so. I guess there's
just loads of reasons why the demand for coffee might increase.
There's tons.
So let's try an example. Say we're in the recession
and people's incomes far or coffee from a cafe becomes
less popular. What will that do to the price of coffee?
So if demand and supply used to be imbalanced, but
there's now less demand, that will cause a surplus, and
a surplus pushes prices down. At a lower price, sellers
will want to make fewer cups of coffee as it's
less profitable for them, so the price and quantity will
both fall.
That's it. And one more thing. Notice that a change
in demand leads price and quantity to also change in
the same direction. Lower price will lead to less quantity,
higher price will lead to more quantity.
Okay, so that's demand. How about when supply changes?
Okay, I think I've got this. If coffee beans become
cheaper or new technology makes it cheaper to produce each cup,
then some's costs are going to go down, So making
and selling coffee is even more profitable for him, so
he's going to want to sell more cups, or new
coffee shops might open, increasing the supply.
As you pointed out, there's lots of reasons why the
supply of coffee might increase. You've now got the tools
to trace through the effects of this.
Okay, there's now more supply that's going to cause a surplus,
and a surplus pushes the price down. A lower price
means buyers are going to want more coffee, So the
price of coffee will fall and the quantity will rise.
That's right. And now I want to notice that the
change in supply leads the price and the quantity to
move in different directions from each other.
Betsy Justin, we've been exploring how we get to an equilibrium.
How would you sum this up?
Buyers and sellers will change their behavior and tell things
balance out. We call this the equilibrium, and it tells
us about price and quantity. So the equilibrium is where
the quantity people want is equal to the quantity sellers
want to sell. That supply and demand.
And that points to something important. Prices depend on what
both buyers and sellers want.
When demand changes, it'll cause prices and quantities to move
in the stale direction. But when supply changes, prices and
quantities will move in opposite directions.
And how should I start thinking about equilibrium so that
I can really get to grips with it.
There's an old economic paradox about how water is essential
to life, yet it's so cheap it's almost free. Like contrast,
diamonds are completely inessential. I mean, they're pretty and they sparkle,
but who really needs them. The paradox is that diamonds
are expensive, water's really cheap. The answer is that prices
aren't just about how useful something is. They reflect both
demand and supply, and water is plentiful while diamonds are scarce.
So over the next few days, try to think of
other things that are a bit like diamonds in that
they're expensive but basically pointless. Also, try to think of
other goods that are like water, that are ridiculously cheap
but essential. Then use your understanding of supply, demand and
equilibrium to make sense of this.
Betsy Justin thanks for teaching us all how to think
like economists.
To get the most out of this show, check out
our bonus episodes and supplemental materials available only on the
Himalaya Learning platform.
Himalaya Learning provides bite sized courses from world class thinkers
and industry experts such as Arianna Huffington, Malcolm Gladwell, Tim
Ferriss and Moore for you to enjoy in the app
on the go.
To get the most out of this podcast and others
like it, go to Himalaya dot com, slash econ and
enter promo code econ eco n at checkout for your
first fourteen days free.
It's time to think like an economist.