Equilibrium Prices

Equilibrium Prices:

So far we have not introduced prices, or markets. If there are only two persons involved they will meet and presumably start a process of haggling about the terms of exchange of the two goods. The outcome of this process cannot be predicted, only that the outcome will likely occur inside the cross-hatched areas, which will define an exchange rate implicitly. However, let us assume that there are a lot of consumers of two types, one group of consumers with the same preferences as consumer 1, and another group with the same preferences as consumer 2. This makes it more likely that there will be one exchange rate between the two goods, which applies to all consumers, i.e., a market price ratio, p1/p2. In this case we write the budget constraints for the two consumers as,
Now, the question is how the prices are established? First we should note that we must choose one good to express the terms of exchange in. Let us choose good 2 and thus set p2=1 (this means that one unit of good 2 cost one unit of good 2, not surprisingly). We can now look at how much of the goods that the two consumers want to sell or buy of the two goods as we vary the price of good 1.

361_equillibrium prices.jpg

In figure above I’ve drawn three price lines going through the endowment point. Let us start with the high price of good, p11; in this case consumer1, who is a net seller of good 1, naturally wants to sell a lot of good 1in exchange for good 2, his best point is at C1; consumer 2, who is a net demander of good 1, doesn’t want to buy very much, her best point is C2. Since, consumer 1 wants to sell more than consumer 2 wants to buy at this price, we have an excess supply, and the price, p11, is too high to be an equilibrium price. Turning now to the low price, p21, consumer 1 doesn’t want to sell very much (B1), while consumer 2 wants to buy a great amount (B2) of good 1; here the price is too low and there is an excess demand. The intermediate price, p1, is an equilibrium price, since at point A, the quantity that consumer 1 wants to sell is equal to the quantity that consumer 2 wants to buy of good 1. Note also that the equilibrium can be determined as the intersection of the two offer curves (OC1 and OC2) of the two consumers. We now proceed by defining a so called aggregate excess demand function for good 1 :

z1(p1) = (x11 − ω11) + (x21 − ω21).

At a general equilibrium the aggregate excess demand functions should be equal to zero (or non-positive) for all goods (zi(p1) = 0, i = 1, 2.). Using the prices in figure above, we have that,

z1(p11) < 0,
z2(p11) > 0,


z1(p21) > 0,
z2(p21) < 0,


z1(p1) = 0,
z2(p1) = 0.

Here we also included the aggregate excess demand function for good 2, which we did not discuss before; however, in this two good case, it will always have the reverse sign compared to that for good 1 (unless we have an equilibrium).

Latest technology based Economics Online Tutoring Assistance

Tutors, at the www.tutorsglobe.com, take pledge to provide full satisfaction and assurance in Intermediate Microeconomics homework help via online tutoring. Students are getting 100% satisfaction by online tutors across the globe. Here you can get homework help for Intermediate Microeconomics, project ideas and tutorials. We provide email based Intermediate Microeconomics homework help. You can join us to ask queries 24x7 with live, experienced and qualified online tutors specialized in Intermediate Microeconomics. Through Online Tutoring, you would be able to complete your homework or assignments at your home. Tutors at the TutorsGlobe are committed to provide the best quality online tutoring assistance for Economics homework help and assignment help services. They use their experience, as they have solved thousands of the Computer assignments, which may help you to solve your complex issues of Intermediate Microeconomics. TutorsGlobe assure for the best quality compliance to your homework. Compromise with quality is not in our dictionary. If we feel that we are not able to provide the homework help as per the deadline or given instruction by the student, we refund the money of the student without any delay.