- [Alex Tabarrok] In this video, I want to review
- [Alex Tabarrok] In this video, I want to review

just a little bit equilibrium and the adjustment process.
just a little bit equilibrium and the adjustment process.

Ordinarily, we won't be doing much review in this class
Ordinarily, we won't be doing much review in this class

since you can always go back and re-watch a video.
since you can always go back and re-watch a video.

But in this case I want to emphasize a few points
But in this case I want to emphasize a few points

and the material is very important.
and the material is very important.

Let's review but we'll do so quickly.
Let's review but we'll do so quickly.

Okay, here's the equilibrium price,
Okay, here's the equilibrium price,

the price where the quantity demanded
the price where the quantity demanded

is equal to the quantity supplied.
is equal to the quantity supplied.

Why is that the equilibrium price?
Why is that the equilibrium price?

Because at any other price, forces are put into play
Because at any other price, forces are put into play

which push the price towards the equilibrium price.
which push the price towards the equilibrium price.

So at a price of $80 per barrel for example,
So at a price of $80 per barrel for example,

we would have a surplus.
we would have a surplus.

The quantity supplied would be greater than the quantity demanded.
The quantity supplied would be greater than the quantity demanded.

Sellers have more goods than they have customers
Sellers have more goods than they have customers

and because of that they had incentive to push the price down
and because of that they had incentive to push the price down

towards the equilibrium price.
towards the equilibrium price.

What if the price is less than the equilibrium price?
What if the price is less than the equilibrium price?

Well, in this case the quantity demanded
Well, in this case the quantity demanded

will exceed the quantity supply.
will exceed the quantity supply.

Buyers will want the good
Buyers will want the good

but there won't be enough of the good to go around.
but there won't be enough of the good to go around.

In other words, there'll be a shortage
In other words, there'll be a shortage

because the buyers have to compete to obtain the good,
because the buyers have to compete to obtain the good,

they're going to push the price up again
they're going to push the price up again

towards the equilibrium price.
towards the equilibrium price.

The equilibrium price is the only stable price.
The equilibrium price is the only stable price.

There is similar kind of argument we can show why this quantity,
There is similar kind of argument we can show why this quantity,

the quantity such that quantity demanded
the quantity such that quantity demanded

is equal to quantity supply
is equal to quantity supply

by this quantity is the equilibrium quantity.
by this quantity is the equilibrium quantity.

Namely, choose any other quantity
Namely, choose any other quantity

and let's show that that can't be an equilibrium.
and let's show that that can't be an equilibrium.

So suppose that the quantity bought and sold
So suppose that the quantity bought and sold

was 50 million barrels of oil per day.
was 50 million barrels of oil per day.

Notice that for this last barrel of oil
Notice that for this last barrel of oil

which is being bought and sold,
which is being bought and sold,

buyers are willing to pay up to $90 for that barrel of oil
buyers are willing to pay up to $90 for that barrel of oil

where for one more barrel of oil they're willing to pay $90.
where for one more barrel of oil they're willing to pay $90.

On the other hand, sellers are willing to sell
On the other hand, sellers are willing to sell

that barrel of oil or one more barrel of oil for just $50.
that barrel of oil or one more barrel of oil for just $50.

So there's a big potential gain from trade here of $40.
So there's a big potential gain from trade here of $40.

Indeed, for any quantity below the equilibrium quantity
Indeed, for any quantity below the equilibrium quantity

there are unexploited gains from trade.
there are unexploited gains from trade.

Now in economics we assume that if you put a potential gain
Now in economics we assume that if you put a potential gain

from trade in front of people, they're going to find it.
from trade in front of people, they're going to find it.

They're going to be able to realize
They're going to be able to realize

that if only they bought and sold a little bit more,
that if only they bought and sold a little bit more,

both the buyers and the sellers could be better off.
both the buyers and the sellers could be better off.

So that's why we assume that the quantity bought and sold
So that's why we assume that the quantity bought and sold

will be pushed to the equilibrium quantity
will be pushed to the equilibrium quantity

because it's only at the equilibrium quantity
because it's only at the equilibrium quantity

that all the gains from trade have been exploited.
that all the gains from trade have been exploited.

In a free market, could the quantity bought and sold
In a free market, could the quantity bought and sold

be greater than the equilibrium quantity?
be greater than the equilibrium quantity?

Well not for any significant period of time.
Well not for any significant period of time.

Imagine for example that 90 million barrels of oil
Imagine for example that 90 million barrels of oil

were being bought and sold.
were being bought and sold.

Well, for this last barrel of oil the suppliers are willing to sell
Well, for this last barrel of oil the suppliers are willing to sell

that barrel of oil for $90, that's their cost.
that barrel of oil for $90, that's their cost.

They require at least $90
They require at least $90

to stay in business and sell that barrel of oil.
to stay in business and sell that barrel of oil.

On the other hand, buyers are willing to pay
On the other hand, buyers are willing to pay

for that barrel of oil only $50.
for that barrel of oil only $50.

So there's a lot of waste going on here.
So there's a lot of waste going on here.

Suppliers are spending more to produce the barrel
Suppliers are spending more to produce the barrel

than the barrel is worth to buyers.
than the barrel is worth to buyers.

Indeed at any quantity above the equilibrium quantity
Indeed at any quantity above the equilibrium quantity

there is waste.
there is waste.

And we don't expect waste
And we don't expect waste

to last very long in this market precisely
to last very long in this market precisely

because if without any intervention suppliers are not going to be able
because if without any intervention suppliers are not going to be able

to sell a product to buyers for more than the buyers
to sell a product to buyers for more than the buyers

are willing to pay for that product,
are willing to pay for that product,

for more than the product is worth to the buyers.
for more than the product is worth to the buyers.

So for this reason
So for this reason

we don't expect waste to last in a free market either.
we don't expect waste to last in a free market either.

So a free market maximizes the gains from trade.
So a free market maximizes the gains from trade.

Remember also that the gains from trade
Remember also that the gains from trade

can be broken down into two parts,
can be broken down into two parts,

the consumer surplus and of course the producer surplus.
the consumer surplus and of course the producer surplus.

Couple of other points just to finish this off.
Couple of other points just to finish this off.

Notice that the equilibrium price
Notice that the equilibrium price

splits the demand curve into two parts.
splits the demand curve into two parts.

The goods are bought by the buyers who value them the most,
The goods are bought by the buyers who value them the most,

the buyers with the highest demands.
the buyers with the highest demands.

These are therefore the buyers and these are the non-buyers
These are therefore the buyers and these are the non-buyers

and goods are sold by the sellers with the lowest costs.
and goods are sold by the sellers with the lowest costs.

So these are the sellers
So these are the sellers

and these with the higher cost are the non-sellers.
and these with the higher cost are the non-sellers.

Okay, let's summarize this whole thing.
Okay, let's summarize this whole thing.

Free market maximizes the gains from trade
Free market maximizes the gains from trade

or the gain from trade are maximized
or the gain from trade are maximized

at the equilibrium price and quantity.
at the equilibrium price and quantity.

And what this means is that the supply of goods is bought
And what this means is that the supply of goods is bought

by the buyers with the highest willingness to pay.
by the buyers with the highest willingness to pay.

The supply of goods are sold by the suppliers with the lowest costs.
The supply of goods are sold by the suppliers with the lowest costs.

And between the buyers and the sellers,
And between the buyers and the sellers,

there are no unexploited gains from trade and no wasteful trades.
there are no unexploited gains from trade and no wasteful trades.

Okay, that concludes our review on to some new material.
Okay, that concludes our review on to some new material.

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- [Announcer] If you want to test yourself,

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click Practice Questions

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