IB DP Economics: Competitive market equilibrium – Revision Notes

These notes condense sub-topic 2.3, competitive market equilibrium, of Unit 2 (Microeconomics) for SL and HL. They follow the IB Diploma Programme Economics guide (first assessment 2022, published February 2020) and are written for the course examined from the 2022 session onwards. One calculation is HL only and is marked. Each idea is explained in full in the study guide. Then test yourself with the practice questions.

Use the course hub and the printable checklist to track what you have covered. For earlier ideas, see demand, supply and market equilibrium revision notes. The free diagnostics show which topics need more work.

Key definitions

Term	Meaning in one line
Competitive market	Many buyers and sellers; none can set the price alone
Equilibrium	Price at which the amounts buyers plan to buy and sellers plan to sell are the same
Excess demand (shortage)	Buyers want more than sellers offer, at a price below equilibrium
Excess supply (surplus)	Sellers offer more than buyers want, at a price above equilibrium
Price mechanism	Prices adjusting as demand and supply change
Signalling	Prices tell buyers and sellers about relative scarcity
Incentive	Prices change what buyers and sellers choose to do
Rationing	A limited amount is shared out to those willing and able to pay
Consumer surplus	What buyers would pay at most, minus what they do pay
Producer surplus	What sellers receive, minus the least they would take
Social/community surplus	Consumer surplus plus producer surplus
Allocative efficiency	Output at which marginal benefit (MB) equals marginal cost (MC)

Equilibrium diagram: checklist

1. Axes: price up the side, quantity along the bottom, with units named.
2. Demand curve D slopes down. Supply curve S slopes up. Label both.
3. Mark the intersection and name it equilibrium.
4. Drop dashed lines to the axes and label the equilibrium price and quantity.
5. For a shift, draw the new curve, label it (D₂ or S₂) and show an arrow.
6. Mark the new equilibrium and label its price and quantity.

Method: what happens when a curve shifts

1. Name the determinant that changed (income, tastes, costs, technology, number of firms and so on).
2. Decide which curve moves, and which way.
3. Draw the shift. Look at the old price: is there now a shortage or a surplus?
4. State the price movement that clears it.
5. State the new equilibrium price and quantity, and the movements along each curve (contraction or extension).

Change	Curve	Price	Quantity
Rise in demand	D shifts right	Rises	Rises
Fall in demand	D shifts left	Falls	Falls
Rise in supply	S shifts right	Falls	Rises
Fall in supply	S shifts left	Rises	Falls

Worked reminder with illustrative figures (a fictional market for lamps). Quantity demanded is 80 at a price of 6 vel and quantity supplied is 80 at the same price, so equilibrium is 6 vel and 80. A rise in costs cuts supply by 20 at every price. At 6 vel, buyers still want 80 but sellers offer 60: a shortage of 20. The price rises until the gap closes. Price rises and quantity falls, with a contraction along demand and a decrease in supply.

If both curves shift, one of price and quantity is certain and the other depends on the relative size of the shifts. Say which, and draw one case.

Price mechanism: three jobs

• Signalling. A rising price signals growing scarcity relative to demand. A falling price signals the opposite.
• Incentive. A higher price raises the reward for supplying. It also pushes some buyers to buy less or switch. Lower prices act the other way.
• Rationing. When quantity is limited, the price decides who gets the good. Those unwilling or unable to pay at that price drop out.

Resource allocation is the combined effect of signalling and incentive. In an answer, apply each function to a named change, not to a general statement.

Surplus: what to shade

• Consumer surplus: under D, above the price line, out to the equilibrium quantity.
• Producer surplus: above S, below the price line, out to the equilibrium quantity.
• Both are triangles when the curves are straight lines.
• A lower price raises consumer surplus and lowers producer surplus, other things equal.

HL only: calculating the surpluses

Each is a triangle, so the area is ½ × base × height. The base is the equilibrium quantity. For consumer surplus the height runs from the equilibrium price up to the demand intercept. For producer surplus it runs from the supply intercept up to the equilibrium price.

Worked reminder with illustrative figures (a fictional market): demand intercept 20, supply intercept 2, equilibrium price 8, equilibrium quantity 50 units.

• Consumer surplus = ½ × 50 × (20 − 8) = 300
• Producer surplus = ½ × 50 × (8 − 2) = 150
• Social surplus = 300 + 150 = 450

Show the formula, the substitution and the units each time. Paper 1 does not allow a calculator, according to the guide, so choose to simplify early.

Allocative efficiency: two statements, one idea

1. At equilibrium, social surplus is at its maximum.
2. At equilibrium, MB equals MC.

D shows MB. S shows MC. Compare any output with the equilibrium output:

Output compared with equilibrium	MB against MC	Effect on social surplus	What should happen
Below	MB larger than MC	Surplus not yet gained	Output should rise
At equilibrium	MB equals MC	Maximum	No reallocation helps
Above	MB smaller than MC	Surplus lost	Output should fall

The loss from a wrong output is a triangle between D and S, which is a welfare loss. The conclusion holds when the curves show all the benefits and costs involved. Where they do not, the outcome can be inefficient, and later sub-topics explain why.

Must-know distinctions

• Movement vs shift. A price change moves you along a curve. A change in any other determinant shifts the curve.
• Shortage vs surplus. Shortage means price too low. Surplus means price too high. Both are horizontal gaps on a diagram.
• Consumer surplus vs consumer spending. Spending is price times quantity. Surplus is the extra value above what was paid.
• Allocative efficiency vs fairness. Efficiency is about MB = MC. It says nothing about how the surplus is shared.
• Signalling vs incentive. Signalling carries information. Incentive changes behaviour.

Quick self-test

All the markets here are fictional and the figures are invented.

1. Define the equilibrium price of a good.
2. In a market the price is 5 vel. At that price buyers want 90 units and sellers offer 50. State the name and size of the gap.
3. At 8 vel in the same market, buyers want 60 and sellers offer 80. State the name and size of the gap and say which way the price moves.
4. Name the two roles of the price mechanism listed under resource allocation.
5. State what is meant by rationing.
6. A fall in costs shifts which curve, in which direction, and what happens to the equilibrium price and quantity?
7. Distinguish between a contraction of demand and a decrease in demand.
8. At the current output, the MB of the last unit is 15 vel and its MC is 9 vel. Should output rise or fall? Explain.
9. Explain why social surplus is largest where D meets S.
10. HL only: demand intercept 20, supply intercept 2, equilibrium price 8, equilibrium quantity 50. Calculate consumer surplus, producer surplus and social surplus.

Answers

1. The price at which buyers’ plans and sellers’ plans match, so it has no tendency to change.
2. Excess demand (a shortage) of 40 units.
3. Excess supply (a surplus) of 20 units. The price falls.
4. Signalling and incentive.
5. Sharing a limited quantity among buyers, with price deciding who gets it: those willing and able to pay.
6. S shifts right. Price falls and quantity rises.
7. A contraction is a movement up the demand curve caused by a rise in price. A decrease in demand moves the whole curve left, because of a non-price determinant.
8. Output should rise. The next unit is worth more to buyers than it costs to make, so social surplus rises until MB equals MC.
9. Up to that output, each unit gives MB above MC, which adds to surplus. Beyond it, each unit costs more than it is worth, which reduces surplus.
10. Consumer surplus = ½ × 50 × 12 = 300. Producer surplus = ½ × 50 × 6 = 150. Social surplus = 450.

Where marks are usually lost

• Drawing a shift but never labelling the new curve or the new equilibrium.
• Showing a shortage or surplus as a vertical gap instead of a horizontal one.
• Using “demand” for a change in the quantity demanded, or the reverse.
• Describing the price mechanism in general terms without applying it to the market in the question.
• Shading consumer surplus below the price line, or producer surplus above it.
• Missing units in an HL surplus answer, or skipping the working.
• Claiming efficiency means fairness, or that a shortage means the market has failed.
• Stating the effect on price but not on quantity, or the reverse.
• Writing that a decrease in supply is a contraction of supply, when it is a shift of the curve.

Official syllabus

Source document: Economics guide for the Diploma Programme, first assessment 2022, from the International Baccalaureate Organization. All figures are invented for illustration.