IB DP Economics: Competitive market equilibrium

This guide covers sub-topic 2.3, competitive market equilibrium, of Unit 2 (Microeconomics) for IB Diploma Programme Economics. It follows the IB Diploma Programme Economics guide (first assessment 2022, published February 2020) and is written for the course examined from the 2022 session onwards. The content is for both SL and HL, except one calculation, which is HL only and is marked as such below.

The guide recommends 35 hours of teaching for all of Unit 2 at SL, and 70 at HL. This sub-topic builds on demand and supply, so read demand, supply and market equilibrium first if either curve is new to you. Then use the revision notes and the practice questions. The course hub and the printable checklist show where this sits in the whole course, and the free diagnostics help you find weak spots.

What the guide asks you to do

Content in the guide	Skill expected	Level
Market equilibrium	Draw a diagram with demand and supply meeting at equilibrium	SL and HL
Changes in equilibrium	Shift either curve and show the new equilibrium, using excess demand (shortage) and excess supply (surplus)	SL and HL
Price mechanism	Explain resource allocation (signalling and incentive) and rationing	SL and HL
Consumer and producer surplus	Show and explain both on a diagram	SL and HL
Social/community surplus	Explain it as the sum of the two surpluses	SL and HL
Allocative efficiency	Explain why it holds at equilibrium: surplus is largest and marginal benefit (MB) equals marginal cost (MC)	SL and HL
Calculating surpluses	Calculate consumer and producer surplus from a diagram	HL only

The guide gives diagram skills (AO4) and explanation (AO2) as the depth for most of this content. The command terms you meet most are draw, explain, analyse and calculate. Draw asks for a labelled, accurate diagram in pencil, with a ruler for straight lines.

Market equilibrium

A competitive market has many buyers and many sellers, and no single one can set the price. The demand curve shows the quantity buyers plan to buy at each price. The supply curve shows the quantity sellers plan to sell. Equilibrium is the price at which the two quantities are equal, so neither side has a reason to push the price either way.

Here is an illustrative market. Verland is a fictional country and kora is a fictional grain. Quantity is in thousand tonnes and price is in vel per tonne. The figures are invented for this guide.

Price (vel)	Quantity demanded	Quantity supplied	Gap
10	40	16	shortage of 24
14	32	32	none
18	24	48	surplus of 24

The equilibrium price is 14 vel per tonne and the equilibrium quantity is 32 thousand tonnes. On your diagram, label the vertical axis “Price (vel per tonne)” and the horizontal axis “Quantity (thousand tonnes)”. Label the downward-sloping curve D and the upward-sloping curve S. Mark the point where they cross as the equilibrium, with the price and quantity dropped to the axes as dashed lines. Always label the equilibrium price and quantity; a diagram that leaves them out gives the reader less to credit.

Excess demand (shortage) occurs when the price is below equilibrium, so the quantity demanded is larger than the quantity supplied. At 10 vel, buyers want 40 and sellers offer 16, a shortage of 24. Sellers can see unsatisfied buyers, so the price rises. The rise trims what buyers ask for and draws out more from sellers, until the two match at 14.

Excess supply (surplus) occurs when the price is above equilibrium. At 18 vel, sellers offer 48 and buyers want 24, a surplus of 24. Unsold stock builds up, so sellers cut the price, and the process runs in reverse.

On the diagram, the shortage or surplus is the horizontal distance between the curves at the price you choose. Draw it as a bracket and label it.

Shifting the curves to a new equilibrium

A move in the good’s own price alone takes you along the same curve, while any other determinant relocates the curve. Use the right word: contraction and extension describe movements along a curve, and increase or decrease in demand or supply describe shifts.

Worked example 1: a rise in demand. Suppose a rise in consumers’ incomes makes buyers want 12 thousand tonnes more at every price. The new quantity demanded is 12 more than before at every price.

1. Draw the original D, S and equilibrium at 14 and 32.
2. Shift D to the right, to a new curve D₂. Label it.
3. At the old price of 14, buyers now want 44 while sellers still offer 32. There is a shortage of 12.
4. The shortage pushes the price up. The new curves cross at a price of 16 vel and a quantity of 40.
5. Describe the movements: a contraction along D₂ from 44 to 40, and an extension along S from 32 to 40.

Check: at 16 vel, buyers want 44 − 2×2 = 40 and sellers offer 32 + 4×2 = 40. Both match.

Worked example 2: a fall in costs. Now start again from the original market. Suppose cheaper machinery lets producers supply 12 thousand tonnes more at every price. S shifts right to S₂. At the old price of 14, buyers want 32 but sellers offer 44, a surplus of 12. The price falls to 12 vel and the quantity rises to 36 thousand tonnes. Price falls and quantity rises.

If both curves shift at once, one effect on the price or quantity is certain and the other is not. Two rightward shifts raise the quantity for sure, but whether the price ends higher, lower or unchanged depends on which shift is larger. Say so in an answer, and show the case you choose.

Functions of the price mechanism

The price mechanism is how prices adjust to reflect changes in demand and supply. The guide lists these functions.

Resource allocation is the way scarce resources are directed to their uses. The guide splits it into two roles:

• Signalling. A price tells producers and consumers about scarcity. In example 1, the higher price of 16 vel signals that kora has become scarcer relative to demand.
• Incentive. A price changes behaviour. The higher price gives farmers a reason to produce more, as it raises the revenue from each tonne. It also gives some buyers a reason to buy less or switch to substitutes.

Together these move resources towards goods that buyers value more highly, with no central planner.

Rationing is the way a limited amount is shared out. When there is not enough to go round, a rising price rations the good to those both willing and able to pay it. In example 1, the buyers who value kora least drop out as the price rises from 14 to 16, and the shortage disappears.

When you write about these functions, link each one to a specific change in your example. A definition on its own is worth less than the definition applied to a named market.

Consumer and producer surplus

Consumer surplus measures the extra value buyers get over what they handed over. On the diagram it is the area bounded by the demand curve, the price line and the price axis, out to the quantity traded.

Producer surplus is the gap between what sellers receive and the least they would have taken. It is the region between the price line and the supply curve, out to the quantity traded.

In the Verland market, the demand curve meets the price axis at 30 vel, and the supply curve meets it at 6 vel. These intercepts are read from the diagram. The surplus areas are triangles:

• Consumer surplus has corners at (0, 30), (0, 14) and (32, 14).
• Producer surplus has corners at (0, 14), (0, 6) and (32, 14).

Draw both, shade them differently and label them. Both depend on the price. If the price falls, consumer surplus grows and producer surplus shrinks, other things equal. If a shift in demand creates a higher price, producer surplus tends to grow.

Calculating surpluses (HL only)

At HL you may be asked to calculate each surplus from a diagram. Each is a triangle, with area ½ × base × height. The base is the equilibrium quantity and the height is a vertical distance.

Worked example 3 (HL only). Using the Verland figures:

• Consumer surplus = ½ × 32 × (30 − 14) = ½ × 32 × 16 = 256.
• Producer surplus = ½ × 32 × (14 − 6) = ½ × 32 × 8 = 128.
• Social surplus = 256 + 128 = 384.

Quantity is in thousand tonnes and price in vel per tonne, so the answers are in thousand vel. Show the formula, the substitution and the unit.

After the demand increase in example 1, the demand curve meets the price axis at 36 vel. The equilibrium is 16 vel and 40 thousand tonnes. Consumer surplus is ½ × 40 × (36 − 16) = 400 and producer surplus is ½ × 40 × (16 − 6) = 200. Both have grown.

Social/community surplus and allocative efficiency

Social (community) surplus is consumer surplus plus producer surplus. It measures the total benefit the market gives to buyers and sellers together.

Allocative efficiency means resources are used to produce the mix of goods that society values most. In a competitive market it is reached at equilibrium, for two linked reasons:

1. Social surplus is at its maximum there.
2. Marginal benefit equals marginal cost there.

The demand curve shows the marginal benefit (MB) of each extra unit to consumers, and the supply curve shows the marginal cost (MC) of producing it. Take the Verland market. At 24 thousand tonnes, MB is 18 vel and MC is 12 vel. The next unit is worth more to buyers than it costs to make, so producing it adds to social surplus. Output should rise until MB = MC, at 32 thousand tonnes.

At 40 thousand tonnes, MB is 10 vel and MC is 16 vel. The last unit costs more than it is worth to buyers, so social surplus falls. In both cases the triangle between the curves is the loss in social surplus (a welfare loss). For 24 thousand tonnes it is ½ × (32 − 24) × (18 − 12) = 24. For 40 it is ½ × (40 − 32) × (16 − 10) = 24, also in thousand vel.

The result holds for the curves as drawn. It assumes the demand and supply curves capture all the benefits and costs involved. Where they do not, the competitive outcome may not be efficient, and other sub-topics in Unit 2 deal with that.

Common errors

• Writing that “demand increases” when only the price changed. A price change is a movement, not a shift.
• Showing a shortage on the diagram at the equilibrium price, or marking it as a vertical gap. Excess demand and excess supply are horizontal gaps.
• Using the price mechanism’s functions as a list of definitions without tying them to the example in the question.
• Shading consumer surplus down to the supply curve. It stops at the price line.
• Forgetting units in HL surplus answers.
• Saying that allocative efficiency means everyone gets what they want. It means MB = MC, so no reallocation can raise social surplus.
• Saying that a shortage means the market has failed. A shortage is part of how the price mechanism finds the new equilibrium.

Papers and calculators

According to the guide, Paper 1 is an extended response paper where calculators are not permitted, so keep your numbers simple and show the working. Paper 2 (a data response paper) contains some numerical questions, and a four-function calculator is enough for them. At HL only, Paper 3 is a policy paper that mixes numerical and written questions.

Official syllabus

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