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MODULE: Microeconomics

TOPIC NO: 4

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Syll No: BA0362

UNDERSTANDING WHAT MARKET EQUILIBRIUM IS


Keywords:market equilibrium, shortage, surplus.
Objective: Learners should be able to
4.1

Identify the market equilibrium

4.2

Explain how market equilibrium is achieved and


maintained by using the following concepts:
(i) surplus
(ii)shortage

4.3 Identify changes to equilibrium that occur when demand


and/or supply changes.
Ref. Books:
Economics: 19th Edition by Campbell R. McConnell,
Stanley L. Brue & Sean M. Flynn, McGraw-Hill Irwin, 2012
(Compiled by SP Business School), Chapter 3.
Singapore Polytechnic School of Business, Economics, Pearson
Publishing, 2009, Chapter 3 and Chapter 6.

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Personal Notes

4.1 Market Equilibrium


What is a market?
A market is any arrangement in which buyers and
sellers interact to determine the price and quantity
of goods and services exchanged.
Buyers and sellers have different viewpoints about
price.
Demand

Supply

() price ()
quantity demanded

() price ()
quantity supplied

Different viewpoints are sorted out in the ________


What is market equilibrium?

Graphically the market is in equilibrium (or cleared)


when the demand curve intersects the supply curve.
Price and quantity at this point of intersection are
called equilibrium price and equilibrium
quantity respectively.
Price
S

D
Q

Quantity

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Personal Notes

4.2 How market equilibrium is achieved and


maintained by using the concepts of surplus
and shortage
Example
Consider the market for energy bars.
Price
(dollars) per
bar

Quantity
demanded
(Qd)

Quantity
supplied
(Qs)

Difference
(Qs Qd)

0.50

22

-22

1.00

15

-9

1.50

10

10

2.00

13

+6

2.50

15

+10

Equilibrium price = $1.50.


Equilibrium quantity = 10 bars.
What happens when the market is not in
equilibrium?
(a) If price is above the equilibrium price?
E.g., at price $2.00
Quantity supplied > Quantity demanded
The market is in surplus.
To get rid of excess supply, firms will lower the
price of the good.
As price falls

Surplus is reduced. Price continues to fall until equilibrium is attained.

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Personal Notes

Energy bars

Price/$

surplus

shortage

2.00
1.50
1.00
D
10

Quantity

(b) If price is below the equilibrium price?


E.g., at price $1.00
Quantity demanded > Quantity supplied
A shortage exists. Price will rise.
As price increases

Quantity demanded

Quantity supplied

Conclusion

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Personal Notes

Price will change whenever the market is not at


equilibrium. While it is true that price will always
change when the market is not at equilibrium, there
are exceptions to the rule.
Exceptions to the rule
These exceptions occur when the government
intervenes in the form of price ceiling and price
floor.
(a) Price ceilings
What is a price ceiling?

E.g., rent control, maximum price on petrol


Why impose a price ceiling?
Price ceiling is imposed when the current equilibrium
price is considered to be too high.
For price ceiling to be effective, it must be
set below the market equilibrium price.
What is the result of price ceiling?
Quantity demanded > quantity supplied
A shortage is created.
NOTE:

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Price Ceiling

Price
S

shortage

P
Pc
D
Q

Quantity

(b) Price floors


What is a price floor?

E.g., minimum wage rate, agricultural price


supports.
Why implement a price floor?
Price floor is imposed when the current equilibrium
price is considered to be too low.
The price floor must be set above the
market equilibrium price.
What is the result of price floor?

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Personal Notes

Quantity supplied > quantity demanded


A surplus is created.
NOTE:

Price Floor
surplusPrice
S
Pf
P

D
Q

Quantity

4.3 Changes in Market Equilibrium


The equilibrium price and equilibrium quantity will
change whenever:
(a) demand changes; or
(b) supply changes; or
(c)

demand and supply change.

RECALL the nonprice determinants


of demand and
supply!

(a) Changes in demand on equilibrium price


and quantity
(i) Increase in demand
E.g., market for energy bars
Assume that its market supply, S, is constant and
market demand increases from D to D1.
What could have caused the demand curve to
shift rightward?

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Personal Notes

For example, more people joining health clubs,


leading to an increase in the demand for
energy bars.
Demand curve shifts rightward from D to D1
shortage at original equilibrium price
Firms respond to the excess demand by raising
the price.
price quantity supplied
price quantity demanded

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(ii) Decrease in demand


Demand curve shifts leftward
surplus at the original equilibrium price
price
quantity demanded, quantity supplied

Price
S
P
P1
D
D1
Q1

Quantity

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Personal Notes

When only demand changes:


(a) we can predict what will happen to equilibrium
price and quantity
(b) demand both equilibrium price & quantity

demand both equilibrium price & quantity

(b) Changes in supply on equilibrium price


and quantity
(i) Increase in supply
Assume that the demand is constant and some
non-price determinant of supply shifts the supply
curve.
Supply
Pricecurve shifts rightward
surplus at the original equilibrium
price
S
price
P1
quantity
demanded, quantity supplied
P
D1
D
Q

Q1

Quantity

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Personal Notes

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Personal Notes

(ii) Decrease in supply


Supply curve shifts leftward
shortage at the original equilibrium price
price
quantity demanded, quantity supplied

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Personal Notes

Price

S1
S

P1
P
Price

S
Q1 Q

D S1

Quantity

When only supply changes:


P
(a) we can predict what
P1 will happen to equilibrium
price and quantity
(b) supply equilibrium price but quantity
D
supply equilibrium price but quantity
Q

Q1

Quantity

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Personal Notes

(c) What happens to the equilibrium price


and quantity when both demand and
supply change (i.e., the demand and
supply curve shift) simultaneously?
As long as only one curve shifts at a time, we can
tell what will happen to the equilibrium price and
quantity.
However, if both demand and supply curves shift at
the same time, the outcome is less obvious. The
table below illustrates the different outcomes.
Equilibriu
m Price

Equilibriu
m
Quantity

Demand

Supply

Increase

Increase

Indetermina
te

Increase

Decrease

Decrease

Indetermina
te

Decrease

Increase

Decrease

Increase

Indetermina
te

Decrease

Increase

Decrease

Indetermina
te

(i) Increase in demand and supply


Equilibrium quantity will always increase
BUT
Equilibrium price can , or remained
unchanged.

Example 1: When the Dd > Ss


equilibrium price will ______
Example 2: When the Dd < Ss
equilibrium price will ______
Example 3: When the Dd = Ss
equilibrium price will be __________
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Dd = Ss

D1

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(ii) Decrease in demand and supply


Equilibrium quantity will always decrease
P

BUT
Equilibrium price can , or remained
unchanged.

Example 1: When the Dd > Ss


D

equilibrium price will ________

Q1S

Example 2: When the Dd < Ss


equilibrium price will ________
Example 3: When the Dd = Ss

Personal Notes
S1

equilibrium price will be __________

Price

Quantity

Dd < Ss
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D1

P1

When demand and supply change in the same


direction:
(a) we are certain what happens to equilibrium
quantity; but
(b) equilibrium price is indeterminate.
(iii) Demand increases and supply
decreases

P
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In this case:
(a) Equilibrium price will rise;
(b) Equilibrium quantity can , or remained
unchanged.
Price

Example 1: When the Dd > Ss


equilibrium quantity will ______
Example 2: When the Dd < Ss
equilibrium quantity will ______
Example 3: When the Dd = Ss
equilibrium quantity will be ________

Dd > Ss

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Personal Notes

(iv) Supply increases and demand


decreases
Note to Learners:
This portion (iv) will be discussed during the
tutorial only.
Practise drawing the following 3 graphs and
discuss them during your tutorial.
(i) if the Dd > Ss
(ii) if the Dd < Ss
(iii) if the Dd = Ss

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MODULE: Microeconomics
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Syll No: BA0362


Personal Notes

Conclusion
(a) When demand and supply changes in the same
direction, we are certain what happens to
equilibrium quantity BUT

(b) When demand and supply changes in opposite


directions, we know what happens to
equilibrium price BUT

4.4 Summary of Topic 4 Market Equilibrium


Do you know
(a)

What is market equilibrium?

(b)

What is a surplus and a shortage?

(c)

How will market equilibrium be achieved and


maintained?

(d)

What is a price ceiling and a price floor?

(e)

What happens to equilibrium price and


equilibrium quantity when demand and/or supply
changes?

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Syll No: BA0362


Personal Notes

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