Market Equilibrium

SUPPLY AND DEMAND TOGETHER

Dr. Mudenda
 SUPPLY AND DEMAND TOGETHER
• So far we have analyzed supply and demand separately
and observed that:
– Demand is not a particular quantity, such as 3 pens but
rather a full description of the quantity of pens buyers
would purchase at each and every price that might be
charged.
– Supply is also not a particular quantity but a complete
description of the quantity that sellers want to sell at each
possible price. Suppose that we can ask all suppliers of
• The price of the good is determined by he interaction of
the demanders and the sellers.
• We now consider price determination in the market by
combining the behavior of buyers and sellers to model
the market

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 Market Equilibrium
• The question is here is:
– what will be the price of pens Price (K) Quantity Quantity
in the market and how much demanded supplied
of it will be purchased and 10 155 0
sold in the market
– From the table, we observed 15 130 50
that at low prices, the quantity 20 110 80
demanded exceeds the 25 100 100
quantity supplied but the
reverse is true at high prices 30 90 125
– At some intermediate price, 35 75 140
K25 in our case, the quantity
demanded just equals the The equilibrium is often called
quantity supplied the state of rest. We assume normal
– We call K25 as the equilibrium good. Both demand and supply are
price, drawn -assuming ceteris paribus

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 Market Equilibrium
Price (K) Quantity Quantity supply
demanded supplied 35
10 155 0
30
15 130 50
25
20 110 80
25 100 100 20
30 90 125 15
Demand
35 75 140 10

• The equilibrium occurs where 0 50 100 130 155

demand =Supply
• At price 15, there is a mismatch The difference of 130 -50 is the excess
between SS and Dd. demand, meaning that the quantity demanded
• Consumers are demanding exceeds the quantity supplied at this price.
more than what the producers Excess demand will create competition
are supplying. among buyers to get hold of the limited amount
available and this will raise the price to 25

Dr. Mudenda
 Market Equilibrium
Price (K) Quantity Quantity supply
demanded supplied 35
10 155 0
30
15 130 50
25
20 110 80
25 100 100 20
30 90 125 15
Demand
35 75 140 10
• At a price such as K30, the 0 50 100 130 155
producers are supplying more
than what the consumers are Excess supply generates competition
willing to buy. among the sellers to sell the limited
amount that the consumers are
• quantity supplied exceeds the
willing to purchase. This causes the price
quantity demanded which is to fall the price converges to 25 at which
described as excess supply there is no excess supply.

Dr. Mudenda
 Market Equilibrium
• At price 25 then, there is market equilibrium, defined as the
situation where excess demand or excess supply is zero.
– Put differently, market equilibrium occurs when quantity
demanded and quantity supplied are equal to each other,
or equivalently the demand and the supply curves intersect
– It is also called market clearing. The corresponding price
is called the equilibrium price
• Equilibrium here is defined as situation in which supply and
demand have been brought into balance equilibrium
– Equilibrium quantity – is the quantity supplied and the
quantity demanded when the price has adjusted to balance
supply and demand
– The dictionary defines the word equilibrium as a situation in
which various forces are in balance

Dr. Mudenda
 Market Equilibrium
• The equilibrium price is sometimes called the market-
clearing price because, at this price, everyone in the
market has been satisfied:
– Buyers have bought all they want to buy, and sellers have
sold all they want to sell.
• If the market price is above the equilibrium price, the
quantity of the good supplied exceeds the quantity
demanded
• There is a surplus of the good: Suppliers are unable to
sell all they want at the going price. They respond to the
surplus by cutting their prices.
• Prices continue to fall until the market attains equilibrium

Dr. Mudenda
 Market Equilibrium
• If the market price is below the equilibrium price and the
quantity of the good demanded exceeds the quantity
supplied. There is a shortage of the good:
• Demanders are unable to buy all they want at the going
price. When a shortage occurs (like the case of maize
meal in June- December 2019 in Zambia) buyers have to
wait in long lines for a chance to buy one of the few bags
of corne that are available.
• With too many buyers chasing too few goods, sellers
can respond to the shortage by raising their prices
without losing customers –e.g. price of maize meal went
up to K200 and people still queued up

Dr. Mudenda
 Stable and Unstable Equilibrium

• Stable equilibrium - is one such that any divergence

from the equilibrium sets up forces which restore the
equilibrium. Thus it occurs when economic forces tend to
push the market towards it.
– In a our preceding example, the price of 15 and quantity
100 is stable. Any excess demand or excess supply will
through competition among buyers and sellers tend to
push the price back to K15
– Any price apart from K15 is called disequilibrium price
because quantity demanded and quantity supplied are not
balanced.

Dr. Mudenda
 Stable and Unstable Equilibrium

• Unstable equilibrium - equilibrium is one such that any

divergence from the equilibrium sets up forces which
push the price further away from equilibrium. This is
common in giffen type of goods. We will explore these in
later lectures.

Dr. Mudenda
 Equilibrium Analysis

• When analyzing how some event affects a market, we

proceed in three steps.
– First, we decide whether the event shifts the supply
curve, the demand curve, or in some cases both
curves.
– Second, we decide whether the curve shifts to the
right or to the left.
– Third, we use the supply-and-demand diagram to
examine how the shifts affect the equilibrium

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 Equilibrium Analysis
Pork market S’
• Case 1: Substitutes: Beef D S
and Pork
• Consider the market for beef P1
and pork which are close
substitutes: P0

• Suppose that there is an S’ D

outbreak of a pig disease S
called swine fever. Explain q3 q1 qo
what happens to the SS of
pork and beef: As a result, the supply curve for pork
will shift from SS to S’S’
1. The outbreak of swine At q3 we have excess demand hence
fever will reduce the There is pressure for prices to move up
quantity of pork supplied.

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 Equilibrium Analysis
Pork market S’
• Case 1: Substitutes: D S
Beef and Pork
• The price will move from P1
Po to P1 and demand falls
P0
from qo to q1
S’ D
– Thus the supply of pork
S
ceteris paribus , falls
from q0 to q1 q3 q1 qo
• Case 2: Beef Market If the price of beef remains constant
• But what happens to the People are likely to replace the pork with
beef. In this case the demand for beef is
price and quantity of beef
likely to increase.
which is a substitute?

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 Equilibrium Analysis
Beef market
S
• Case 2: Beef Market D’
D
• But what happens to the
price and quantity of beef P1
which is a substitute?
P0
• Because consumers shift D’
spending to beef the
S D
substitute, the demand for
beef shifts from DD to D’D’ qo q1
• This will push the price of
So overall: The fall in the supply of
beef from po to p1 and the
pork, increases the price of pork and
quantity supplied increases
the consumers shift the demand to
from q0 to q1 due to the beef the substitute, whose demand
price increase and price increases and

Dr. Mudenda
 Equilibrium Analysis

• Review questions:
1. Please explain the price dynamics of good x and y
which are compliments to the disaster that causes the
supply of x to fall.
2. Explain how the expectations of the price rise will affect
the supply and demand for good y

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 Equilibrium Analysis
Key boards
S
• Case 3: Jointly S’
D
produce/supplied goods:
(Ex. computer keyboard and P1
computer monitor) P0
• If the supply for monitors fall, the S’
supply of key boards will fall,
resulting in the SS-curve shifting to S D
S’S’
q1 qo
• At the original price, Po there is
excess demand for key boards. This Key Result:
will result in the upward adjustment A fall in the SS of a good will reduce
of the price to P1 and the quantity the SS of jointly supplied goods,
demanded falls to q1 thereby raising their prices

Dr. Mudenda
 S U P P L Y , D E M A N D , A N DG O V E R N M E N T
POLICIES

– As social scientists, we develop and test theories to

explain the world around them.
– As policy advisers, we the theories to help change the
world for the better.
– In the preceding slides, we the focus has been scientific.
– We saw how supply and demand determine the price of a
good and the quantity of the good sold.
– We have also seen how various events shift supply and
demand and thereby change the equilibrium price and
quantity instantanousy
– We next analyze various types of government policy using
only the tools of supply and demand

Dr. Mudenda
 Effects of a government policy
• The effects of sales tax: Government can impose a tax on a
good. It can be targeted at consumers or suppliers.
• Now assume:
– government imposes a sales tax: i.e., a type of indirect tax
imposed on a sale of a product
– Per unit sales tax –i.e., which is imposed such that
government collects an equal amount of money per unit sold.
– Assume the tax is collected from the suppliers.
• Depending on the nature of the supply curve, the supplier
can shift, all or part of this sales tax to consumers.

Dr. Mudenda
 Taxation and equilibrium
• Assume a sales tax of K2 per Tax on good X S’
unit sold. D S
• Before the tax, the suppliers will B
be willing to supply qo units of P1
r c
good x
P0 A
• Because of the tax on supply,
the amount supplied reduces S’
D
as indicated by the shift in the S
demand curve from SS to S’S’
q1 qo
by the full amount of the tax
• The output falls from qo to q1. The area P1 P0 AB is the revenue or
amount of money government gets for
• The price rises from Po to P1,
imposing a tax
meaning that buyers now pay
The amount: P1rBC is paid by tax payers
more
in form of high prices due to the tax
PorCA – paid by the suppliers
Dr. Mudenda
 Taxation and equilibrium

• The result above shows that St

buyers and sellers share the
tax burden.
• The distribution of the tax
between buyers and sellers
is called the effective
incidence of the tax.
• It depends on the elasticity
of demand and supply
• If demand is perfectly
elastic, the sales tax falls
entirely on the suppliers
S
St
S
q’ q
In this case any change in price
May reduce demand to zero. Hence
The sales tax leaves the price
unchanged
So that the suppliers bear the tax
This will be the case also if the SS
is perfectly inelastic

Dr. Mudenda
 Taxation and equilibrium
D
PRICE
• If the DD curve is perfectly
St
inelastic or SS curve is perfectly
elastic, the tax incidence would
fall entirely on the buyers of the S
good.
• General Rule: The more D
q’ q
inelastic the DD curve and the
more elastic the SS curve, the D
greater will be the share of the St
S
sales tax falling on consumers
• The more elastic the DD curve
and the more inelastic the SS St
curve the greater the share of
S
th tax falling on suppliers

Quantity per day

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 Disequilibrium and Government Analysis
• Disequilibrium – is a situation in which the expectations
of the buyers and the sellers in the market are not
realised
– The market is in the state of flux – we have either excess
demand or excess supply
• Disequilibrium may persist in markets characterised by:
– Government or other agent impose artificial restrictions on
either price or quantity
– Market equilibrium is an unstable one
– Production plans are unrealised
– Lagged responses

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 Artificial restrictions on Quantity or Price
• Consider the market for maize in 2018/2019 season in
Zambia. The drought led to low supply of maize market.
The result was the rise in prices from about K60 to over
K204 on the market.
• In this case suppliers were happy while the demanders
complained of high prices because some people could no
afford it
– buyers of any good always want a lower price while sellers
want a higher price, the interests of the two groups conflict
• Government found the prices of K204 to be unacceptable.
Thus government by law set a maximum price of K135.
This price is called a price ceiling

Dr. Mudenda
 Artificial restrictions on Quantity or Price
• Price ceiling -a legal maximum
on the price at which a good can
be sold. It cannot be sold above
that price.
• In the case of maize, government
set a maximum price of K135
which is below the equilibrium
price of K204
• A price ceiling causes excess
demand or market shortage
• A market shortage is the amount
by which the quantity demanded
exceeds the quantity supplied at
any given price – q2 –q1
Dr. Mudenda
D S
K204
K135
Price
ceiling
Excess demand
D
q1 q2
since the price is not allowed to rise
back to equilibrium, unsatisfied demand
exists and this will show off in queues
forming or indeed the black markets
Government may adopt a system of
rationing – where people can only buy a
limited amount of the good (e.g., no more
than 1 bag of maize per family, which may
not be enough
 Artificial restrictions on Quantity or Price
• Price Floor is-a legal minimum D
on the price at which a good can S
Excess supply (Glut)
be sold. K204

– A price floor is a government-

determined price below which a
specified good cannot be sold.
• For example if the market price of
maize is K135, government can
choose to set the price above it
such as K204
• A price floor causes excess
supply which is also called glut
K135
Price
ceiling
D
q1 q2
Since the price is not allowed to fall
back to equilibrium, excess DD exists
Government may intervene by buying the
excess supply and the glut shows itself in
authorities’ stock piles of the good.
This common in the EU where government
pay higher prices to farmers to promote
production and food security

Dr. Mudenda
 Government Interventions
Intervention Reason for Effect on Price Effect on Who gains &
using it quantity who loses
Price floor To protect producers Price cant go be low Qty demanded Producers earn more
the set minimum decreases & SS revenue per item,
increases (excess SS) other producers
have no mkt
Price ceiling Keep consumer Price cant go above Qty demanded Consumers who buy
costs low set maximum increases & SS all goods they want
decreases benefit others suffer
(shortages) from shortages
Tax To discourage Price increases Equilibrium qty Government
activity or increase decreases revenue increases.
government revenue Society gains if tax
decrease socially
harmful behaviour .
Buyers and sellers
may bear the
incidence of the tax
Subsidy To encourage an Price decreases Equilibrium qty Buyers purchase
activity, to provide increases more goods at lower
benefits to a certain price. Society may
group benefit if subsidy
encourages good
Dr. Mudenda behaviour
 Consumer Surplus
• Consumers buy goods because the purchase make them better off
• The consumer surplus measures how much better off individuals
are, in aggregate, because they can buy goods in the market
• Because consumers place different values on consumption of
particular goods, the maximum amount they are willing to pay for
those goods also differ
• Consumer surplus: is the difference between what a consumer is
willing to pay (reservation price) for the good and the amount
actually paid
– That is what the buy is willingness to pay minus the amount the
buyer actually pays
• For example, if you are willing to pay K5 for a pen, but you find and
buy it at K3, then K2 is your consumer surplus.

Dr. Mudenda
 Consumer Surplus
• Assume John is willing to pay $100
for an album, but the price of the
album is $80
• His surplus is $20
• If Paul is willing to pay $80 for one
unit and actually pays $70, then
his consumer surplus is $10.
• The total consumer surplus for both
John and Paul is ($30 for john at
the price of $70) and US$10 for
Paul.
• The total consumer surplus is $40
• The CS -measures for the gains
that consumers obtain from
trading at theequilibrium price

Dr. Mudenda
 Consumer Surplus
• The CS is the total benefit from the
consumption of a product, less the
total cost of purchasing it.
• It is calculated as the area below
the demand curve but above the
price.
• The shaded area in the graph
constitutes the CS.
• Since the demand curve is straight
in this case,
– areas = ½ base x height (which is
the CS)

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 Producer Surplus
• Similarly we can define a measure
for the gain sellers obtain from
selling a given quantity of a good
or service at the equilibrium price
• Producer surplus can be thought of in
much the same way as consumer surplus
• Producer surplus: The difference
between the lowest price a firm would
accept for a good or service and the price
it actually receives
– What is the lowest price a firm would
accept for a good or service?
• Total producer surplus is equal to the
area above the supply curve and below
the market price of K2.00

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 Producer Surplus

• Consumer surplus measures the

net benefit to consumers from
participating in a market rather
than the total benefit
• Similarly, producer surplus
measures the net benefit
received by producers from
participating in a market
• The total surplus = CS + PS
– Consumer Surplus = Total
Benefit –Total Price Paid
– Producer Surplus = Total
Revenue –Total Cost

Dr. Mudenda
 Price Floors: Agricultural Price Supports

• Equilibrium price = K3.00

• Quantity =2 bushels per day
• If wheat farmers convince the
government to impose a price
floor of K3.50/bushel they supply
a quantity of 1.8 from 2.
• Area A is the surplus transferred
from consumers to producers
If farmers do not realize they will not
• Economic surplus is reduced be able to sell all of their wheat, they
by area B + C, the will produce 2.2 billion bushels
deadweight loss This results in a surplus, or excess supply,
of 0.4 bushels of wheat

Dr. Mudenda
 Price Ceilings : Rent Controls

• Equilibrium price= K1,500

per month.
• Equilibrium Quantity= 2
million apartments per
month
• If the government imposes
a rent ceiling of K1,000,
what happens?
• Q=1,900,000, but demand
=2,100,000,
• A shortage of 200,000
apartments

Dr. Mudenda
 Price Ceilings : Rent Controls

• PS equal to the area of the

blue rectangle A is transferred
from landlords to renters.
• There is a deadweight loss
equal to the areas of yellow
triangles B and C
• This deadweight loss
corresponds to the surplus
that would have been derived
from apartments that are no • Some people lose, and
longer rented. Deadweight loss (loss of total surplus) will
• When a government imposes price generally occur
controls Economists seldom recommend price controls,
with the possible exception of minimum wage
– Some people win, laws for equity reasons

Dr. Mudenda