LECTURE 5: MARKET EQUILIBRIUM

In a market economy, a price is derived or determined if the forces of demand and supply
operate together.

Equilibrium

- a state of balance when demand Is equal to supply

- This equality shows that the quantity that sellers are willing to sell is also the quantity
that buyers are willing to buy for a price

120

100

80

60 Demand
Supply

40

20

0
100 200 300 400 500 600 700 800

Market equilibrium is attained at the point of intersection of the demand and supply curve.

DETERMINATION OF MARKET EQUILIBRIUM

Assuming that the demand function for Good X is:

Qd= 60- P/2

And the supply function for Good X is:

Qs= 5 + 5P
Applying the equations, we derive the following demand and supply schedules given the prices
below:

PRICE DEMAND SCHEDULE FOR SUPPLY SCHEDULE FOR

GOOD X GOOD X
P0 60 5
2 59 15
4 58 25
6 57 35
8 56 45
10 55 55
12 54 65
14 53 75
16 52 85

Equilibrium quantity is attained where Qd= Qs

Equilibrium quantity is 55 and the equilibrium price is P10.

Through computation:

60-P/2= 5+5P

60-5= 5P + P/2

2(55)= (5P + P/2) 2

110= 10 P + P

110/ 11= 11P/11

P= 10

Now, substitute the price P10 to the Qd and Qs functions:

For Qd:

Qd= 60- P/2

Qd= 60 – (10/2)

Qd= 60 – 5

Qd=55
For Qs:

Qs= 5 + 5P

Qs= 5 + 5 (10)

Qs= 5 + 50

Qs= 55

- The ideal situation in market economy is at the point where the demand and supply
curves intersect, which is known as market equilibrium as mentioned above. However, during
relative scarcity (shortage) and overproduction (surplus), the government may intervene to
control the price in the market.

- The problem of scarcity is addressed through the changes in price and the
corresponding responses of buyers and sellers

Example:

1. In case of shortage, the price normally increases

Corresponding response in the market:

Buyers – Decrease demand

Sellers – Increase supply

In this case, a price ceiling is set by the government to protect the buyers

2. In case of surplus, the price normally decreases

Corresponding response in the market:

Buyers – Increase consumption

Sellers – Reduce production

In this case, a price floor is set by the government to protect the sellers