Chapter 3.

2
EQUILIBRIUM
Dr. Nguyen Bich Diep
nguyenbichdiep@vnu.edu.vn
MARKET EQUILIBRIUM

• A market clears or is in equilibrium when the total quantity demanded

by buyers exactly equals the total quantity supplied by sellers.
 Market Market
p
demand supply
q=S(p)

D(p*) = S(p*); the market

is in equilibrium.
p*
q=D(p)

q* D(p), S(p)
 Market Market
p
demand supply
q=S(p)
D(p’) < S(p’); an excess
p’ of quantity supplied over
p* quantity demanded.
q=D(p)

D(p’) S(p’) D(p), S(p)

Market price must fall towards p*.

 Market Market
p
demand supply
q=S(p)
D(p”) > S(p”); an excess
of quantity demanded
p* over quantity supplied.
p” q=D(p)

S(p”) D(p”) D(p), S(p)

Market price must rise towards p*.
MARKET EQUILIBRIUM

• An example of calculating a market equilibrium when the market

demand and supply curves are linear.

D ( p ) = a − bp
S ( p ) = c + dp
 Market Market
p
demand supply
S(p) = c+dp

What are the values

p* of p* and q*?
D(p) = a-bp

q* D(p), S(p)
MARKET EQUILIBRIUM

D ( p ) = a − bp
S ( p ) = c + dp
• At the equilibrium price p*, D(p*) = S(p*).
That is,
a − bp* = c + dp*
* a−c
p =
which gives b+d
and * * ad + bc
*
q = D ( p ) = S( p ) = .
b+d
 Market Market
p
demand supply
S(p) = c+dp
*
p =
a−c
b+d
D(p) = a-bp
ad + bc D(p), S(p)
q =
*
b+d
MARKET EQUILIBRIUM

• Two special cases are

• when quantity supplied is fixed, independent of the market price
• when quantity supplied is extremely sensitive to the market price
 Market Market quantity supplied is
p
demand fixed, independent of price.
S(p) = c+dp, so d=0 and S(p)  c

p*

D-1(q) = (a-q)/b

q* = c q
 Market Market quantity supplied is
p
demand fixed, independent of price.
S(p) = c+dp, so d=0 and S(p)  c

p* = p* = D-1(q*); that is,

(a-c)/b p* = (a-c)/b.
D-1(q) = (a-q)/b

q* = c q
p Market quantity supplied is
extremely sensitive to price.

q
 Market Market quantity supplied is
p
demand extremely sensitive to price.
S-1(q) = p*

p* = D-1(q*) = (a-q*)/b so
p* q* = a-bp*
D-1(q) = (a-q)/b

q* = q
a-bp*
QUANTITY TAXES

• A quantity tax levied at a rate of $t is a tax of $t paid on each unit

traded.
• If the tax is levied on sellers then it is called an excise tax.
• If the tax is levied on buyers then it is called a sales tax.
QUANTITY TAXES

• A tax makes the price paid by buyers, pb, different from the price
received by sellers, ps.
• In fact, the buyer and seller prices must differ by exactly the amount of
the tax.
pb − p s = t
QUANTITY TAXES

• Even with a tax present the market must still clear, so the quantity
demanded by buyers facing the price pb and the quantity supplied by
sellers facing the price ps must be equal.

D ( pb ) = S( p s )
QUANTITY TAXES

pb − p s = t and D ( pb ) = S( p s )
describe the market’s equilibrium. Notice that these two conditions
apply no matter if the tax is levied on sellers or on buyers.
Hence, a sales tax levied at a rate of $t has exactly the same effect on a
competitive market’s equilibrium as an excise tax levied at a rate of $t.
 Market Market
p
demand supply

No tax

p*

q* D(p), S(p)
 Market Market
p
demand supply
An excise tax
raises the market
pb $t supply curve by $t,
p* raises the buyers’
ps price and lowers the
quantity traded.

qt q* D(p), S(p)
And sellers receive only ps = pb - t.
 Market Market
p
demand supply

No tax

p*

q* D(p), S(p)
 Market Market
p
demand supply
A sales tax lowers the
market demand curve
by $t
p*
$t

q* D(p), S(p)
 Market Market
p
demand supply
A sales tax lowers the
market demand curve by
$t, lowers the sellers’
p* price and reduces the
ps quantity traded.
$t

qt q* D(p), S(p)
 Market Market
p
demand supply
A sales tax lowers the
market demand curve by
pb $t, lowers the sellers’
p* price and reduces the
ps quantity traded. And
$t buyers pay pb = ps + t.

qt q* D(p), S(p)
 Market Market
p
demand supply
A sales tax levied at rate
$t has the same effects
pb $t on the market
p* equilibrium as does an
ps excise tax levied at rate
$t $t.

qt q* D(p), S(p)
QUANTITY TAXES & MARKET EQUILIBRIUM

• Who pays the tax of $t per unit traded?

• The division of the $t between buyers and sellers is called the
incidence of the tax.
 Market Market
p
demand supply
Tax paid by
buyers
pb
p*
ps Tax paid by
sellers

qt q* D(p), S(p)
QUANTITY TAXES & MARKET EQUILIBRIUM

• An example of computing the effects of a quantity tax on a market

equilibrium.
• Again suppose the market demand and supply curves are linear.

D ( p b ) = a − bp b
S ( p s ) = c + dp s
QUANTITY TAXES & MARKET EQUILIBRIUM

D ( p b ) = a − bp b and S ( p s ) = c + dp s .
• With the tax, the market equilibrium satisfies
p b = p s + t and D ( pb ) = S( p s ) so

pb = p s + t and a − bp b = c + dp s .

• Substituting for pb gives

a − c − bt
a − b ( p s + t ) = c + dp s  p s = .
b+d
QUANTITY TAXES & MARKET EQUILIBRIUM

D ( p b ) = a − bp b and S ( p s ) = c + dp s .

a − c − bt
ps = and p b = p s + t gives
b+d
a − c + dt
pb = qt = D ( pb ) = S( ps )
b+d
• The quantity traded at equilibrium is ad + bc − bdt
= a + bpb = .
b+d
QUANTITY TAXES & MARKET EQUILIBRIUM

a − c − bt
ps =
b+d t ad + bc − bdt
q =
a − c + dt b+d
pb =
b+d
The total tax paid (by buyers and sellers combined) is

t ad + bc − bdt
T = tq = t .
b+d
DEADWEIGHT LOSS AND
OWN-PRICE ELASTICITIES
• A quantity tax imposed on a competitive market reduces the quantity
traded at equilibrium and so reduces the gains-to-trade; i.e. the sum of
Consumers’ Surplus and Producers’ Surplus is reduced.
• The loss in total surplus is called the deadweight loss, or excess
burden, of the tax.
 Market Market
p
demand supply

No tax

p*

q* D(p), S(p)
 Market Market
p
demand supply

No tax
CS
p*
PS

q* D(p), S(p)
 Market Market
p
demand supply
The tax reduces both
pb CS $t CS and PS
p*
ps PS

qt q* D(p), S(p)
 Market Market
p
demand supply
The tax reduces both
pb CS $t CS and PS, transfers
p* Tax surplus to government,
ps PS and lowers total
surplus.

qt q* D(p), S(p)
 Market Market
p
demand supply

pb CS $t
p* Tax
ps PS Deadweight loss

qt q* D(p), S(p)
 Market Market
p
demand supply
Deadweight loss falls as
pb $t market demand becomes
p* less own-price elastic.
ps

qt q* D(p), S(p)
 Market Market
p
demand supply
Deadweight loss falls as
pb $t market demand becomes
p* less own-price elastic.
ps

qt q* D(p), S(p)
 Market Market
p
demand supply
Deadweight loss falls as
pb $t market demand becomes
ps= p* less own-price elastic.
When eD = 0, the tax causes
no deadweight loss.

qt = q* D(p), S(p)
DEADWEIGHT LOSS AND
OWN-PRICE ELASTICITIES
• Deadweight loss due to a quantity tax rises as either market demand
or market supply becomes more own-price elastic.
• If either eD = 0 or eS = 0 then the deadweight loss is zero.