The Determination of Equilibrium

Price and Quantity

 Individual vs Market
Demand & Supply

• the individual demand curve—sometimes also called the household

demand curve—that is based on an individual’s choice among different
goods.

• We build the market demand curve from these individual demand

curves.

• Then we do the same thing for supply, showing how to build a market
supply curve from the supply curves of individual firms.

• Finally, we put them together to obtain the market equilibrium.

 Individual Demand

• We have an example of chocolate bar.

• The Demand Curve of an Individual Household explained by an example of a household’s

demand for a chocolate bar say , each month.

• Taking a particular price of a chocolate bar , the household decides how many chocolate bars
to buy.

• Its choice is represented as a point on the household’s demand curve. For example, at Rs. 5,
the household wishes to consume five chocolate bars each month.

• The remainder of the household income—which is its total income minus the Rs. 25 it spends
on chocolate—is spent on other goods and services.

• If the price decreases to Rs.3, the household buys eight bars every month. In other words,
the quantity demanded by the household increases.

• Equally, if the price of a chocolate bar increases, the quantity demanded decreases. This is
the law of demand in operation.
The household demand
curve shows the
quantity of chocolate
bars demanded by an
individual household at
each price. It has a
negative slope: higher
prices lead people to
consume fewer
chocolate bars.
 Market demand

• In most markets, many households purchase the good or the service

traded.

• We need to add together all the demand curves of the individual

households to obtain the market demand curve.

• Market demand is obtained by adding together the individual

demands of all the households in the economy.

• If we introduce one more household to the model

• at Rs. 5, household 2 buys 2 bars per month;

• at Rs. 3, it buys 3 bars per month.

• To get the market demand, we simply add together the demands of the two
households at each price.

• For example, when the price is Rs.5, the market demand is 7 chocolate bars (5
demanded by household 1 and 2 demanded by household 2).

• When the price is Rs,3, the market demand is 11 chocolate bars (8 demanded by
household 1 and 3 demanded by household 2).

• When we carry out the same calculation at every price, we get the market
demand curve
• Because the individual demand curves are downward sloping, the
market demand curve is also downward sloping:

• the law of demand carries across to the market demand curve. As the
price decreases, each household chooses to buy more of the product.

• Thus the quantity demanded increases as the price decreases.

• Although we used two households in this example,

• the same idea applies if there are 200 households or 20,000

households. In principle, we could add together the quantities
demanded at each price and arrive at a market demand curve.
Individual Supply curve

• In a competitive market, a single firm is only one of the many sellers

producing and selling exactly the same product.

• The demand curve facing a firm exhibits perfectly elastic demand, which
means that it sets its price equal to the price prevailing in the market, and
it chooses its output such that this price equals its marginal cost of
production.

• we derive the supply curve of a firm in a competitive market. If it were to

try to set a higher price, it could not sell any output at all. If it were to set a
lower price, it would be throwing away profits.

• Thus, for a competitive firm, the quantity produced satisfies this condition:

• price = marginal cost.

• A firm’s supply curve, which is the same as its marginal cost curve, shows the
quantity of a commodity it is willing to supply at each price.

• We typically expect that marginal cost will increase as a firm produces more
output.

• Marginal cost is the cost of producing one extra unit of output.

• The cost of producing an additional unit of output generally increases as firms

produce a larger and larger quantity.

• For example, a factory might be able to produce more output only by running
extra shifts at night, which require paying higher wages.

• So supply curve is upward slopping

 market supply curve

• The market supply curve tells us the total amount supplied at each
price.

• It is obtained analogously to the market demand curve: at each price

we add together the quantity supplied by each firm to obtain the
total quantity supplied at that price.

• If we perform this calculation for every price, then we get the market
supply curve
Individual vs Market
supply curve
• "Market Supply" shows an example with two firms. At $3, firm 1
produces 7 bars, and firm 2 produces 3 bars. Thus the total supply at
this price is 10 chocolate bars.

• At $5, firm 1 produces 8 bars, and firm 2 produces 5 bars. Thus the
total supply at this price is 13 chocolate bars.

• As price increases, each firm in the market finds it profitable to

increase output to ensure that price equals marginal cost.

• Moreover, as price increases, firms who choose not to produce and

sell a product may be induced to enter into the market
 Market Equilibrium

• The term equilibrium refers to the balancing of the forces .

• Here balancing of supply and demand in the market.

• Equilibrium is a state of a system which does not intend to change,

once attained.

• At the equilibrium price, the suppliers of a good can sell as much as

they wish, and demanders of a good can buy as much of the good as
they wish. There are no disappointed buyers or sellers.
 The logic of the model of demand and supply

•The logic of the model of demand and supply is simple.

• The demand curve shows the quantities of a particular good or

service that buyers will be willing and able to purchase at each
price during a specified period.

• The supply curve shows the quantities that sellers will offer for
sale at each price during that same period.

•By putting the two curves together, we should be able to find a

price at which the quantity buyers are willing and able to
purchase equals the quantity sellers will offer for sale.
Market Equilibrium
Market Equilibrium
Numerical examples
Finding the equilibrium price and quantity
levels…
• Given
• QD = 50 – P
• QS = 20 + 2P
• Market equilubrium is when QD = QS
• 50-P = 20+2P
• 50- 20 = 2P+P
• 30 = 3P
• P = 30/3 = 10
• P= 10
Find equilibrium quantity

• Now substituting P in any of the equation , we have quantity. ( at

equi qty ss and dd are equal)
• QS = 20 + 2P
• Q = 20 + 2 x 10 (substituting P= 10)
• Q = 20 + 20
• Q= 40
• Now check if it’s correct in QD = 50 – P .
• 40 = 50 – 10
• 40= 40
• Check Qs =20+ 2P
• 40 = 20 + 2 x 10
• 40= 20+20
• 40=40
• In both equations if P=10 then Q=40
Excess demand and Supply

• Excess demand will push the prices upward and back to equilibrium
• Excess supply will push prices down , and back to equilibrium..
• Thus even if economy tends away from equilibrium the market forces will fix
them back.