PRICE

DETERMINATION
CHAPTER 11
DEFINITIONS
MARKET EQUILIBRIUM
EQUILIBRIUM MEANS STATE OF BALANCE
MARKET EQUILIBRIUM – MARKET DD = MARKET SS
EQUILIBRIUM PRICE – PRICE AT WHICH MARKET DD= MARKET SS
EQUILIBRIUM QUANTITY – QUANTITY AT WHICH MARKET DD = MARKET SS
1. MARKET DEMAND INCREASES FROM DD
TO D1D1
2.SUPPLY REMAINS CONSTANT AT SS
3. EQUILIBRIUM PRICE INCREASES FROM
OP TO OP1
4. EQUILIBRIUM QUANTITY INCREASES
FROM OQ TO OQ1
5. EQUILIBRIUM POINT SHIFTS FROM
E TO E1
 1. MARKET DEMAND DECREASES FROM DD
TO D1D1
2.SUPPLY REMAINS CONSTANT AT SS
3. EQUILIBRIUM PRICE DECREASES FROM
PRICE (Rs.)

OP TO OP1
4. EQUILIBRIUM QUANTITY DECREASES
FROM OQ TO OQ1
5. EQUILIBRIUM POINT SHIFTS FROM
E TO E1

QUANTITY (UNITS)
 1. MARKET SUPPLY INCREASES FROM SS
TO S1S1
2.DEMAND REMAINS CONSTANT AT DD
3. EQUILIBRIUM PRICE DECREASES FROM
PRICE (Rs.)

OP TO OP1
4. EQUILIBRIUM QUANTITY INCREASES
FROM OQ TO OQ1
5. EQUILIBRIUM POINT SHIFTS FROM
E TO E1

QUANTITY (UNITS)
 1. MARKET SUPPLY DECREASES FROM SS
TO S1S1
2.DEMAND REMAINS CONSTANT AT DD
PRICE (Rs.)

3. EQUILIBRIUM PRICE INCREASES FROM

OP TO OP1
4. EQUILIBRIUM QUANTITY DECREASES
FROM OQ TO OQ1
5. EQUILIBRIUM POINT SHIFTS FROM
E TO E1

QUANTITY (UNITS)
DEMAND IS PERFECTLY ELASTIC SUPPLY
INCREASES

1. DEMAND IS PERFECTLY ELASTIC AT DD

2. SUPPLY INCREASES FROM SS TO S1S1
3. EQUILIBRIUM PRICE REMAINS CONSTANT AT OP
4. EQUILIBRIUM QUANTITY INCREASES FROM
OQ TO OQ1
PRICE (Rs.)

5. EQUILIBRIUM POINT SHIFTS FROM E TO E1

QUANTITY (UNITS)
SUPPLY IS PERFECTLY ELASTIC AND
DEMAND INCREASES
1. SUPPLY IS PERFECTLY ELASTIC AT SS
2. DEMAND INCREASES FROM DD TO D1D1
3. EQUILIBRIUM PRICE REMAINS CONSTANT AT OP
4. EQUILIBRIUM QUANTITY INCREASES FROM OQ TO OQ1
5. EQUILIBRIUM POINT SHIFTS FROM E TO E1
PRICE (Rs.)

QUANTITY (UNITS)
DEMAND IS PERFECTLY INELASTIC AND
SUPPLY INCREASES
1.DEMAND IS PERFECTLY INELASTIC AT DD
2. SUPPLY INCREASES FROM SS TO S1S1
3. EQUILIBRIUM QUANTITY REMAINS CONSTANT AT
OQ
4. EQUILIBRIUM PRICE DECREASES FROM OP TO OP1
5. EQUILIBRIUM POINT SHIFTS FROM E TO E1
PRICE (Rs.)

QUANTITY (UNITS)
SUPPLY IS PERFECTLY INELASTIC AND
DEMAND INCREASES
1. Supply is perfectly inelastic at SS
2. Demand increases from DD to D1D1
3. Equilibrium price increases from OP to OP1
4. Equilibrium quantity remains constant at OQ
PRICE (Rs.)

5. Equilibrium point shifts from E to E1

6. Supply curve is parallel to Y-axis and its Es = 0

QUANTITY (UNITS)
SIMULTANEOUS INCREASE IN DEMAND AND
SUPPLY
1. INCREASE IN DEMAND = INCREASE IN SUPPLY

2. INCREASE IN DEMAND > INCREASE IN SUPPLY

3. INCREASE IN DEMAND < INCREASE IN SUPPLY

1. INCREASE IN DEMAND = INCREASE IN
SUPPLY
1. Relative Increase in demand is same as the relative
Increase in supply (proportional / percentage / rate of increase
in demand is same as Increase in supply )
2. Equilibrium price remains constant at OP
PRICE (Rs.)

3. Equilibrium Quantity increases from OQ to OQ1

4. Equilibrium point shifts from E to E1

QUANTITY (UNITS)
2. INCREASE IN DEMAND > INCREASE IN
SUPPLY
1. Relative Increase in demand is more than the relative
Increase in supply (proportional / percentage / rate of increase
in demand is more than Increase in supply )
2. Equilibrium price increases from OP to OP1
3. Equilibrium Quantity increases from OQ to OQ1
PRICE (Rs.)

4. Equilibrium point shifts from E to E1

QUANTITY (UNITS)
3. INCREASE IN DEMAND < INCREASE IN
SUPPLY
1. Relative Increase in demand is less than the relative
Increase in supply (proportional / percentage / rate of increase in
demand is less than Increase in supply )
2. Equilibrium price decreases from OP to OP1
PRICE (Rs.)

3. Equilibrium Quantity increases from OQ to OQ1

4. Equilibrium point shifts from E to E1

QUANTITY (UNITS)
SIMULTANEOUS DECREASE IN DEMAND AND
SUPPLY
1. DECREASE IN DEMAND = DECREASE IN SUPPLY

2. DECREASE IN DEMAND > DECREASE IN SUPPLY

3. DECREASE IN DEMAND < DECREASE IN SUPPLY

EXCESS
DEMAND /
EXCESS
SUPPLY
A commodity can only be sold when both consumers and producers
consent with a price. At this price, the market forces of demand and
supply work in harmony and the market is said to be in equilibrium. But
what happens in the case of excess demand or excess supply?
 SCHEDULE
PRICE (Rs.) Q.D.(UNITS) Q.S. (UNITS)
10 10 2
20 8 4
30 6 6 MARKET EQUILIBRIUM
40 4 8
50 2 10

PRICE INC.DEMAND DEC. PRICE INC. SUPPLY INC.

LAW OF DEMAND LAW OF SUPPLY
EXCESS DEMAND
WHEN MARKET PRICE (MARKET DETERMINED PRICE)
IS BELOW THE EQUILIBRIUM PRICE

Excess demand is the situation where the price is below

PRICE (Rs.)

its equilibrium price.

The quantity supplied is lower than the quantity
demanded by the consumers.

QUANTITY (UNITS)
 EXCESS DEMAND
• When at the current price level, the quantity demanded is more than quantity supplied, a
situation of excess demand is said to arise in the market.
• Excess demand (AB) occurs at a price less than the equilibrium price.
• Since the prices would decrease, it would act as a bait for buyers to flock in markets which
would lead to competition among these buyers.
• This competition would lead to an increase in prices from OP1 to OP.
• As the prices increase the law of demand will operate to decrease the demand and the buyers
will start vanishing.
• Conversely, this increase in prices would lure the suppliers to increase supply with hopes to
earn greater profits.
• Due to increase in price there is contraction in demand from point B to point E and there is
extension of supply from point A to point E.
• Such a decrease in demand and increase in supply resulted by an effective increase in prices
continues until the equilibrium level is attained at point E.
• Thus automatically the conditions of excess demand are wiped out of the market.
EXCESS SUPPLY
PRICE (Rs.)

QUANTITY (UNITS)
WHEN MARKET PRICE (MARKET DETERMINED PRICE)
IS ABOVE THE EQUILIBRIUM PRICE
EXCESS SUPPLY
• Excess supply (AB) is a market condition when the quantity supplied is greater
than the demand for a commodity at the prevailing market price.
• It occurs at a price greater than the equilibrium price level i.e. at OP1.
• As the price will be greater than the equilibrium price the sellers would sense
this as an opportunity to earn greater profits and would pump in the supply.
• This would lead to an effective increase in stocks and a tough competition
among the sellers to sell their respective supplies.
• Consequently, to sell more supply, suppliers would start decreasing the prices
to sell the excess stock.
• Due to decrease in price there is contraction in demand from point A to point E
and there is extension of supply from point B to point E.
• This decrease in price manoeuvres the market supply and market demand
which fall (law of supply) and rise (law of demand) respectively.
• This self-adjusting mechanism pulls the price back to the equilibrium level.
Effectively excess supply is wiped out of the market.
Questions
1. Briefly discuss the effect on equilibrium price and quantity, when
decrease in supply is less than decrease in demand.

2. If the prevailing market price is above the equilibrium price, explain

the chain of effects.
3. Explain with the help of a diagram the effect of a rightward shift of
supply curve of a commodity on its equilibrium price and quantity?
4. Market for a good is in equilibrium. There is increase in demand for
this good. Explain the chain of effects of this change. Use diagram.
5. “Equilibrium price does not change due to simultaneous shifts in
demand and supply curves.” Explain.
6. If equilibrium price of a good is greater than its market price, explain
all the changes that will take place in the market. Use diagram and
schedule.
7. At a price of Rs.50 per chocolate, the demand is 700 chocolates and
the supply is 900 chocolates. What is likely to be its effect on the
equilibrium price of chocolates?
8. “If demand and supply both increase, equilibrium price will remain
same”. Do you agree with the statement?
9. What will happen to equilibrium price when demand is perfectly
elastic and supply increases?
10. What will happen to equilibrium price, if both demand and supply
increase in the same proportion?
11. What will be the effect on equilibrium quantity, if both demand and
supply decrease in the same proportion?
12. When do we say there is excess supply for a commodity in the
market?