Market Equilibrium

Chapter three
• In an economic model equilibrium is a balance
of forces such that the economic variables
that the model seeks to explain neither
increase nor decrease.
• Market equilibrium exists when there is no
tendency for the market price or the quantity
sold to change.
• At equilibrium
Ps = Pd
Qd = Qs
 Excess Demand Causes the Price to Rise

1. If there is excess demand, the price

will tend to increase, causing the
quantity demanded to decrease and
the quantity supplied to increase.
2. In some cases, the government
causes excess demand for a good by
setting a maximum price (price
ceiling). An example of this is rent
controls.
Any movement away from the
equilibrium price sets up forces to
return the market to its previous
equilibrium.
At 6$ the quantity demanded would
exceed the quantity supplied (Qd >
Qs), a shortage exists.
 Excess Supply Causes the Price to Drop

1. If there is excess supply, the price

will tend to decrease, causing the
quantity demanded to increase and
the quantity supplied to decrease.
2. In some cases, the government
causes excess supply for a good by
setting a minimum price (price floor).
An example of this is agricultural price
supports.
If the price is above the equilibrium
level quantity demanded will fall
short of quantity supplied (Qd < Qs),
the difference between quantity
supplied and quantity demanded at a
given price is called a surplus (an
excess in supply).
 Market Effects of Changes in Demand

A decrease in demand shifts the

(A) Decrease in Demand demand curve to the left when

The good is normal and income

decreases
The good is poorer and income
increases
The price of a substitute good
decreases
The price of a complementary
good increases

Population decreases

Consumer tastes shift away from

the product

Consumers expect a lower price in

the future
An increase in demand
shifts the demand curve to
the right when (B) Increase in Demand

The good is normal and

income increases
The good is inferior and
income decreases
The price of a substitute
good increases
The price of a
complementary good
decreases
Population increases
Consumer tastes shift in
favour of the product
Favourable advertising
Consumers expect a higher
price in the future
 Market Effects of a change in supply

A decrease in supply
(A) Decrease in Supply shifts the supply
curve to the left when
The cost of an input
decreases

The number of firms

decreases
Producers expect a
higher price in the
future
Tax
(B) Increase in Supply An increase in supply
shifts the supply curve
to the right when

The cost of an input

decreases
A technological
advance decreases
production costs
The number of firms
increases
Producers expect a
lower price in the future

Subsidy
 Market Effects of Simultaneous Changes in
Demand and Supply
• What happens to equilibrium price and
quantity when both supply and demand
increase?
• It depends on which change is larger

An increase in demand tends to pull the price up, while

an increase in supply tends to push the price down.
Larger increase in demand
 If the increase in demand is larger than the increase in supply (if the shift of the
demand curve is larger than the shift of the supply curve), both the equilibrium
and the equilibrium quantity will increase.
Larger increase in supply
 If the increase in supply is larger than the increase in demand (if the shift of the
supply curve is larger than the shift of the demand curve), the equilibrium price
will decrease and the equilibrium quantity will increase.
 Summary

• When demand
Change in Demand or Change in Change in changes and demand
Supply Price Quantity curve shifts, price
and quantity change
Increase in demand Increase Increase
in the same direction.
• When supply changes
Decrease in demand Decrease Decrease and the supply curve
Increase in supply Decrease Increase shifts, price and
quantity change in
Decrease in supply Increase Decrease
opposite direction.
• When demand changes and
demand curve shifts, price and
quantity change in the same
direction.
• When supply changes and the
supply curve shifts, price and
quantity change in opposite
direction.
1- Below is a Market demand schedule for a good in a certain
city:

P Q
2 10000
3 9000
4 8000
5 7000
6 6000

Draw the demand curve for that good. And find the demand
function.
1- Derive the market demand and supply
schedule and the market demand and supply
curve if the individual demand function is Qd =
12 – 2Pd and the individual supply function is
Qs = 20Ps taking in consideration that there
are 10000 buyers and 1000 sellers in the
market. Find the equilibrium price and
quantity.
• Given the demand and supply schedule for a
good, do you think that the market is stabile
or not?

P 5 4 3 2 1
Qs 5000 6000 7000 8000 9000
Qd 1000 4000 7000 10000 13000
• The daily demand curve for a good in a small town
is described by the following equation: Qd = 600 –
2Pd. The supply curve of the same good is
described by the following equation: Qs = 300 +
4Ps.
- Derive the market demand and supply schedule
and the market demand and supply curve.
- What is the market equilibrium price and
quantity?
- Is the market stable?
 
• The supply curve for a good is described by
the following equation Qs = - 40 + 20 Ps. The
demand curve for the same good is described
by the equation Qd = 8 – Pd.
- Derive the demand and supply schedule and
the demand and supply curve.
- What is the market equilibrium price and
quantity?
-Is the market stable?
3- The table below demonstrate the consumption of tea
and coffee for an employee before and after an
increase in the price of coffee.
Before After
P Q P Q
Coffee 20 50 30 30
Tea 10 40 10 50

• Draw a curve to describe the change in consumption

and explain it.