Market Equilibrium

- Bharathi
1
 The Market Mechanism
 Market Mechanism Summary
1) Supply and demand interact to
determine the equilibrium price.
2) When not in equilibrium, the market
will adjust to a shortage or surplus and
return to the equilibrium.
3) Markets must be competitive for
the mechanism to be efficient.

2
MARKET DEMAND & SUPPLY

Price Price
MARKET MARKET
P QD 200 DEMAND P QS 200 SUPPLY

Rs.5 10 B 2,000 Rs.5 60 S 12,000

4 20
3 35 x U 4,000
Y 7,000
4 50
3 35 x
E 10,000
L 7,000

2 55 E
11,000 2 20 L
4,000
R E
1 80 16,000 1 5 1,000
S R
S

EQUILIBRIUM 3
 MARKET DEMAND & SUPPLY
Price

Price Rs.5
Demand S Price Supply

P QD P Q
4
Rs.5 2,000 Market Rs.5 12,000
S
Equilibrium
Rs.4 4,000Rs3 Rs.4 10,000
Rs.3 7,000 Rs.3 7,000
Rs.211,000 2 Rs.2 4,000
Rs.116,000 Rs.1 1,000
1
D
o 2 4 6 78 10 12 14 16 Q
4

Quantity
 The Market Mechanism
Y
S
Price
(Rs. per unit)

P E

Quantity
O Q X 5
The Market Mechanism
Price
S
(Rs. per unit)
Surplus
P1
If price is above equilibrium
Point-Supply exceeds
Demand.
P

Q Quantity
6
 The Market Mechanism
Price
S
(Rs per unit)
Surplus
P1
Assume the price is P1 , then:
1) Quantity Supplied is >
Quantity Demanded
P2 2) Producers lower price.
3) Quantity supplied decreases
4) Equilibrium is restored

Q1 Q3 Q2 Quantity
7
 The Market Mechanism
Price
(Rs. per unit) S

E Assume the price is P2, then:

1) Quantity Demanded is greater
than quantity Supplied
P3 2) Producers raise price.
3) Quantity supplied increases
4) Equilibrium is restored

P2
Shortage
D

Q1 Q3 Q2 Quantity
8
 Change in Supply

P D1 S1
S2
Price

P2

P1

o Q2 Q1 Q
Quantity
 Change in Demand

D2 S1
P D1

P2
Price

P1

o Q1 Q2 Q
 D P Q D P Q
A D1
D1 D1 S S
B
P2 D2
P1
P1
P2

“Increase in Demand” Q1 Q2 Q2 Q1 “Decrease in Demand”

Four Possibilities
S P Q S P Q
D D
D S2
C S1
S1 P2
P2 S1 P1
P1

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“Increase in Supply” Q1 Q2 Q2 Q1
“Decrease in Suply”
Change in Supply = Change in Demand

D2 S3
D1
S1
D3 S2

12
 Effects of Government Intervention
Price Controls

 If the Government decides that the

equilibrium price is too high, they may
establish a maximum allowable ceiling
price.

13
TAX SHIFTING AND THE ELASTICITIES
OF DEMAND AND SUPPLY

 When a product is taxed, who ultimately

shoulders the tax burden depends upon the
elasticity of demand and supply of the
product taxed.
 Usually the tax burden is shared between
producers and consumers.
 Consumers pay more of the tax, if demand
is relatively less elastic than supply
 Producers pay more of the tax if demand is
relatively more elastic than supply.
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 Price Ceilings
and Price Floors
 Price Ceiling
 is a legally established maximum
price which a seller can charge or a
buyer must pay.

 Price Floor
 is a legally established minimum
price which a seller can charge or a
buyer must pay.

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 Price Ceilings
 When the Government imposes a
price ceiling (i.e., a legal
maximum price at which a good
can be sold) two outcomes are
possible:
 The price ceiling is not binding.
 The price ceiling is a binding
constraint on the market, creating
shortages.

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A Binding Price Ceiling
Price
S

Price
PE Ceiling

PC
Shortage
D

QS QE QD Quantity/time
17
 Market Impacts
of a Price Ceiling
 A Binding Price Ceiling creates. . .
 Shortages (QD > QS)
 Shortages create :
 Queuing
 Discrimination criteria set by sellers
 Bundled pricing with other goods
 Bribery/corruption

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 Price Floors

 When the Government imposes a

price floor (i.e., a legal minimum
price at which a good can be sold)
two outcomes are possible:
 The price floor is not binding.
 The price floor is a binding constraint
on the market, creating surpluses.

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 A Binding Price Floor

Price S
Surplus

PF
Price Floor
PE

QD QE QS Quantity/time
20
 Market Impacts
of a Price Floor

 A Binding Price Floor creates. . .

 Surpluses (QS > QD)
 Surpluses create :
 Discrimination criteria set by buyers
 Examples:
 Agricultural Price Supports

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22
The Circular Flow of Income
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23
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