Market Equilibrium

All Rights ReservedMicroeconomics© Oxford University Press Malaysia, 2008

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Market Equilibrium3CHAPTER


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Market equilibrium is a situation where

quantity demanded and quantity

supplied are equal and there is no

price or quantity to change.

QDD = QSS

DEFINITION OF MARKET EQUILIBRIUM


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EQUILIBRIUM PRICE AND OUTPUT

Market equilibrium is determined by the intersection of the the demand curve and the supply curve.

Equilibrium price and quantity refers to the price and quantity that consumers and suppliers are willing to buy and sell.

Market equilibrium can be determined using a demand and supply model, graphical illustration and through mathematical equation.


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GRAPHICAL ILLUSTRATION OF EQUILIBRIUM PRICE AND OUTPUT

A Graphical illustration

SURPLUS (QSS > QDD)

SHORTAGE (QDD > QSS)

E

SS

DD

P*

Q*0

1

2

3

4

5

6

Price

Quantity2 4 6 8 10


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(1)Price (RM)

(2)Quantity

Demanded (units)

(3)Quantity Supplied

(units)

(4)Market

Condition

(5)Market Prices

9.00 2000 10000 SURPLUS Falls

8.50 4000 8000 SURPLUS Falls

8.00 6000 6000 EQUILIBRIUM Equilibrium

7.50 8000 4000 SHORTAGE Rises

7.00 10000 2000 SHORTAGE Rises

GRAPHICAL ILLUSTRATION OF EQUILIBRIUM PRICE AND OUTPUT(CON’T)


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The market demand and supply functions are given below:

Market demand, QDD = 38000 – 4000P (equation 1)

Market supply, QSS = – 26000 + 4000P (equation 2)

To find market equilibrium price and quantity, QDD = QSS

QDD = QSS

38000 – 4000P = – 26000 + 4000P

8000P = 64000

P = RM8.00

MATHEMATICAL EQUATION OF EQUILIBRIUM PRICE OUTPUT (CON’T)


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Substitute P = 8 into equation 1 and 2 to obtain the quantity.

QDD = 38000 – 4000(8) (equation 1) = 6000 units.

QSS = – 26000 + 4000(8) (equation 2) = 6000 units.

So, the equilibrium quantity, Q = 6000 units.

MATHEMATICAL EQUATION OF EQUILIBRIUM PRICE OUTPUT (CON’T)


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SHOCKS IN EQUILIBRIUM

Once the market reaches equilibrium level, it remains there so long as no pressure is put on the prices.

Market equilibrium will change when there is a shock that would shift the demand or supply curve.

The shock that shifts the supply and demand curves are due to changes in non-price factors.

MICROECONOMICS 9


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EFFECT OF CHANGES ON DEMAND

Increase in Demand

DD curve shifts to the right

Equilibrium price and quantity

increasesDecrease in Demand

DD curve shifts to the left

Equilibrium price and quantity decreases

Price (RM)

P1

P*

P2

Q2 Q* Q1

SS

DD1

DDDD2

Quantity

ASSUME THAT SUPPLY IS CONSTANT


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Increase in Supply

SS curve shifts to the right

Equilibrium price decreases and

quantity increasesDecrease in Supply

SS curve shifts to the left

Equilibrium price increases and

quantity decreases

EFFECT OF CHANGES ON SUPPLYASSUME THAT DEMAND IS CONSTANT

Quantity

Price (RM)

P2

P*

P1

Q2 Q* Q1

SS

SS1

DD

SS2


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Case 1: Increase at same magnitude

Equilibrium price undetermined and quantity increases

Quantity

Price (RM)

P*

Q* Q1

SS

SS1U

DD

DD1

SUPPLY AND DEMAND INCREASE

EFFECT OF CHANGES ONDEMAND AND SUPPLY


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SUPPLY AND DEMAND DECREASE

EFFECT OF CHANGES ONDEMAND AND SUPPLY (CON’T)

Case 2: Decrease at same magnitude

Equilibrium price undetermined and quantity

decreases

Quantity

Price (RM)

P*

Q1 Q*

SS1

SS

DD

DD1


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Case 3: Changes in different magnitude

Equilibrium price decreases and quantity undetermined


Price (RM)

P*

Q*

SS

SS1

DDDD1

Quantity

P1

SUPPLY INCREASE AND DEMAND DECREASES


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SUPPLY DECREASES AND DEMAND INCREASES

Case 4: Changes in different magnitude

Equilibrium price increases and quantity undetermined

Price (RM)

Q*

P*

SSSS1

DD

DD1

Quantity

P1



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GOVERNMENT INTERVENTION

GOVERNMENT INTERVENTION IN THE MARKET

MAXIMUM PRICE MAXIMUM PRICE

TAXES SASUBSIDIES


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MAXIMUM PRICE/ CEILING PRICE

Government-imposed regulations prevent prices

from rising above the maximum level.

The equilibrium price is P* and the quantity is Q*.

Price ceiling The government imposes a

maximum price of P1.

Price

Quantity

DD

SS

P*

P1

Suppliers reduce the amount offered to Q1 but demand would rise to Q2 creating a

shortage.

Q*Q1 Q2

Shortage occurs

Advantage Consumers purchase

at lower price.

Disadvantages

• Emergence of black market.

• Reduction in quantity produced.

• Producers tend to receive illegal payments from consumers.

GOVERNMENT INTERVENTION (CON’T)


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GOVERNMENT INTERVENTION (CON’T)

MINIMUM PRICE/ FLOOR PRICEGovernment-imposed regulations prevent prices from falling below a

minimum level.

The equilibriumprice is P* and the quantity is Q*.

Advantages

• Protects producer’s income

• Higher wage rate

Disadvantages Consumers pay more. Waste of

resources of productionCreates unemployment

The government imposes a minimum price of P1

Suppliers increase the amount offered to Q2 but demand drop to

Q1 creating a surplus.

Surplus occurs

Price

Quantity

DD

SS

P*

Q*

P1Floor price

Q1 Q2


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The tax amount of RM4 is shared equally between buyer and seller.

400

INDIRECT TAXTax that is imposed by the government on producers or sellers but paid by or passed on to end-users.

12

Quantity

SS

SS1

Price

DD

The equilibrium price is RM12 and the quantity is 400 units

14

200

10

Tax

= R

M4

The government imposes a sales tax of RM4 per carton.

SS curve shift to the left from SS to SS1 and new equilibrium is RM14 and 200

units.

EFECT OF TAXATION

CONSUMER’S

SHAREPRODUCE

R’S SHARE

S + tax (RM4)

S

0

12

15

400

D

PRODUCERS’ SHARE

P

Q

11

CONSUMERS’ SHARE

Demand less elastic than supply

S + tax

S

O

9

12

13

400

D

P

Q

CONSUMERS’ SHARE


PRODUCER’ SHARE

S + tax

S

O

12

16

400

D

CONSUMERS’SHARE

P

Q

Perfectly inelastic demand

S+ tax

P

Q O

18

121

400

D

S

Incidence of tax: elastic supply

PRODUCERS’SHARE


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45

10

SUBSIDYAn incentive from the government to encourage producers to produce more.Price

Quantity

D

S

S1

The equilibrium price is RM50 and the quantity is 10.

20

50

40

Subs

idy

= R

M10

CONSUMER’S

SHAREPRODUCE

R’S SHARE

The government provides a subsidy of RM10 per unit.

SS curve shift right from SS to SS1 and new equilibrium is RM45 and

20 units.

The subsidy amount of RM10 is shared equally between buyer and

seller.

EFECT OF SUBSIDIES


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EFECT OF PRICE ELASTICITYON SUBSIDIES

S + tax

S

O

40

4750

10

D

P

Q

CONSUMERS’ SHARE

PRODUCERS’ SHARE

Demand is more elastic than supply

S + tax (RM4)

S

0

43

50

10

D

CONSUMERS’ SHARE

PRODUCERS’ SHARE

P

Q


40

Documents

Market Equilibrium