MARKET EQUILIBRIUM

MARKET EQUILIBRIUM Market equilibrium exists when quantity

demanded (Qd) equals quantity supplied (Qs). It can be determined by the intersection

between demand and supply curves. At equilibrium, there is no tendency for the

market price to change. Equilibrium Price - The price that balances supply

and demand. On a graph, it is the price at which the supply

and demand curves intersect. Equilibrium Quantity - The quantity that balances

supply and demand. On a graph it is the quantity at which the supply

and demand curves intersect.

Price (RM) Quantity 0.00 0

0.50 0 1.00 1 1.50 4 2.00 7 2.50 10 3.00 13

Price (RM) Quantity 0.00 19

0.50 16 1.00 13 1.50 10 2.00 7 2.50 4 3.00 1

Demand Schedule

Supply Schedule

At RM2.00, the quantity demanded is equal to the

quantity supplied!

Supply

Demand

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

Equilibrium of Supply and Demand

21 3 4 5 6 7 8 9 10

12

11

0

RM3.00

2.502.00

1.501.00

0.50

Surplus When Qs exceeds Qd there is excess supply or a

surplus Happens when price is above the equilibrium

price. Suppliers will lower the price to increase sales,

thereby moving toward equilibrium

Shortage When Qd exceeds Qs there is excess demand or

a shortage. Happens when price is below the equilibrium

price. Suppliers will raise the price due to too many

buyers chasing too few goods, thereby moving toward equilibrium.

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

21 3 4 5 6 7 8 9 10 12

11

0

RM3.00

2.50

2.00

1.501.00

0.50

Supply

Demand

Surplus

Shortage

WHAT CAUSES A CHANGE IN MARKET EQUILIBRIUM?

A change in demandA change in supply

Three Steps To Analyzing Changes in Equilibrium

Decide whether supply or demand curve shifts (or both shift).

Decide whether the curve(s) shift(s) to the left or to the right.

Examine how the shift affects equilibrium price and quantity.

EFFECT OF CHANGES IN DEMANDIncrease in

DemandPrice (RM)

Qty (Unit)

P1

P0

Q1Q0

S0

D0

D1

- Increase in demand – D curve shift to the right (D0 to D1) e.g: increase in population.

- New equilibrium (E0 to E1)- Higher demand leads to

higher equilibrium price (P0 to P1) and higher equilibrium quantity (Q0 to Q1) .

E0

E1

EFFECT OF CHANGES IN DEMAND

Decrease in Demand

Price (RM)

Qty (Unit)

P0

P1

Q0Q1

S0

D1

D0

- decrease in demand – D curve shift to the left (D0 to D1)

- e.g: decrease in income.- New equilibrium (E0 to E1)- Lower demand leads to

lower equilibrium price (P0 to P1) and lower equilibrium quantity (Q0 to Q1).

E0

E1

EFFECT OF CHANGES IN SUPPLY

Increase in Supply

Price (RM)

Qty (Unit)

P0

P1

Q1Q0

S0

S1

D0

- increase in supply – S curve

shift to the right (S0 to S1)- e.g: increase in numbers of seller. - New equilibrium (E0 to E1)- Higher supply leads to lower equilibrium price (P0 to P1) and higher equilibrium quantity (Q0 to Q1).

E0

E1

EFFECT OF CHANGES IN SUPPLY

Decrease in Supply

Price (RM)

Qty (Unit)

P1

P0

Q0Q1

S0

S1

D0

- decrease in supply – S curve

shift to the left (S0 to S1)- e.g: increase in cost of

production - New equilibrium (E0 to E1)- Lower supply leads to higher equilibrium price (P0 to P1) and lower equilibrium quantity (Q0 to Q1).

E1

E0

Price (RM)

Qty (Unit)

P0

P1

Q1Q0

S0

S1

D1

E0

E1

CHANGES IN EQUILIBRIUM PRICE & CHANGES IN EQUILIBRIUM PRICE & OUTPUTOUTPUT

Simultaneous Change: Demand and Supply

D0

• The relative The relative magnitudes of change magnitudes of change in supply and demand in supply and demand determine the determine the outcome of market outcome of market equilibrium.equilibrium.

GOVERNMENT INTERVENTION IN MARKETSMAXIMUM PRICE/CEILING PRICE

Government-imposed regulations that prevent prices from rising above a maximum level

Price

Quantity

D S

P*

Q*

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

P1

Price ceiling

The government imposes a maximum price of P1

Q1Q2

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

Shortages occur

Advantage:

• Consumers purchase at lower price

Disadvantages:• Shortages• Unfair to sellers (lower P)• Emergence of black market• Exploitation of customers• Hoarding activity

GOVERNMENT INTERVENTION IN MARKETS

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

Price

Quantity

D

S

P*

Q*

P1 Pmin

The government imposes a minimum price of P1

Q1 Q2

Surplus

Disadvantages:• Unfair to consumers (Higher P)• Surplus-Waste of resources•Unfair to taxpayers – tax used to buy surplus

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

Suppliers increase the amount offered to Q2 but demand drop to Q1 creating a surplus

Advantages:• Protects the producer’s income• Higher wage rate

PRODUCERS’ SHARE

CONSUMERS’ SHARE

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

EFFECT OF TAXATION

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

Price

Quantity

D

S

12

400

14

S1

200

The equilibrium price is RM12 and the quantity is 400

10

Tax

= RM4

The government imposes a sales tax of RM4 per carton

S curve shift to left from S to S1 and new equilibrium is RM14 and 200 units

S + tax (RM4)

S

0

12

15

400

D

CONSUMERS’SHARE

11PRODUCERS’ SHARE

P

Q

Demand less elastic than supply

S + tax

S

O

12

16

400

D

CONSUMERS SHARE

P

Q

Perfectly inelastic demandPerfectly inelastic demand

S + tax

S

O

9

12

13

400

D

P

Q

PRODUCERS’ SHARE

Demand is more elastic than supplyDemand is more elastic than supply

CONSUMERS' SHARE

S + tax

PRODUCERS’’ SHARE

P

Q O

18

12

400

D

S

Incidence of tax: elastic supplyIncidence of tax: elastic supply

PRODUCER’S SHARE

CONSUMER’S SHARE

EFFECT OF SUBSIDIES

SUBSIDYAn incentive from the government to encourage producers to produce more

Price

Quantity

D

S

45

20

50

S1

10

The equilibrium price is RM50 and the quantity is 10

40

Subs

idy

= RM10

The government provides a subsidy of RM10 per unit

SS curve shifts to the right from S to S1 and new equilibrium is RM45 and 20 units

The subsidy amount of RM10 is shared equally between buyer and seller

EFFECT OF SUBSIDIESDemand less elastic than supply

S +sub

S

O

40

4750

10

D

P

Q

CONSUMERS’ SHARE

PRODUCERS’ SHARE

S

0

43

50

10

D

CONSUMERS’ SHARE

40PRODUCERS ’ SHAREPRODUCERS’ SHARE’

P

Q

Demand less elastic than supply

S+ sub (RM4)

MARKET FAILURE

Market failure exists when a free market is unable to deliver an efficient allocation of resources which leads to a loss of economic efficiency.

Causes of market failure

1. Externalities

2. Existence of monopoly power

3. Public goods

4. Incomplete information