Market Equilibrium

2. CHAPTER 3 Market Equilibrium

3. Market equilibrium is a situation where quantity demanded and quantity suppliedare equal and there is no price or quantity to change. DEFINITION OF MARKET EQUILIBRIUM QDD= QSS

4. 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.

5. 6 SURPLUS (QSS > QDD) 5 4 P* E 3 Price SS 2 DD 1 SHORTAGE (QDD > QSS) Q* 0 2 4 6 8 10 Quantity GRAPHICAL ILLUSTRATION OF EQUILIBRIUM PRICE AND OUTPUT A Graphical illustration

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

7. 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)

8. 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)

9. 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

10. EFFECT OF CHANGES ON DEMAND Increase in Demand DD curve shifts to the right Equilibrium price and quantity increases Price (RM) SS P1 P* DD1 P2 DD DD2 Quantity Q2 Q* Q1 ASSUME THAT SUPPLY IS CONSTANT Decrease in Demand DD curve shifts to the left Equilibrium price and quantity decreases

11. Price (RM) SS2 SS P2 SS1 P* P1 DD Quantity Q2 Q* Q1 EFFECT OF CHANGES ON SUPPLY ASSUME THAT DEMAND IS CONSTANT Increase in Supply SS curve shifts to the right Equilibrium price decreases and quantity increases Decrease in Supply SS curve shifts to the left Equilibrium price increases and quantity decreases

12. Price (RM) DD1 SS P* SS1U DD Quantity Q* Q1 EFFECT OF CHANGES ONDEMAND AND SUPPLY SUPPLY AND DEMAND INCREASE Case 1: Increase at same magnitude Equilibrium price undetermined and quantity increases

13. SUPPLY AND DEMAND DECREASE EFFECT OF CHANGES ONDEMAND AND SUPPLY (CON’T) Price (RM) SS1 SS P* DD DD1 Quantity Q1 Q* Case 2: Decrease at same magnitude Equilibrium price undetermined and quantity decreases

14. Price (RM) SS SS1 P* P1 DD DD1 Q* Quantity EFFECT OF CHANGES ONDEMAND AND SUPPLY (CON’T) SUPPLY INCREASE AND DEMAND DECREASES Case 3: Changes in different magnitude Equilibrium price decreases and quantity undetermined

15. SUPPLY DECREASES AND DEMAND INCREASES Price (RM) SS1 SS P1 P* DD1 DD Quantity Q* EFFECT OF CHANGES ONDEMAND AND SUPPLY (CON’T) Case 4: Changes in different magnitude Equilibrium price increases and quantity undetermined

16. MAXIMUM PRICE MAXIMUM PRICE TAXES SASUBSIDIES GOVERNMENT INTERVENTION GOVERNMENT INTERVENTION IN THE MARKET

17. Price Advantage Consumers purchase at lower price. SS Suppliers reduce the amount offered to Q1 but demand would rise to Q2 creating a shortage. P* • Disadvantages • Emergence of black market. • Reduction in quantity produced. • Producers tend to receive illegal payments from consumers. Price ceiling P1 The government imposes a maximum price of P1. Shortage occurs DD The equilibrium price is P* and the quantity is Q*. Q1 Q* Q2 Quantity GOVERNMENT INTERVENTION (CON’T) MAXIMUM PRICE/ CEILING PRICE Government-imposed regulations prevent prices from rising above the maximum level.

18. Price SS Surplus occurs P1 Suppliers increase the amount offered to Q2 but demand drop to Q1 creating a surplus. • Advantages • Protects producer’s income • Higher wage rate Floor price P* Disadvantages Consumers pay more. Waste of resources of production Creates unemployment DD The equilibrium price is P* and the quantity is Q*. Quantity Q2 Q1 Q* GOVERNMENT INTERVENTION (CON’T) MINIMUM PRICE/ FLOOR PRICE Government-imposed regulations prevent prices from falling below a minimum level. The government imposes a minimum price of P1

19. INDIRECT TAX Tax that is imposed by the government on producers or sellers but paid by or passed on to end-users. SS1 Tax = RM4 Price SS The equilibrium price is RM12 and the quantity is 400 units 14 CONSUMER’S SHARE The government imposes a sales tax of RM4 per carton. 12 PRODUCER’S SHARE 10 DD 200 400 Quantity EFECT OF TAXATION SS curve shift to the left from SS to SS1 and new equilibrium is RM14 and 200 units. The tax amount of RM4 is shared equally between buyer and seller.

20. Demand less elastic than supply Perfectly inelastic demand P D P S + tax (RM4) S + tax 15 S S 16 CONSUMERS’ SHARE CONSUMERS’ SHARE 12 12 PRODUCERS’ SHARE 11 D 400 O Q 400 0 Q Demand less elastic than supply Incidence of tax: elastic supply P P S + tax S + tax S S 13 12 CONSUMERS’ SHARE D 12 1 PRODUCERS’ SHARE 18 PRODUCER’ SHARE D 9 400 400 O O Q Q

21. SUBSIDY An incentive from the government to encourage producers to produce more. S Subsidy = RM10 Price S1 The equilibrium price is RM50 and the quantity is 10. 50 CONSUMER’S SHARE 45 PRODUCER’S SHARE 40 D 10 20 Quantity EFECT OF SUBSIDIES 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.

22. Demand is more elastic than supply Demand less elastic than supply P P S + tax (RM4) S 50 S S + tax CONSUMERS’ SHARE 50 CONSUMERS’ SHARE 47 43 PRODUCERS’ SHARE 40 PRODUCERS’ SHARE D 40 D 10 0 Q 1 0 O Q EFECT OF PRICE ELASTICITYON SUBSIDIES