Market Equilibrium

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# Market Equilibrium - PowerPoint PPT Presentation

CHAPTER. 3. Market Equilibrium. Market equilibrium is a situation where quantity demanded and quantity supplied are equal and there is no price or quantity to change. DEFINITION OF MARKET EQUILIBRIUM. Q DD = Q SS. EQUILIBRIUM PRICE AND OUTPUT.

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Presentation Transcript

CHAPTER

3

Market Equilibrium

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

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.

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

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)

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)

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

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

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

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

SUPPLY AND DEMAND DECREASEEFFECT 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

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

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

MAXIMUM PRICE

MAXIMUM PRICE

TAXES

SASUBSIDIES

GOVERNMENT INTERVENTION

GOVERNMENT INTERVENTION IN THE MARKET

Price

Consumers purchase at lower price.

SS

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

P*

• 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.

Price

SS

Surplus occurs

P1

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

• Protects producer’s income
• Higher wage rate

Floor price

P*

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

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.

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

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.

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