Market equilibrium

In this concept it is assumed that

- We have pure competition in the market
place i.e. no government intervention and no
participant in the market has any power
Market equilibrium: Where the quantity supplied and
the quantity demanded of a particular commodity is
equal at a certain price level. This leaves the market in
no excess of supply or demand and there is no
tendency for change in either price or quantity
It occurs when
Demand=supply
The market clears
There is no tendency to change
Establishing market equilibrium
Market equilibrium occurs where the
demand and supply curve intersect
Excess in demand
When there is an excess in demand, there will be an
increase in price due to the competition to obtain the
limited quantity of the product. This reduces the
demand until they reach a certain point where the
supply is in equilibrium with the demand i.e. the
market clears
Excess in supply
When there is an excess in supply (a glut in the
market) sellers offer their goods at a lower cost. The
fall in price that causes an expansion in demand and
contraction in supply (since the goods are being
purchased) this will continue until the supply is in
equilibrium with the demand.

Market mechanism achieves consistency between the
plans and outcomes for consumers and producers
without any explicit coordination.





















Changes in equilibrium 8.3
Caused by any circumstances causing the
demand or supply curve to shift
*shifts in the demand and curves are causing
by changes in condition behind supply and
demand and NOT the good its self
How an increase in demand can change equilibrium
As demand rises from D1 to D2, consumers demand
more umbrellas at the original equilibrium price OPE1.
At this price, the quantity demanded exceeds the
supply. Consequently, competition to buy the product
pushes the price up causing an expansion in the
supply curve that will meet at the new equilibrium
price QE2
A summary of other conditions that can change
equilibrium
Keys for the diagram:
S1 and D1=the original supply and
demand curves
S2 and D2- the new supply and demand
curves
PE1 and QE1= the original equilibrium
price and quantity
PE2 and DE2= the new equilibrium price
and quantity

















An increase in demand

A decrease in demand

An increase in supply









The role of the market 8.4
Price mechanism solves the economic problem in the
market economy
*the price determined gives information which can be
a solution to the questions about production,
distribution and exchange of goods and services in the
economy
Price mechanism attempts to solve the economic
problems in
1. The product market
2. The factor market
The product market
The demand curve shows the desires of individuals
whilst the supply curve represents the production of
firms with limited resources. The interaction of the
two determines a price and quantity that satisfies the
individual wants with the limited resources available,
giving a solution to the economic problem.
The factor market
The same applies to the factor market. The cost of
labour will be higher for those with a higher demand
and resources such as skills

Price mechanism is efficient because
1. Any consumer willing to purchase at the
market price will be satisfied
2. Any producer offering goods and services at
the market price will be satisfied
The competition amongst the producers also ensures
that the most cost efficient method is used so that
they maintain their profits and sell at a sensible price.




















Product market: the interaction of demand and supply of
the outputs of production
In the product market, producers will only produce what
consumers demand to maximise profits. They will also
allocate their resources to produce products in demand
since they will face a greater opportunity cost as the price
of the demanded product increases.
The quantity of a good produced is determined by the
demand and supply of resources. If the demand is high, it
will be translated through an increase in price.
From this the tastes/ preferences of consumers are
communicated with firms in the economy with-out the
need to obtain information with direct contact of
consumers
Market mechanism also guarantees allocative efficiency
(the economys ability to allocate resources to satisfy
consumer wants) because the equilibrium is met where the
demands of the consumers and the supply available meet
which effectively satisfies the consumer wants.

Government intervention in the market place
8.5
- The government intervenes because if the
market becomes dependant on the supply
and demand there will be a market failure
the equilibrium achieved by the
interactions of supply and demand may
be considered too high or too low or
some products necessary may not be
produced at all




In the graph
1. the socially optimum price level is above the
market price

price mechanism undervalues the natural
environment
2. socially optimum quantity is less than the
market level
Market forces result in the over use of
natural resources
Price intervention
If the government feels that the equilibrium met for a
commodity is too high, they will implement a price
ceiling
If the government feels that the equilibrium met for a
commodity is too low, they will implement a price
floor
*this may lead to equilibrium as the price met
discourages the supply to be produced according to
the demand







Price ceiling

Price floor


Market failure: when the price mechanism
takes account of private benefits and cost
of production to consumers but neglects
costs such as environmental damage
Price ceiling- the maximum price for a good/service
Price floor- the minimum price for a good or service

Quantity intervention
Externalities (social costs and benefits) are not
considered when some commodities are produced in
excess or deficient quantities. The government can
impose taxes or artificially restrict production levels
through laws such as the carbon tax to internalise the
externality.
The government will laws and taxes to reduce
negative externalities and give provision to those who
provide merit goods which have positive externalities
Some good and services wont be provided at all by
individual firms because they will not be profiting
from the people who are not willing to pay for
benefiting from a good/ service. So the government
will need to provide these goods for the society. E.g.
defence, police service, cleaning up water ways and
public roads.





Competition and market power 8.6
In reality, there is such thing as pure competition (the
assumption that there is a large number of firms in
each industry and no firm has the market power to
raise prices above the equilibrium). In most industries,
firms enjoy some degree of market power which
results in a price higher than its equilibrium price and
lower equilibrium quantity that would occur in a pure
competition scenario.
In reality, the degree of competition in an industry in
mostly influenced by market structure (the number
and relative size of firms, the nature of the product
being sold and the ease with which new firms can
enter in that industry









P.T.O







Problem Government
action
Out come
Market price
too high
Price ceiling Reduces price, quantity
storage (disequilibrium)
Market price
too low
Price floor Increases price, quantity
in excess
(disequilibrium)
Market
quantity too
high
(negative
externalities)
Taxes Increases equilibrium
price, reduces
equilibrium quantity
Market
quantity too
low
(positive
externalities)
Subsidies Reduces equilibrium
price, reduces
equilibrium quantity
Market does
not provide
good or
service
(public
goods)
Government
provides good
or service
Government must
collect taxation revenue
to finance its supply

Competition Conditions characterising the competition Comments
Pure competition

The utopian structure
there are many small buyers in which none are
sufficiently large enough to influence market
price
products sold by all firms are homogenous (all
the same)
all buyers and sellers know the product is
homogenous and know the price the product
sells for throughout the market
buyers dont gain any cost saving advantages/
disadvantages from moving to another supplier
there are no barriers to entering or leaving the
market
sellers can sell as much of their product at the
market price
- firms are price takers
they must
accept the price
determined by
the forces of
supply and
demand
- if seller try to sell
above the given
price, no one would
buy it
- if the sellers try to
sell at a lower price
it would not be
profit maximising
- advertising is useless
Monopolistic
competition
The sub boss
Imperfect competition
there is a large number of relatively small firms
products sold in markets are similar but not
identical
firms engage in product differentiation
packaging their product differently
the differentiation in packaging gives some
degree of price setting power
there are barriers to entering the market
firms have existing loyal customers who
consider that their firm supplies the best
products (also called brand loyalty)

No firm is a monopolist (a
firm that possesses great
power because of its
products that are exclusive
to the company only)
because there are firms that
offer many substitutes of it

Advertising has a great role
in attracting new customers

Some examples are
hairdressers and restaurants

Monopoly
The boss
there is only one firm selling the product
there is no market competition at all
the product sold has no close substitutes
there are significant barriers which prevents any
potential competitors from entering the market
Unlike pure competitors,
they are the price setters.
Advertising is used to
maintain product image

Oligopoly there are only a few relatively large firms, each
with a significant share of the market
they sell similar but differentiated products
there are significant barriers to entry which is
why there are only a few firms in the industry

They monitor the behaviour
of other rival firms as it need
to very carefully consider the
reaction of its competitors
whenever it decides to
change its pricing or output
policies
They compete via advertising
campaigns/ promotive
behaviours