DEFINITION OF MARKET

EQUILIBRIUM

Market equilibrium is a situation where

quantity demanded and quantity
supplied are equal and there is no
price or quantity to change.

QDD = QSS
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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
6
SURPLUS (QSS > QDD)
5

4
E
P*
3
Price

SS
2
DD

1
SHORTAGE (QDD > QSS)
Q*
0
2 4 6 8 10
Quantity
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 GRAPHICAL ILLUSTRATION OF
EQUILIBRIUM PRICE AND
OUTPUT(CON’T)
(1) (2) (3) (4) (5)
Price (RM) Quantity Quantity Market Market
Demanded Supplied Condition Prices
(units) (units)
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

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 MATHEMATICAL EQUATION OF
EQUILIBRIUM PRICE OUTPUT (CON’T)
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
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 MATHEMATICAL EQUATION OF
EQUILIBRIUM PRICE OUTPUT (CON’T)
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.

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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.

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MICROECONOMICS 73– 7
 EFFECT OF CHANGES ON
DEMAND
ASSUME THAT SUPPLY IS CONSTANT
Increase in
Price (RM) Demand
SS DD curve shifts to
the right
P1
Equilibrium price
and quantity
Decrease in P* increases
Demand
P2 DD1
DD curve shifts to
the left
DD
Equilibrium price
DD2
and quantity
Quantity
decreases Q2 Q* Q1

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EFFECT OF CHANGES ON SUPPLY
ASSUME THAT DEMAND IS CONSTANT

Price (RM) Increase in Supply

SS2
SS curve shifts to the
SS right
Equilibrium price
P2 decreases and
Decrease in SS1 quantity increases
P*
Supply
SS curve shifts to P1
the left
Equilibrium price DD
increases and
quantity Quantity
Q2 Q* Q1
decreases

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 EFFECT OF CHANGES ON
DEMAND AND SUPPLY
SUPPLY AND DEMAND INCREASE

Price (RM)
DD1
Case 1: Increase at
SS same magnitude
Equilibrium price
undetermined and
quantity increases
P* SS1U

DD
Quantity
Q* Q1

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 EFFECT OF CHANGES ON
DEMAND AND SUPPLY (CON’T)
SUPPLY AND DEMAND DECREASE

Price (RM)
Case 2: Decrease at
SS1 same magnitude
SS Equilibrium price
undetermined and quantity
decreases
P*

DD
DD1
Quantity
Q1 Q*

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 EFFECT OF CHANGES ON
DEMAND AND SUPPLY (CON’T)
SUPPLY INCREASE AND DEMAND DECREASES
Price (RM)
Case 3: Changes in
SS different magnitude
SS1 Equilibrium price decreases
and quantity undetermined
P*

P1

DD1 DD

Q* Quantity

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 EFFECT OF CHANGES ON
DEMAND AND SUPPLY (CON’T)
SUPPLY DECREASES AND DEMAND INCREASES
Price (RM)

SS1 Case 4: Changes in

SS different magnitude
Equilibrium price increases
P1 and quantity undetermined

P*
DD1

DD
Quantity
Q*

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 GOVERNMENT INTERVENTION

MAXIMUM PRICE MAXIMUM PRICE

GOVERNMENT INTERVENTION IN
THE MARKET

TAXES SASUBSIDIES

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 GOVERNMENT INTERVENTION
(CON’T)
Advantage MAXIMUM PRICE/
Price
Consumers purchase SS CEILING PRICE
at lower price. Government-imposed
regulations prevent prices
from rising above the
maximum level.

Suppliers reduce the amount

Disadvantages P* offered to Q1 but demand
• Emergence of would rise to Q2 creating a
black market. shortage.
• Reduction in Price
P1
quantity The government imposes a
produced. ceiling
maximum price of P1.
• Producers tend Shortage occurs
to receive illegal
payments from DD The equilibrium price is P*
consumers. and the quantity is Q*.
Q1 Q* Q2 Quantity
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 GOVERNMENT INTERVENTION
(CON’T)
Price MINIMUM PRICE/ FLOOR PRICE
SS Government-imposed regulations
Surplus occurs prevent prices from falling below a
minimum level.

Advantages P1 Suppliers increase the amount

Floor price offered to Q2 but demand drop to
• Protects Q1 creating a surplus.
producer’s P*
income The government imposes a
• Higher minimum price of P1
wage rate
Disadvantages
Consumers pay more. Waste of
resources of production
DD Creates unemployment
The equilibrium
price is P* and Q1 Q* Q2 Quantity
the quantity is
Q*.

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 EFECT OF TAXATION
INDIRECT TAX

4
SS1

RM
Tax that is imposed by the government
on producers or sellers but paid by or

=
Price passed on to end-users.

x
SS

Ta
The equilibrium price is RM12 and the
quantity is 400 units
14
CONSUME
R’S The government imposes a sales tax of
SHARE RM4 per carton.
12 PRODUCE
R’S
10 SHARE 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

DD equally between buyer and seller.
200 400 Quantity
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 Demand less elastic than supply Perfectly inelastic demand
P
P D
S + tax (RM4)

15 S + tax
S S
16
CONSUMERS’
CONSUMERS’
SHARE
SHARE
12
12
PRODUCERS’ SHARE
11

D
O 400 Q
0 400 Q

Demand less elastic than supply Incidence of tax: elastic supply

P S + tax P

S + tax
S
S

13
12
CONSUMERS’ SHARE 121 D
PRODUCERS’
18 SHARE
PRODUCER’ SHARE
D
9

O 400 Q O 400 Q
 EFECT OF SUBSIDIES

10
SUBSIDY

M
R
S An incentive from the government to

=
dy
encourage producers to produce
Price

i
bs
S1 more.

Su
The equilibrium price is RM50 and
the quantity is 10.

50 CONSUME
R’S The government provides a subsidy
SHARE of RM10 per unit.
45 PRODUCE
R’S SS curve shift right from SS to SS1
SHARE
40 and new equilibrium is RM45 and
20 units.

The subsidy amount of RM10 is

shared equally between buyer and
D seller.
10 20 Quantity

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 EFECT OF PRICE ELASTICITY
ON SUBSIDIES
Demand is more elastic than supply Demand less elastic than supply
P P
S + tax (RM4)
S
50
S + tax S
CONSUMERS’
SHARE
50
47 CONSUMERS’ SHARE
43
PRODUCERS’ SHARE
40
PRODUCERS’ SHARE
D
40
D

O 10
0 10 Q
Q

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