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CHAPTER

3 Market Equilibrium
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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)

Price

4
3

P*

SS
2

DD

SHORTAGE (QDD > QSS)

Q*

0
2

10

Quantity
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GRAPHICAL ILLUSTRATION OF
EQUILIBRIUM PRICE AND
OUTPUT(CONT)
(1)
Price (RM)

(2)
Quantity
Demanded
(units)

(3)
Quantity
Supplied
(units)

(4)
Market
Condition

(5)
Market
Prices

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 (CONT)
The market demand and supply functions are given below:
Market demand, QDD
Market supply, QSS

= 38000 4000P (equation 1)

= 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 (CONT)
Substitute P = 8 into equation 1 and 2 to obtain the
quantity.
QDD
QSS

=
=
=
=

38000 4000(8)
6000 units.
26000 + 4000(8)
6000 units.

(equation 1)
(equation 2)

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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EFFECT OF CHANGES ON
DEMAND
ASSUME THAT SUPPLY IS CONSTANT
Increase in
Demand

Price (RM)

DD curve shifts to
the right

SS
P1

Decrease in
Demand
DD curve shifts to
the left

Equilibrium price
and quantity
increases

P*
DD1

P2

Equilibrium price
and quantity
decreases
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DD

DD2
Q2

Q*

Q1

Quantity
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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

right

SS
P2
Decrease in
Supply

P*

SS curve shifts to
the left

P1

Equilibrium price
increases and
quantity
decreases
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SS1

Equilibrium price
decreases and
quantity increases

DD
Q2

Q*

Q1

Quantity

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EFFECT OF CHANGES ON
DEMAND AND SUPPLY
SUPPLY AND DEMAND INCREASE
Price (RM)

DD1

Case 1: Increase at
same magnitude

SS

P*

SS1U

Equilibrium price
undetermined and
quantity increases

DD
Quantity
Q*
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Q1
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EFFECT OF CHANGES ON
DEMAND AND SUPPLY (CONT)
SUPPLY AND DEMAND DECREASE

Price (RM)

Case 2: Decrease at
same magnitude

SS1
SS
P*

Equilibrium price
undetermined and quantity
decreases

DD
DD1
Q1
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Q*

Quantity

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EFFECT OF CHANGES ON
DEMAND AND SUPPLY (CONT)
SUPPLY INCREASE AND DEMAND DECREASES

Price (RM)

Case 3: Changes in
different magnitude

SS
SS1
P*

Equilibrium price decreases

and quantity undetermined

P1
DD1
Q*
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DD
Quantity
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EFFECT OF CHANGES ON
DEMAND AND SUPPLY (CONT)
SUPPLY DECREASES AND DEMAND INCREASES
Price (RM)
SS1

Equilibrium price increases

SS

and quantity undetermined

P1
P*

DD1
DD
Q*

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Case 4: Changes in
different magnitude

Quantity

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GOVERNMENT INTERVENTION
MAXIMUM PRICE

MAXIMUM PRICE

GOVERNMENT INTERVENTION IN
THE MARKET

TAXES
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SASUBSIDIES
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GOVERNMENT INTERVENTION
(CONT)
Price

Disadvantages

Advantage
Consumers purchase
at lower price.

MAXIMUM PRICE/
CEILING PRICE
Government-imposed
regulations prevent prices
from rising above the
maximum level.

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
Shortage occurs
Q1

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Q*

Q2

DD

The government imposes a

maximum price of P1.
The equilibrium price is P*
and the quantity is Q*.

Quantity

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GOVERNMENT INTERVENTION
(CONT)
Price

SS

Surplus occurs
Advantages

P1

Protects
producers
income

P*

Floor price

Suppliers increase the amount

offered to Q2 but demand drop to
Q1 creating a surplus.
The government imposes a
minimum price of P1

Higher
wage rate

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

MINIMUM PRICE/ FLOOR PRICE

Government-imposed regulations
prevent prices from falling below a
minimum level.

DD
Q1

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Q*

Q2

Disadvantages
Consumers pay more. Waste of
resources of production
Creates unemployment

Quantity

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EFECT OF TAXATION
RM
4

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

SS1
Ta
x

Price

SS

The equilibrium price is RM12 and the

quantity is 400 units

14
12
10

CONSUME
RS
SHARE
PRODUCE
RS
SHARE

The government imposes a sales tax of

RM4 per carton.
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.

DD
200 400
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Perfectly inelastic demand

Demand less elastic than supply

P

S + tax (RM4)

S + tax

15

16
CONSUMERS
SHARE

CONSUMERS
SHARE
12

12

PRODUCERS SHARE

11

D
400

Demand less elastic than supply

P

400

Incidence of tax: elastic supply

P

S + tax

S + tax
S

13
CONSUMERS SHARE
12

121
18

PRODUCER SHARE

D
PRODUCERS
SHARE

400

400

10

EFECT OF SUBSIDIES
=

Su
bs
i

Price

An incentive from the government to

encourage producers to produce
more.

dy

SUBSIDY

S1

The equilibrium price is RM50 and

the quantity is 10.

50
45
40

CONSUME
RS
SHARE
PRODUCE
RS
SHARE

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.

D
10

20

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EFECT OF PRICE ELASTICITY

ON SUBSIDIES
Demand is more elastic than supply

Demand less elastic than supply

P

S + tax (RM4)

S
50

S + tax

S
CONSUMERS
SHARE

50
47 CONSUMERS SHARE

43
40

PRODUCERS SHARE

PRODUCERS SHARE

D
40
D
O

10

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Q
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