Theory of

Market Equilibrium

PowerPoint Slides
by Ambigah d/0 Sandran
LEARNING OBJECTIVES

Student will be able to learn:

How the market system determine the
equilibrium price and quantity.
How changes in demand and supply can
influence the market price and output.
Define the effect of government in market
system fixing minimum price and maximum
price.
Define the concept of consumer surplus and
producer surplus.
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LEARNING OUTCOMES
At the end of the lesson, students should be able to:
Explain the market system determine the
equilibrium price and quantity.
Explain how changes in demand and supply can
influence the market price and output.
Explain the effect of government intervention in
market system by setting minimum price and
maximum price
Explain the concept of consumer surplus and
producer surplus
3
 INTRODUCTION
Demand and supply together make a market.

A market exists when buyers and sellers interact

bringing into play the laws of demand and
supply.

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 DEFINITION OF
MARKET EQUILIBRIUM

Market equilibrium is a situation in which

there is no tendency for price or quantity to
change. Therefore, in a condition of
equilibrium, price and quantity are stable.
A market is in equilibrium when the market
demand curve and the market supply curve
intersect.

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 MARKET EQUILIBRIUM

Market equilibrium refers to the interactions

between demand and supply in the market,
causing the quantity demanded to become
equal to the quantity supplied at a certain
price.
The price at the point of equilibrium is known
as the equilibrium price, while the quantity at
the point of equilibrium is known as the
equilibrium quantity. However, the point of
equilibrium is not stable or permanent.

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 Market Equilibrium

Market
DD = SS
intercept
Buyers = Sellers

To determined the equilibrium price and

equilibrium quantity of goods and servicers.
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 EQUILIBRIUM PRICE AND OUTPUT
Figure 1: Determined Of Equilibrium Price (P*) and Output
(Q*)
Price
S

P* E

D
Quantity
8

0 Q*
 SURPLUS AND SHORTAGE
Figure 2 : Determinant of Surplus and Shortage in a Market

Surplus (Qs > Qd)

Price
S

P* E

Shortage (Qd >Qs) 9

Quantity
0 Q*
 EQUILIBRIUM PRICE, OUTPUT,
SURPLUS AND SHORTAGE
Table 1: Determinant of equilibrium price and quantity,
shortage and surplus.

Price Qd Qs Market Market price

(RM) (units) (units) condition
5 2 10 Surplus Falls
4 4 8 Surplus Falls
3 6 6 Equilibrium Equilibrium
2 8 4 Shortage Rises
1 10 2 Shortage Rises
10

Deviga & Karunagaran, 2010, pp. 64

 Demand
shift but
supply
constant

Changes in
equilibrium
price and
Demand and output Supply shift
supply shift happen but demand
simultaneously constant
when :

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 CHANGES IN EQUILIBRIUM
PRICE AND OUTPUT:
A) DEMAND SHIFT, SUPPLY CONSTANT

Demand can arise or fall because of:

1. Change in consumers income

2. Change in taste/ preferences

3. Change in price of substitutes or complement

4. Change in future price

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 CHANGES IN EQUILIBRIUM
PRICE AND OUTPUT:
A) DEMAND SHIFT, SUPPLY CONSTANT

Figure 3: Increase in Demand

Price

S
E1
P1
Eo

Po shortage D1

Do
13
Quantity
0 Qo Q1
Deviga & Karunagaran, 2010, pp. 67
 CHANGES IN EQUILIBRIUM
PRICE AND OUTPUT:
A) DEMAND SHIFT, SUPPLY CONSTANT

Figure 4: Decrease in Demand

Price

S
surplus Eo

Po
E2

P2 Do

D2
14
Quantity
0 Q2 Qo
Deviga & Karunagaran, 2010, pp. 67
 CHANGES IN EQUILIBRIUM
PRICE AND OUTPUT:
B) SUPPLY SHIFT, DEMAND CONSTANT

Supply can arise or fall because of:

1. Change in consumers income
2. Change in taste/ preferences
3. Change in price of substitutes or
complement
4. Change in future price

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 CHANGES IN EQUILIBRIUM
PRICE AND OUTPUT:
B) SUPPLY SHIFT, DEMAND CONSTANT

Figure 5: Increase in Supply

Price
So

S1
Eo surplus
Po E1

P2
D
16
Quantity
0 Qo Q2
Deviga & Karunagaran, 2010, pp. 68
 CHANGES IN EQUILIBRIUM
PRICE AND OUTPUT:
B) SUPPLY SHIFT, DEMAND CONSTANT

Figure 6: Decrease in Supply

Price
S2

So
E2

Po Eo

Shortage
P2
D

17
Quantity
0 Qo Q2
Deviga & Karunagaran, 2010, pp. 68
 Changes in Equilibrium
Price and Output:
c) Supply and demand shift simultaneously

Figure 7: Both Demand and Supply Increase

Price
So

S1

D1
Do
18
Quantity
0 Qo Q1
Deviga & Karunagaran, 2010, pp. 69
 Changes in
Equilibrium Price and Output:
c) Supply and demand shift simultaneously

Figure 8: Both Demand and Supply Decrease

Price
S2

So

Do
D2
19
Quantity
0 Q2 Qo
Deviga & Karunagaran, 2010, pp. 69
 Changes in
Equilibrium Price and Output:
c) Supply and demand shift simultaneously
Figure 9: Magnitude shift of supply (increase) is greater that demand
shift (increase), equilibrium price falls and equilibrium quantity rises
Price
So
S
Eo
Po E1 1

P1
D1
Do
20
Quantity
0 Qo Q1
Deviga & Karunagaran, 2010, pp. 70
 Changes in
Equilibrium Price and Output:
c) Supply and demand shift simultaneously

Figure 10: Magnitude shift (increase) of demand is greater that supply

shift (increase), equilibrium price rises and equilibrium quantity rises

Price

So
S1

P1
Po
D1
Do 21

Quantity
0 Qo Q1
Deviga & Karunagaran, 2010, pp. 70
 Changes in
Equilibrium Price and Output:
c) Supply and demand shift simultaneously

Figure 11: Supply Increase and Demand Decreases

Price
So
Eo S1
Po

P1
Do
D1
22

Quantity
0 Q
Deviga & Karunagaran, 2010, pp. 70
 Changes in
Equilibrium Price and Output:
c) Supply and demand shift simultaneously

Figure 12: Supply Decreases and Demand Increase

Price
S1

So
P1

Po Eo
D1
Do
Quantity 23

0 Q
Deviga & Karunagaran, 2010, pp. 70
 Changes in
Equilibrium Price and Output:
c) Supply and demand shift simultaneously

Figure 13: Magnitude shift (increase) of supply is greater than demand

shift (decrease), equilibrium price falls and equilibrium quantity rises
Price
So
Eo S1
Po
E1
P1
Do
D1
24
Quantity
0 Qo Q1
Deviga & Karunagaran, 2010, pp. 70
 Changes in
Equilibrium Price and Output:
c) Supply and demand shift simultaneously

Figure 14: Magnitude shift (decrease) of demand is greater than supply

shift (increase), equilibrium price falls and equilibrium quantity falls
Price

So
S1

Po
P1
Do
D1
25

Quantity
0 Q1 Qo
Deviga & Karunagaran, 2010, pp. 70
 Government
Intervention in the
Market

Maximum Price Minimum Price

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Government Intervention in the Market

The government controls and fixed prices for certain

goods and services.
For example sugar, rice, cooking oil, cement and
others.
Government determines the price and not the price
mechanism.
There are two types of price control: ceiling price
(maximum price) and floor price (minimum price).

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 Government Intervention in the Market:
Ceiling Price
Ceiling price is a government imposed regulation that
prevents the prices from rising above a maximum level
as set by the government.
Ceiling price = maximum price.

The ceiling price applied to keep the price below the

equilibrium level.
Shortage occurs.

Price is not allowed to rise.

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 Government Intervention in the Market:
Ceiling Price

Advantages
consumer purchases products
at a lower price.
Disadvantages
emergence of black market
reduce quantity produced
producers tend to receive illegal
payments from consumers

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Government Intervention in the Market:
Ceiling Price
Figure 15 : Ceiling price

Price
S

P* E

Ceiling price
D

Shortage (Qd >Qs) 30

Quantity
0 Q*
Government Intervention in the Market:
Floor Price

Floor price is a government imposed regulation that

prevents prices from falling below minimum level set
by government.
Floor price = minimum price.

Surplus occurs.

Price is not allowed to fall.

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 Government Intervention in the Market:
Floor Price

Advantages Disadvantages
Protects producers income Consumer pay more
Higher wage rate waste of resources of production
Creates unemployment

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Government Intervention in the Market:
Floor Price
Figure 16 : Floor price

Surplus (Qs >Qd)

Price
S
Floor price

P* E

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Quantity
0 Q*
SUMMARY
Market equilibrium is a condition in which there is no
tendency for price or quantity to change.
Surplus occurs when the quantity supplied is greater
than the quantity demanded at a certain price.
Excess supply will cause the price of the goods to fall,
the quantity supplied to contract and the quantity
demanded to expand.
Shortage occurs when the quantity demanded greater
than the quantity supplied at a certain price.
Excess demand will cause the price of the goods to
rise, the quantity supplied to expand and the quantity
demanded to contract.
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KEY TERMS:
Term Definition

Market Exist when quantity demanded equal quantity

equilibrium supplied.

Occurs when quantity demanded is greater than

Shortage
quantity supplied.

Occurs when quantity supplied is greater than

Surplus
quantity demanded.
Government imposed regulations that prevent
Ceiling price prices from rising above a maximum level set by the
government which can lead to shortage.
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KEY TERMS:
Term Definition
Government imposed regulations that prevent
Floor price prices from falling below a minimum level set by the
government which can lead to surplus.

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