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FINC 304


Session 3 – Market Equilibrium


Contact Information:

College of Education
School of Continuing and Distance Education
2014/2015 – 2016/2017
Session Overview
• We have looked at the behavior of the consumer separately
through the concept of demand and the behavior of the
producer separately through the concept of supply. In the real
market, the producer and the consumer will interact. Through
their interaction, sometimes, how much consumers are willing
to buy will be more than what producers are willing to put on
the market for sale. Other times, how much producers will
want to put on the market for sale will exceed that of
consumers. There will be one price at which how much
consumers are willing to put on the market for sale is just
equal to how much consumers are willing to buy. This is the
equilibrium price. This price gives a state of rest and will have
no tendency to change unless an external shock occurs.

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Session Outline
The key topic to be covered in the session are as follows:
• Market Equilibrium

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Reading List
• Baye Michael and Prince Jeffery : Managerial Economics and
Business Strategy, Chapter 2

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Following increased demand for organic dairy products and Guernsey dairy
products in particular, Lakenham Crearmery , a small but rapidly growing
company that supplies ice cream to major stores in London and East Anglia,
has initiated plans to expand its Norkfolk Country ice cream selections by
introducing organic ice cream made entirely from imported Guernsey milk
and cream.
Lakenham Crearmery’s current workforce is not large enough to produce the
new ice cream selections. As a result, Nigel Stewart, the company’s Human
Resource director, has taken proper measures by interviewing a large number
of candidates in an attempt to increase the company’s workforce by 25
percent. The company owner, Mary Hatchins, while watching the BBC News,
learned that weather conditions, which involved strong winds, heavy rain,
and poor crop harvests resulted in a drastic reduction in cattle feed,
prompting Guernsey Dairy, the primary dairy producer in the British Channel
Island of Guernsey, to suspend its production of organic milk. Mary
immediately contacted Nigel to ask him to postpone the company’s plans to
increase the workforce. Did Mary make the right call?

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Market Equilibrium
• Market equilibrium occurs when there is no
tendency for the price to rise or fall. It is a state of
• It occurs when at the going market price the
quantity demanded equals the quantity supplied
• consumers want to buy as much producers want to sell
• ie. Quantity demanded is just equal to the quantity supplied

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• Consider the following demand and supply

functions for fries.
• Qx = −188 + 12Px
• Qx = 143 − 3Px
• Differentiate the demand
function from the
supply function
• Draw the D & S functions for fries in the
• What is the equilibrium price? Quantity?
• Calculate the consumer and producer surpluses

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Market Equilibrium: Example
• In equilibrium: Qd = Qs =>
−188 + 12Px = 143 − 3Px
• P=22.07
• Q=76.8

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Consumer and Producer Surpluses

• The consumer surplus is the right angled-

triangle on top. Area of this right angled triangle
gives the consumer surplus. Area is given by
half *base*height
• Consumer surplus: 1/2*76.8*25.6 = 983.04
Producer Surplus is the right-angled triangle
• Producer surplus: 1/2*76.8*6.4 = 245.76

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What Causes a Change in the Price of a
• If the equilibrium price is supposed to be a state of
rest, what causes prices to change in reality?
Equilibrium price will change if:
1. Any factor that causes demand to change apart
from the price changes
2. Any factor which causes supply to change apart
from the price changes
3. Any factor which causes both demand and supply to
change at the same

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A change in Demand
• When any of the determinants of demand (apart from the good’s
own price) changes, it causes a change in demand
• ie a rightward or leftward shift of the demand curve

• Such changes in demand will affect the equilibrium price and


• For instance a change in income, price of related commodities,

size of the market, taste and preferences will all shift the demand
curve and affect the equilibrium price and quantity

• Example: Assume that price of milo rises, how will this affect the
market equilibrium for “this way” chocolate drink?

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A Change in Supply
• As with demand, a change in any of the
determinants of supply apart from the good’s own
price will shift the supply curve and affect the market
• Recall the supply shifters include technology, price of inputs,
government taxes and subsidies

• Example, suppose the price of maize increase due

to heavy rainfall. How will this affect the market
equilibrium of wheat?

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Answer to Headline
• Mary realized that the suspension of organic milk
production would lead to a higher price of milk. Since
milk is a key input in the production of ice cream, an
increase in the price of milk will lead to a decrease in
the market supply of ice cream. As a result, the
quantity of ice cream sold in the market falls as the
equilibrium changes. Mary made the right call

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