Market Equilibrium

-Dexy Kent Dulcesimo L. Barillo

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• Supply and demand interact to deter
mine the equilibrium price.
• When not in equilibrium, the market
will adjust to a shortage or surplus and
return to the equilibrium.
• Markets must be competitive for the
mechanism to be efficient.

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 Properties
 The behavior of agents is consistent.

 No agent has an incentive to change its

behavior.

 Equilibrium is the outcome of some dynamic

process

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MARKET DEMAND & SUPPLY

Price Price
MARKET MARKET
P QD 200 DEMAND P QS 200 SUPPLY

Rs.5 10 B 2,000 Rs.5 60 S 12,000

4
3
20
35 x U
Y
E
4,000
7,000
4
3
50
35
x E
L
L
10,000
7,000
2 55 11,000 2 20 4,000
R E
1 80 16,000 1 5 1,000
S R
S

EQUILIBRIUM 4
 MARKET DEMAND & SUPPLY
Price

Price Rs.5
Demand S Price Supply

P QD P Q
4
Rs.5 2,000 Market Rs.5 S12,000
Equilibrium
Rs.4 4,000
Rs3 Rs.4 10,000
Rs.3 7,000 Rs.3 7,000
Rs.2 11,0002 Rs.2 4,000
Rs.1 16,000 Rs.1 1,000
1
D
o 2 4 6 78 10 12 14 16 Q
5

Quantity
 Y
S
Price
(Rs. per unit)

P E

Quantity 6
O Q X
 Price
S
(Rs. per unit)
Surplus
P1
If price is above equilibrium
Point-Supply exceeds
P Demand.

Q Quantity
7
 Price
S
(Rs per unit)
Surplus
P1
Assume the price is P1 , then:
1) Quantity Supplied is > Quantit
y Demanded
P2 2) Producers lower price.
3) Quantity supplied decreases
4) Equilibrium is restored

Q1 Q3 Q2 Quantity
8
 Price
(Rs. per unit) S

E Assume the price is P2, then:

1) Quantity Demanded is greater
than quantity Supplied
P3 2) Producers raise price.
3) Quantity supplied increases 4
) Equilibrium is restored

P2
Shortage
D

Q1 Q3 Q2 Quantity
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 Change in Supply

P D1 S1
S2
Price

P2

P1

o Q2 Q1 Q
Quantity
 Change in Demand

D2 S1
P D1

P2
Price

P1

o Q1 Q2 Q
 D P Q D P Q
A D1
D1 D1 S S
B
P2 D2
P1
P1
P2

“Increase in Demand” Q1 Q2 Q2 Q1 “Decrease in Demand”

Four Possibilities
S P Q S P Q
D D
D S2
C S1
S1 P2
P2 S1 P1
P1

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“Increase in Supply” Q1 Q2 Q2 Q1
“Decrease in Suply”
Change in Supply = Change in Demand

D2 S3
D1
S1
D3 S2

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 Effects of Government Intervention
Price Controls

 If the Government decides that the equil

ibrium price is too high, they may establ
ish a maximum allowable ceiling price.

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TAX SHIFTING AND THE ELASTICITIES
OF DEMAND AND SUPPLY

 When a product is taxed, who ultimately sho

ulders the tax burden depends upon the ela
sticity of demand and supply of the product
taxed.
 Usually the tax burden is shared between pr
oducers and consumers.
 Consumers pay more of the tax, if demand i
s relatively less elastic than supply
 Producers pay more of the tax if demand is
relatively more elastic than supply.
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 Price Ceilings
and Price Floors
 Price Ceiling
 is a legally established maximum pri
ce which a seller can charge or a buy
er must pay.

 Price Floor
 is a legally established minimum pric
e which a seller can charge or a buye
r must pay.

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 Price Ceilings
 When the Government imposes a
price ceiling (i.e., a legal maximu
m price at which a good can be so
ld) two outcomes are possible:
 The price ceiling is not binding.
 The price ceiling is a binding constrai
nt on the market, creating shortages
.

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A Binding Price Ceiling
Price
S

Price
PE Ceiling

PC
Shortage
D

Q QE Q Quantity/time
S D 18
 Market Impacts
of a Price Ceiling
 A Binding Price Ceiling creates. . .
 Shortages (QD > QS)
 Shortages create :
 Queuing
 Discrimination criteria set by sellers
 Bundled pricing with other goods
 Bribery/corruption

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 Price Floors

 When the Government imposes a pr

ice floor (i.e., a legal minimum price
at which a good can be sold) two ou
tcomes are possible:
 The price floor is not binding.
 The price floor is a binding constraint o
n the market, creating surpluses.

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 A Binding Price Floor

Price S
Surplus

PF
Price Floor
PE

Q QE Q Quantity/time
D S
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 Market Impacts
of a Price Floor

 A Binding Price Floor creates. . .

 Surpluses (QS > QD)
 Surpluses create :
 Discrimination criteria set by buyers
 Examples:
 Agricultural Price Supports

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23
The Circular Flow of Income
Rest of the
Financial System World

3
2

4
Investors

Consumers 1

Government

5 Firms
(produce the
6 domestic product)

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