1 - Bharathi Market Equilibrium

2 The Market Mechanism  Market Mechanism Summary 1)Supply and demand interact to determine the equilibrium price. 2) When not in equilibrium, the market will adjust to a shortage or surplus and return to the equilibrium. 3)Markets must be competitive for the mechanism to be efficient.

3 MARKET DEMAND & SUPPLY Rs Rs BUYERS P QDQDQDQDPriceMARKETDEMAND 2,0004,0007,00011,00016, SELLERS 12,00010,0007,0004,0001,000 P QSQSQSQSPriceMARKETSUPPLY EQUILIBRIUM xx

4 7 S Q o Rs.54Rs P QDQDQDQD Rs. 5 Rs. 4 Rs. 3 Rs. 2 Rs. 1 2,0004,0007,00011,00016,000 Rs.5Rs.4Rs.3Rs.2Rs.1 12,00010,0007,0004,0001,000 DP QSQSQSQS Price Quantity MarketEquilibrium Demand PriceSupply Price

5 Quantity D SE P O Q X Y The Market Mechanism Price (Rs. per unit)

6 Quantity D S P Q Price If price is above equilibrium Point-Supply exceeds Demand. P1P1Surplus The Market Mechanism

7 D S Q1Q1 Assume the price is P 1, then: 1) Quantity Supplied is > Quantity Demanded 2) Producers lower price. 3) Quantity supplied decreases 4) Equilibrium is restored P1P1Surplus Q2Q2 QuantityPrice (Rs per unit) P2P2 Q3Q3

8 The Market Mechanism D S Q1Q1 Q2Q2 P2P2 Shortage QuantityPrice (Rs. per unit) Assume the price is P 2, then: 1) Quantity Demanded is greater than quantity Supplied 2) Producers raise price. 3) Quantity supplied increases 4) Equilibrium is restored Q3Q3 P3P3 E

Change in Supply Q o D1D1D1D1 Quantity Price S1S1S1S1 S2S2S2S2 P Q1Q1Q1Q1 Q2Q2Q2Q2 P1P1P1P1 P2P2P2P2

Q o D1D1D1D1 Price S1S1S1S1 P Q1Q1Q1Q1 Q2Q2Q2Q2 P1P1P1P1 P2P2P2P2 D2D2D2D2 Change in Demand

11 Four Possibilities D1D1D1D1 D1D1D1D1 S A B C D S D1D1D1D1 D2D2D2D2 “Increase in Demand” “Decrease in Demand” “Increase in Supply” “Decrease in Suply” D P Q D P Q S QP P S Q D S1S1S1S1 D S1S1S1S1 S2S2S2S2 P2 P1 Q 1 Q 2 Q 1 Q 2 Q 2 Q 1 P2 S1S1S1S1 P1 P2P2P2P2 P1P1P1P1 P1P1P1P1 P2P2P2P2 Q 1 Q 2 Q 2 Q 1

12 P Q S1S1 D1D1 D2D2 D3D3 S3S3 S2S2S2S2 Change in Supply = Change in Demand

13 Effects of Government Intervention Price Controls  If the Government decides that the equilibrium price is too high, they may establish a maximum allowable ceiling price.

14  When a product is taxed, who ultimately shoulders the tax burden depends upon the elasticity of demand and supply of the product taxed.  Usually the tax burden is shared between producers and consumers.  Consumers pay more of the tax, if demand is relatively less elastic than supply  Producers pay more of the tax if demand is relatively more elastic than supply. TAX SHIFTING AND THE ELASTICITIES OF DEMAND AND SUPPLY

15 Price Ceilings and Price Floors  Price Ceiling is a legally established maximum price which a seller can charge or a buyer must pay. is a legally established maximum price which a seller can charge or a buyer must pay.  Price Floor is a legally established minimum price which a seller can charge or a buyer must pay. is a legally established minimum price which a seller can charge or a buyer must pay.

16 Price Ceilings  When the Government imposes a price ceiling (i.e., a legal maximum price at which a good can be sold) two outcomes are possible: The price ceiling is not binding. The price ceiling is not binding. The price ceiling is a binding constraint on the market, creating shortages. The price ceiling is a binding constraint on the market, creating shortages.

17 A Binding Price Ceiling S D Price Quantity/time PEPE QEQE Price Ceiling PCPC QSQS QDQD Shortage

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

19 Price Floors  When the Government imposes a price floor (i.e., a legal minimum price at which a good can be sold) two outcomes are possible: The price floor is not binding. The price floor is not binding. The price floor is a binding constraint on the market, creating surpluses. The price floor is a binding constraint on the market, creating surpluses.

20 A Binding Price Floor S D Price Quantity/time PEPE QEQE Price Floor PFPF QSQS QDQD Surplus

21 Market Impacts of a Price Floor  A Binding Price Floor creates... Surpluses (QS > QD) Surpluses (QS > QD) Surpluses create : Surpluses create :  Discrimination criteria set by buyers Examples: Examples:  Agricultural Price Supports

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Investors Government Firms (produce the domestic product) Consumers Financial System Rest of the World Saving (S) Consumption (C) Investment (I) C + I Government C + I + G Imports (IM) Exports (X) C + I + G + Transfers Disposable Income (DI) Taxes Gross National Income (Y) (X – IM) Purchases (G) The Circular Flow of Income

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