2. CHAPTER 3
Market Equilibrium

3. 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

4. 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.

5. GRAPHICAL ILLUSTRATION OF EQUILIBRIUM PRICE AND OUTPUT
A Graphical illustration 1 2 3 4 5 6
Price
Quantity 8 10
SURPLUS (QSS > QDD) E SS DD P* Q*
SHORTAGE (QDD > QSS)

6. GRAPHICAL ILLUSTRATION OF EQUILIBRIUM PRICE AND OUTPUT(CON’T)
(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
8.00
6000
EQUILIBRIUM
Equilibrium
7.50
SHORTAGE
Rises
7.00

7. MATHEMATICAL EQUATION OF EQUILIBRIUM PRICE OUTPUT (CON’T)
The market demand and supply functions are given below: Market demand, QDD = – 4000P (equation 1) Market supply, QSS = – P (equation 2) To find market equilibrium price and quantity, QDD = QSS QDD = QSS – 4000P = – P 8000P = P = RM8.00

8. MATHEMATICAL EQUATION OF EQUILIBRIUM PRICE OUTPUT (CON’T)
Substitute P = 8 into equation 1 and 2 to obtain the quantity. QDD = – 4000(8) (equation 1) = 6000 units. QSS = – (8) (equation 2) So, the equilibrium quantity, Q = 6000 units.

9. 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.
MICROECONOMICS

10. EFFECT OF CHANGES ON DEMAND
ASSUME THAT SUPPLY IS CONSTANT
Increase in Demand
DD curve shifts to the right
Equilibrium price and quantity increases
Price (RM) P1 P* P2 Q2 Q* Q1 SS
DD1 DD
DD2
Quantity
Decrease in Demand
DD curve shifts to the left
Equilibrium price and quantity decreases

11. EFFECT OF CHANGES ON SUPPLY ASSUME THAT DEMAND IS CONSTANT
Quantity
Price (RM) P2 P* P1 Q2 Q* Q1 SS
SS1 DD
SS2
Increase in Supply
SS curve shifts to the right
Equilibrium price decreases and quantity increases
Decrease in Supply
SS curve shifts to the left
Equilibrium price increases and quantity decreases

12. EFFECT OF CHANGES ON DEMAND AND SUPPLY
SUPPLY AND DEMAND INCREASE
Quantity
Price (RM) P* Q* Q1 SS
SS1U DD
DD1
Case 1: Increase at same magnitude
Equilibrium price undetermined and quantity increases
THIS CONCEPT CAN APPLY WHEN BOTH DEMAND AND SUPPLY BOTH DECREASE.

13. EFFECT OF CHANGES ON DEMAND AND SUPPLY (CON’T)
SUPPLY AND DEMAND DECREASE
Quantity
Price (RM) P* Q1 Q*
SS1 SS DD
DD1
Case 2: Decrease at same magnitude
Equilibrium price undetermined and quantity decreases
THIS CONCEPT CAN APPLY WHEN BOTH DEMAND AND SUPPLY BOTH DECREASE.

14. EFFECT OF CHANGES ON DEMAND AND SUPPLY (CON’T)
SUPPLY INCREASE AND DEMAND DECREASES
Price (RM) P* Q* SS
SS1 DD
DD1
Quantity P1
Case 3: Changes in different magnitude
Equilibrium price decreases and quantity undetermined
THIS CONCEPT CAN APPLY WHEN BOTH DEMAND AND SUPPLY BOTH DECREASE.

15. EFFECT OF CHANGES ON DEMAND AND SUPPLY (CON’T)
SUPPLY DECREASES AND DEMAND INCREASES
Price (RM) Q* P* SS
SS1 DD
DD1
Quantity P1
Case 4: Changes in different magnitude
Equilibrium price increases and quantity undetermined
THIS CONCEPT CAN APPLY WHEN BOTH DEMAND AND SUPPLY BOTH DECREASE.

16. GOVERNMENT INTERVENTION GOVERNMENT INTERVENTION IN THE MARKET
MAXIMUM PRICE
MAXIMUM PRICE
GOVERNMENT INTERVENTION IN THE MARKET
TAXES
SASUBSIDIES

17. GOVERNMENT INTERVENTION (CON’T) MAXIMUM PRICE/ CEILING PRICE
Government-imposed regulations prevent prices from rising above the maximum level.
Advantage
Consumers purchase at lower price.
Disadvantages
Emergence of black market.
Reduction in quantity produced.
Producers tend to receive illegal payments from consumers.
Price
Quantity DD SS P* P1
The government imposes a maximum price of P1.
Suppliers reduce the amount offered to Q1 but demand would rise to Q2 creating a shortage. Q* Q1 Q2
Shortage occurs
The equilibrium price is P* and the quantity is Q*.
Price
ceiling

18. GOVERNMENT INTERVENTION (CON’T) MINIMUM PRICE/ FLOOR PRICE
Quantity DD SS P* Q* P1
Floor price Q1 Q2
MINIMUM PRICE/ FLOOR PRICE
Government-imposed regulations prevent prices from falling below a minimum level.
Suppliers increase the amount offered to Q2 but demand drop to Q1 creating a surplus.
Surplus occurs
The equilibrium
price is P* and the quantity is Q*.
Advantages
Protects producer’s income
Higher wage rate
Disadvantages
Consumers pay more. Waste of resources of production
Creates unemployment
The government imposes a minimum price of P1

19. EFECT OF TAXATION Quantity SS SS1 Price DD 14 200 10 Tax = RM4 400 12
The equilibrium price is RM12 and the
quantity is 400 units 14
200 10
Tax = RM4
The government imposes a sales tax of RM4 per carton.
400
INDIRECT TAX
Tax that is imposed by the government on producers or sellers but paid by or passed on to end-users. 12
CONSUMER’S SHARE
PRODUCER’S SHARE
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.

20. Perfectly inelastic demand Demand less elastic than supply
+ tax O 12 16
400 D
CONSUMERS’
SHARE P Q
Perfectly inelastic demand S +
tax (RM4) 12 15
400 D
PRODUCERS’ SHARE P Q 11
CONSUMERS’ SHARE
Demand less elastic than supply S
+ tax O 9 12 13
400 D P Q
CONSUMERS’ SHARE
Demand less elastic than supply
PRODUCER’ SHARE S
+ tax P Q O 18 12 1
400 D
Incidence of tax: elastic supply
PRODUCERS’
SHARE

21. EFECT OF SUBSIDIES SUBSIDY D Price Quantity S S1 45 10 20 50 40
Subsidy = RM10
SUBSIDY
An incentive from the government to encourage producers to produce more.
Price
Quantity D S S1 45 10
The equilibrium price is RM50 and the quantity is 10. 20 50 40
CONSUMER’S SHARE
PRODUCER’S 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.

22. EFECT OF PRICE ELASTICITY ON SUBSIDIES
+ tax O 40 47 50 1 D P Q
CONSUMERS’ SHARE
PRODUCERS’ SHARE
Demand is more elastic than supply S
+ tax (RM4) 43 50 10 D
CONSUMERS’ SHARE
PRODUCERS’ SHARE P Q
Demand less elastic than supply 40