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1 - Bharathi Market Equilibrium
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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.
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3 MARKET DEMAND & SUPPLY Rs.54321 1020355580 Rs.54321 60503520 5 200BUYERS P QDQDQDQDPriceMARKETDEMAND 2,0004,0007,00011,00016,000 200SELLERS 12,00010,0007,0004,0001,000 P QSQSQSQSPriceMARKETSUPPLY EQUILIBRIUM xx
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4 7 S Q o Rs.54Rs321 2 4 6 8 10 12 14 16 2 4 6 8 10 12 14 16P 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
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5 Quantity D SE P O Q X Y The Market Mechanism Price (Rs. per unit)
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6 Quantity D S P Q Price If price is above equilibrium Point-Supply exceeds Demand. P1P1Surplus The Market Mechanism
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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
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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
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Change in Supply Q o D1D1D1D1 Quantity Price S1S1S1S1 S2S2S2S2 P Q1Q1Q1Q1 Q2Q2Q2Q2 P1P1P1P1 P2P2P2P2
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Q o D1D1D1D1 Price S1S1S1S1 P Q1Q1Q1Q1 Q2Q2Q2Q2 P1P1P1P1 P2P2P2P2 D2D2D2D2 Change in Demand
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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
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12 P Q S1S1 D1D1 D2D2 D3D3 S3S3 S2S2S2S2 Change in Supply = Change in Demand
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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.
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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
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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.
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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.
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17 A Binding Price Ceiling S D Price Quantity/time PEPE QEQE Price Ceiling PCPC QSQS QDQD Shortage
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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
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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.
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20 A Binding Price Floor S D Price Quantity/time PEPE QEQE Price Floor PFPF QSQS QDQD Surplus
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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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23 1 3 6 5 4 2 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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