1 - Bharathi Market Equilibrium 2 The Market Mechanism Market Mechanism Summary 1)Supply and demand interact to determine the equilibrium price. 2)

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- Bharathi- Bharathi

Market EquilibriumMarket Equilibrium

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The Market MechanismThe Market Mechanism

Market Mechanism SummaryMarket Mechanism Summary

1)1) Supply and demand interact to Supply and demand interact to determine the equilibrium price.determine the equilibrium price.

2) When not in equilibrium, the market 2) When not in equilibrium, the market will adjust to a shortage or surplus and will adjust to a shortage or surplus and return to the equilibrium.return to the equilibrium.

3)3) Markets must be competitive for Markets must be competitive for the the mechanism to be efficient.mechanism to be efficient.

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MARKET DEMAND & SUPPLY MARKET DEMAND & SUPPLY

Rs.5Rs.544332211

10102020353555558080

Rs.5Rs.544332211

6060505035352020 55

200200

BB

UU

YY

EE

RR

SS

PPQQDD

PricePriceMARKETMARKET

DEMANDDEMAND

2,0002,0004,0004,0007,0007,000

11,00011,00016,00016,000

200200

SS

EE

LL

LL

EE

RR

SS

12,00012,00010,00010,000

7,0007,0004,0004,0001,0001,000

PPQQSS

PricePrice

MARKETMARKET

SUPPLYSUPPLY

EQUILIBRIUMEQUILIBRIUM

xx xx

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MARKET DEMAND & MARKET DEMAND & SUPPLYSUPPLY

77

SS

QQoo

Rs.5Rs.5

44

Rs3Rs3

22

11

2 4 6 8 10 12 14 162 4 6 8 10 12 14 16

PP QQDD

Rs.Rs.55Rs.Rs.44Rs.Rs.33Rs.Rs.22Rs.Rs.11

2,0002,0004,0004,0007,0007,000

11,00011,00016,00016,000

Rs.5Rs.5

Rs.4Rs.4

Rs.3Rs.3

Rs.2Rs.2

Rs.1Rs.1

12,00012,00010,00010,0007,0007,0004,0004,0001,0001,000

DD

PP QQ

SS

PricePrice

QuantityQuantity

MarketMarketEquilibriumEquilibrium

DemandDemand PricePrice SupplySupply

PricePrice

5QuantityQuantity

D

S

EEPP

OO QQ XX

YY


PricePrice(Rs. per unit)(Rs. per unit)

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QuantityQuantity

D

S

P

Q


If price is above equilibrium If price is above equilibrium Point-Supply exceedsPoint-Supply exceedsDemand. Demand.

P1

SurplusSurplus


7


D

S

Q1

Assume the price is PAssume the price is P11 , then: , then:

1) Quantity Supplied is > 1) Quantity Supplied is > Quantity Demanded Quantity Demanded 2) Producers lower price.2) Producers lower price.3) Quantity supplied decreases 3) Quantity supplied decreases 4) Equilibrium is restored4) Equilibrium is restored

P1

SurplusSurplus

Q2 QuantityQuantity

PricePrice(Rs per unit)(Rs per unit)

P2

Q3

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D

S

Q1 Q2

P2

Shortage

QuantityQuantity


Assume the price is P2, then:1) Quantity Demanded is greater than quantity Supplied2) Producers raise price.

3) Quantity supplied increases 4) Equilibrium is restored

Q3

P3

EE

Change in SupplyChange in Supply

Qo

DD11

Quantity

Pri

ce

Pri

ce

SS11SS22

P

QQ11QQ22

PP11

PP22

QQoo

DD11

Pri

ce

Pri

ce

SS11PP

QQ11 QQ22

PP11

PP22

DD22

Change in DemandChange in Demand

11

Four Possibilities

DD11 DD11 SSAA BB

CCDD

SSDD11

DD22

““Increase in Demand”Increase in Demand” “Decrease in Demand”

“Increase in Supply”““Decrease in Suply”Decrease in Suply”

DD PP QQ DD PP QQ

SS QQ PPPP SS QQDD

SS11

DD

SS11SS22

P2P2

P1P1

QQ1 1 QQ22 QQ2 2 Q Q11

P2P2

SS11 P1P1

PP22

PP11PP11

PP22

QQ1 1 QQ22 QQ2 2 QQ11

12

PP

QQ

S1D1

D2

D3

S3

SS22

Change in Supply = Change in DemandChange in Supply = Change in Demand

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Effects of Government Intervention Effects of Government Intervention Price ControlsPrice Controls

If the Government decides that the If the Government decides that the equilibrium price is too high, they may equilibrium price is too high, they may establish a maximum allowable establish a maximum allowable ceiling ceiling price.price.

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When a product is taxed, who ultimately When a product is taxed, who ultimately shoulders the shoulders the tax burdentax burden depends upon the depends upon the elasticity of demand and supply of the elasticity of demand and supply of the product taxed.product taxed.

Usually the tax burden is shared between Usually the tax burden is shared between producers and consumers.producers and consumers.

Consumers pay more of the tax, if demand Consumers pay more of the tax, if demand is relatively less elastic than supplyis relatively less elastic than supply

Producers Producers pay more of the tax if demand is pay more of the tax if demand is relatively more elastic than supply.relatively more elastic than supply.

TAX SHIFTING AND THE ELASTICITIES TAX SHIFTING AND THE ELASTICITIES OF DEMAND AND SUPPLY OF DEMAND AND SUPPLY

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Price CeilingsPrice Ceilingsand Price Floorsand Price Floors

Price CeilingPrice Ceiling is a legally established is a legally established maximum maximum

priceprice which a seller can charge or a which a seller can charge or a buyer must pay.buyer must pay.

Price FloorPrice Floor is a legally established is a legally established minimum minimum

priceprice which a seller can charge or a which a seller can charge or a buyer must pay.buyer must pay.

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Price CeilingsPrice Ceilings

When the Government imposes a When the Government imposes a price ceiling (i.e., a legal price ceiling (i.e., a legal maximum price at which a good maximum price at which a good can be sold) two outcomes are can be sold) two outcomes are possible:possible: The price ceiling is not binding.The price ceiling is not binding. The price ceiling is a binding The price ceiling is a binding

constraint on the market, creating constraint on the market, creating shortages. shortages.

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A A Binding Binding Price CeilingPrice Ceiling

S

D

Price

Quantity/time

PE

QE

PriceCeiling

PC

QS

QD

Shortage

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Market ImpactsMarket Impactsof a Price Ceilingof a Price Ceiling

A Binding Price Ceiling creates. . .A Binding Price Ceiling creates. . . Shortages (QD > QS)Shortages (QD > QS) Shortages create :Shortages create :

QueuingQueuing Discrimination criteria set by sellersDiscrimination criteria set by sellers Bundled pricing with other goodsBundled pricing with other goods Bribery/corruptionBribery/corruption

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Price FloorsPrice Floors

When the Government imposes a When the Government imposes a price floor (i.e., a legal minimum price floor (i.e., a legal minimum price at which a good can be sold) price at which a good can be sold) two outcomes are possible:two outcomes are possible: The price floor is not binding.The price floor is not binding. The price floor is a binding constraint The price floor is a binding constraint

on the market, creating surpluses.on the market, creating surpluses.

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A A Binding Binding Price FloorPrice Floor

SS

DD

Price

Quantity/time

PE

QE

Price FloorPrice Floor

PF

QS

QD

SurplusSurplus

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Market ImpactsMarket Impactsof a Price Floorof a Price Floor

A Binding Price Floor creates. . .A Binding Price Floor creates. . . Surpluses (QS > QD)Surpluses (QS > QD) Surpluses create :Surpluses create :

Discrimination criteria set by buyersDiscrimination criteria set by buyers Examples:Examples:

Agricultural Price SupportsAgricultural Price Supports

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1

3

6

5

4

2

Investors

Government

Firms(produce the

domestic product)

Consumers

Financial SystemRest of the

World

Saving (S)

Consumption (C

)

Inve

stm

ent (

I) C + I

Gov

ernm

ent

C + I + G

Imports (IM

)

Exports (X)

C +

I + G

+

Transfers

Disposable

Income (DI)

Taxes

Gross

National Income (Y)

(X – IM

)

Purch

ases

(G)

The Circular Flow of IncomeThe Circular Flow of Income

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Documents

1 - Bharathi Market Equilibrium 2 The Market Mechanism Market Mechanism Summary 1)Supply and demand interact to determine the equilibrium price. 2)