Chapter 4 Market Equilibrium

CHAPTER 4:MARKET EQUILIBRIUM

PREPARED BY: ROSMAH BT ABD GHANI @ ISMAIL

Definition

1. Market : a place where buyers and sellers interact to determine the price and quantity of goods and services exchanged

2. Market equilibrium: a situation that occur at any price at which the quantity demanded equals the quantity supplied

Notes:PE=equilibrium priceQE=equilibrium quantity

Qd = Qs

Quantity that buyers are willing to buy = Quantity that sellers are willing to sell

Determinants of PE & QE

QD < QS Surplus

QD = QS Equilibrium

P QD

1020355580

CORN

$54321

60503520 5

QSMarket outcomes

QD > QS Shortage

1. Surplus-occurs when Qd < Qs-when the price is set abovethe equilibrium price- Excess supply

2. Shortage-occurs when Qd > Qs -when the price is setbelow the equilibrium price- Excess demandPE = RM3

QE = 35 kg

SP

Qo

$5

4

3

2

1

10 20 30 40 50 60 70 80

P

Qo

$5

4

3

2

1D

Price of Corn

Quantity of Corn

10 20 30 40 50 60 70 80

P QD

1020355580

CORN

$54321

60503520 5

QS

E

SP

Qo

$5

4

3

2

1

10 20 30 40 50 60 70 80

P

Qo

$5

4

3

2

1D

Price of Corn

Quantity of Corn

10 20 30 40 50 60 70 80

E

surplus

shortage

QD < QS Surplus

QD > QS Shortage

Price(RM)

Qd (kg)

Qs (kg)

Market outcomes

1 12 4

2 10 6

3 8 8

4 5 11

5 4 12

Example :

Table: Market demand and supply for Rambutan

Example :

Price(RM)

Qd (kg)

Qs (kg)

Market outcomes

1 12 4 Qd>Qs →shortage

2 10 6 Qd>Qs →shortage

3 8 8 Qd=Qs→Equilibrium

4 5 11 Qd<Qs →Surplus

5 4 12 Qd<Qs →Surplus

Table: Market demand and supply for Rambutan

= 12 – 4 = 8 kg

= 10 – 6 = 4 kg

PE= RM3/kg; QE= 8kg

= 11 – 5 = 6 kg

= 12 – 4 = 8 kg

Price (RM/ kg)

Quantity (kg)

PE = 3

QE=8

S

D

1

2

4

5

4 126 10115

E

Surplus

Shortage

Price (RM/ kg)

Quantity (kg)

PE = 3

QE=8

S

D

1

2

4

5

4 126 10

E

Surplus

Shortage

12-4= 8kg

10-6= 4kg

Contd.

Price (RM/ kg)

Quantity (kg)

PE = 3

QE=8

S

D

1

2

4

5

4 126 10115

E

Surplus

Surplus

Shortage

Shortage

Exercises

Question 1

Price per ton (RM)

Quantity Supplied (ton)

Quantity Demanded (ton)

Surplus/shortage (ton)

80 600 1200 _________90 800 1100 _________

100 1000 1000 _________110 1200 900 _________

QUESTION 2Table 2 shows the quantities of corn demanded and supplied at various prices.

a. Complete Table 2 by specifying whether there will be a shortage or surplus and the size of it.

(2 marks)b. On a graph paper, draw the demand and supply curves for corn.

(2 marks)

c. What is the equilibrium price and quantity of corn? (1 mark)

Price per unit (RM)

Quantity Demanded

(units)

Quantity Supplied (Units)

3.00 600 2006.00 500 3009.00 400 400

12.00 300 50015.00 200 600

QUESTION 3The following table gives the demand and supply schedules for good A.

a. Plot the demand and supply curves for good A. (2marks)

b. What are the equilibrium price and quantity (1mark)

c. Is there a surplus or shortage at the price of RM6.00? How much is the surplus or shortage? (2 marks)

d. Give three (3) factors that can shift supply curve to the right. (3 marks)

Price (RM) per box

Quantity demanded (units)

Quantity supplied (units)

100 100 60200 90 70300 80 80400 60 90500 50 100600 40 110

QUESTION 4Below is the demand and supply schedule for a product.

a. Draw a diagram to show the demand and supply curves for a product.(2 marks)

b. What is the equilibrium price and quantity for a product? (2 marks)

c. What will happen if the product’s price level is set at RM200 per unit? By how much? (3 marks)

d. What if the price of the product is set at RM600 per unit? By how much?(3 marks)

Changes in PE & QE

i. ∆ in DD , SS constantii. DD constant, SS ∆iii. both changes

i. ∆ in DD , SS constant

E1

D1

P1

Q1

S0

D0

Q

P

E0P0

Q0

Eq point (Qd=Qs) initial Eq :

E = E0

PE = P0

QE = Q0

factors influences ∆ in DD (non-P factors) suppose, there is an ↑ in consumers incomeDD curve will shift to the right (D0→D1) new Eq :

E = E1

PE = P1

QE = Q1

supply curve constant (S0) As a result, the

PE rises from Po to P1

QE rises from Qo to Q1

New market equilibrium = E1

o DD ↑

E1

D1

P1

Q1

S0

D0

P

E0P0

Q0

Q


E = E0

PE = P0

QE = Q0

factors influences ∆ in DD (non-P factors) suppose, there is an ↓ in number of buyersDD curve will shift to the left (D0→D1) new Eq :

E = E1

PE = P1

QE = Q1

supply curve constant (S0) As a result, the

PE falls from Po to P1

QE falls from Qo to Q1


o DD ↓

ii. DD constant, ∆ in SS

ROSMAH

E1

S1

P1

Q1

S0

D0

Q

P

E0

P0

Q0


E = E0

PE = P0

QE = Q0

factors influences ∆ in SS (non-P factors) suppose, there is an ↓ in cost of production (↓ in cost of raw material) SS will ↑, SS curve will shift to the right (S0→S1) new Eq :

E = E1

PE = P1

QE = Q1

demand curve constant (D0) As a result, the

PE falls from Po to P1



o SS↑

ROSMAHROSMAH

E1

S1

P1

Q1

S0

D0

Q

P

E0

P0

Q0


E = E0

PE = P0

QE = Q0

factors influences ∆ in SS (non-P factors) suppose, there is an ↑ in cost of production (↑ wages ) SS will ↓, SS curve will shift to the left (S0→S1) new Eq :

E = E1

PE = P1

QE = Q1


PE rises from Po to P1

QE falls from Qo to Q1


o SS↓

iii. both changes Eq point (Qd=Qs) initial Eq :

E = E0

PE = P0

QE = Q0

suppose there is an increase in demand for chickens during Hari Raya. DD increase DD curve will shift to the right (D0→D1) Government overcome this problem by increase the supply of imported chickens SS will ↑, SS curve will shift to the right (S0→S1) new Eq :

E = E1

PE = P0

QE = Q1


PE constant QE rises from Qo to Q1


o ∆SS = ∆DD, P constant

S0

D0

P0

Q0

D1

S1

E0 E1

Q1Q

P

P0


E = E0

PE = P0

QE = Q0

suppose there is an increase in demand for chickens during Hari Raya. DD increase DD curve will shift to the right (D0→D1) Government overcome this problem by ↑ the supply of imported chickens in larger quantities SS will ↑, SS curve will shift to the right (S0→S1) new Eq :

E = E1

PE = P1

QE = Q1


PE falls from P0 to P1



o ∆SS > ∆DD, P ∆

S0

D0

P0

Q0

D1

S1

E0

E1

Q1Q

P

P1


E = E0

PE = P0

QE = Q0

suppose there is an increase in demand for chickens during Hari Raya. DD increase DD curve will shift to the right (D0→D1) Government overcome this problem by ↑ the supply of imported chickens in only smaller quantities SS will ↑, SS curve will shift to the right (S0→S1) new Eq :

E = E1

PE = P1

QE = Q1


PE rises from P0 to P1



o ∆SS < ∆DD, P ∆

S0

D0

P0

Q0

D1

S1

E0

E1

Q1Q

P

P1

Application of demand and supply analysis

A. Price controls: Government intervention

B. Impact of taxes and subsidies :-effects on price and quantity, incidence of tax

C. Market failures (externalities)

1.CEILING PRICE 2.FLOOR PRICE

Government intervention in the market:

CEILING PRICE

1. Ceiling price

-also called as maximum price

-is set below the equilibrium price

-Ceiling price is imposed on essentials goods such as cooking oil, flour and sugar

- to help consumers when P of goods & services are extremely high in the market.

-to restrain inflation

-it will occurs shortage

Price (RM/kg)

Quantity

(kg)

2.00

Qe Qd

D

E

S

1.45

Qs

Shortage

1. Ceiling price

Advantage Consumers pay

less

Disadvantages Emergence of black

market Reduced quantity

produced due to limits profits in the controlled market.

Exploit consumers-Producers tend to receive illegal payments from consumers

FLOOR PRICE

2. Floor price

-also called as minimum price

-is set above the equilibrium price

-Floor price is initiated by the government in the agricultural sectors. For example: price of paddy

-to help farmers to increase their income

-it will occurs surplus

Price (RM/kg)

Quantity

(kg)

2.00

Qe Qs

D

E

S

2.50

Qd

Surplus

2. Floor price

Advantages Protects producer’s

income Higher wage rate

Disadvantages Consumers pay

more Waste of resources

of production Creates

unemployment

Differences between ceiling price & floor price

Criteria Floor price Ceiling priceDEFINITION -Minimum price

- P is not allowed to fall- Surplus

-Maximum price- P is not allowed to rise-Shortage

ADVANTAGES -Protects producer’s income- Higher wage rate

- Consumers pay less

DISADVANTAGES

-Consumers pay more- Waste of resources production- Creates unemployment

-Emergence of black market- Reduces qty produced- Exploit consumers

Impact of taxation

P of G&S will rise by the same amount as the tax imposed.

Types of tax : Direct tax

imposed directly on to a person e.g. income tax, company tax

Indirect tax imposed on a person but that person can shift the burden of

paying tax to someone else e.g. sales tax, import tax.

Government imposed indirect tax (IT) IT→ tax that imposed by the government on

producers or sellers but paid by or passed on to the end-users/consumer.

producers will reduce the supply of G&S.

A

S1

20

S0

D0

Q

P

E0

40

B

C

14

12

10

Seller

Buyer

RM2 bear by the buyer

RM2 bear by the seller

1. Effect of taxes on P* and Q*

- The initial equilibrium is Eo with P*=12 and Q*=40

- suppose government imposed a sales tax of RM 4 per carton of cigarettes

- when a tax imposed, there are no changes in demand. movement only occurs along the demand curve

- tax will increase cost of production, thus supply will decrease

- supply curve will shift to left from So to S1

-

D

E

F

Impact of taxation

Effect of taxes

i.Equilibrium price rises to new P*=RM14 and

equilibrium quantity falls to new Q*= 20

ii.Consumers:

-needs to buy with RM14 which is RM2 higher than before tax

-consumer’s tax burden=ABED

iii.Producers:

-receive RM10 which is RM2 lower than before tax

-producer’s tax burden=BCFE

iv.Total government revenue from tax

=4 x 20 = 80.(FCAD)

A

S1

20

S0

D0

P

E0

40

B

C

14

12

10

seller

buyer



D

E

F

A

S1

20

S0

D0

P

E0

40

B

C

14

12

10

seller

buyer



D

E

F

Consumers

Producers

Before tax

pays : RM12 Sells: RM12

After tax

pays : RM14 Sells: RM14But, sellers needs to pay RM4 to the government(RM14-RM4=RM10)

Burden of tax

RM2=(RM14-RM12)

RM2=(RM12-RM10)

TOTAL GOVERNMENT REVENUE FROM TAX=4 x 20 = RM 80

Exercise:A specific tax was imposed on the sale of potatoes. The diagram below shows the SS & DD curves for potatoes.

B

S0

8

20

S1

D0

Q

A101

10

5

PBased on the diagram, answer the following questions.

a. The price paid by the buyers before tax is RM______

b. The price paid by the buyers after tax is RM______

c. The amount of tax per unit is RM____________

d. Calculate the amount of tax per unit shared by the:i. Consumer_________ii. Producer__________

e. The movement form point A to point B is called__________

the equal sharing of the tax burden does not occur all the time.

Its depends on the elasticity of DD & SS.

Effect of elasticities on tax burden

DD is perfectly inelastic

Before tax After tax

Consumers pay : RM12

producers sells : RM12

Consumers pay : RM16 producers sells : RM16

sellers needs to pay RM4 to the government(RM16-RM4=RM12)

* So buyers needs to pays the entire taxConsumers Burden of tax : RM(16-12=4)

DD is perfectly elastic

Consumers pay : RM12

producers sells : RM12

Consumers pay : RM12producers sells : RM12

But, sellers needs to pay RM4 to the government(RM12-RM4)=RM8

• sellers pays the entire taxProducers /sellers Burden of tax : RM(16-12=4)

PD

Qd

16

12

40

S2

S1

P

D

Qd

12

40

S2

S1

8

Demand is inelastic to supply

Demand is more elastic than supply

Price (RM)

Quantity

12

40

Do

S1

11

So

15

buyer

seller

Price (RM)

Quantity

12

40

Do

S1So

13buyer

seller9

-goods with low substitutes: petrol, cigarettes

-the buyer shared more of the burden of tax since its demand is inelastic

-goods with high substitutes: toothpaste, cloth

-seller would share higher portion of the tax burden since the demand is more elastic than supply

ROSMAH

B.2. Impact of subsidies

2. Effect of subsidies on P* and Q*-subsidies is an incentive from government to encourage producers or sellers to produce more-subsidies will lower the cost of production-subsidies are provided for petrol, diesel and others- - The initial equilibrium is Eo with P*=1.50 and Q*=1.2-suppose government provided RM1 per gallon of petrol-subsidies will lower the cost of productions.-supply curve shift to right from So to S1

Price

Quantity

(gallon)

1.00

1.2 1.4

Do

So S1

1.50

0.50

Buyer

Seller

Contd.

Effect of subsidies

i. P*falls to RM1 and Q*rises to 1.4gallon

ii. Consumers

-buy with lower price = RM1 per gallon

-enjoy by buyer =

iii.Producers

-receive RM0.50 per gallon

-enjoy by seller =

*the buyers and seller shares RM 0.50 each from the total subsidy of RM1 per gallon

Effect of elasticities on subsidy Demand is inelastic to

supply Demand is more elastic

than supplyPrice

Quantity

(gallon)

0.80

1.2

Do

So S1

1.50

0.50

Buyer

Seller

Price

Quantity

(gallon)

1.00

1.2

Do

SoS1

1.50

0.50

Buyer

Seller

-buyer enjoy more subsidy than seller

-seller enjoy more subsidy than buyer

C. Market Failures (externalities) Externality is a cost or benefit

imposed on people other than producers and consumers of a good or services

It is also a spillover effects or neighbourhood effects

Negative externalities: pollution Positive externalities: neat gardens

and well educated society

C. Market Failures (externalities)

• Negative externalities

- Gov punish negative externalities by imposing a tax or fine on producers

- Taxation will increase the cost of production

- As a result

→P* rises

→Q* falls

Price (RM/kg)

Quantity (kg)

Po

Qo

D

Eo

So

P1

Q1

S1

E1

Price (RM/kg)

Quantity (kg)

P1

Q1

D

E1

S1

Po

Qo

So

Eo

• Positive externalities

-subsidy will reduce production costs and therefore will increase supply

- As a result

→P* falls

→Q* rises

Documents

Chapter 4 Market Equilibrium