6 market equilibrium-_class

Market Equilibrium and Effects of Shift in

Demand and

Supply Curves

What is a market?

• It is defined as a mechanism by which buyers and sellers interact to determine the price and quantity of a good or service.

Features of market

- There must be a commodity which is being demanded and sold.

- There must be buyers and sellers of the commodity.

- There must be communication between buyers and sellers.

- There must be a place or area where buyers and sellers could interact with each other.

Types of different Market Structures

• Perfect Competition

• Monopoly

• Monopolistic Competition

• Oligopoly

Perfect Competition Market

It is a market structure in which an individual firm cannot influence the prevailing market price of the product in its own. WHY ?BECAUSE in a perfect competition market there are large number of buyers and sellers that no individual buyer or seller can influence the price of the commodity in the market. Any change in the output supplied by the single firm will not affect the total output of the industry. To an individual producer the price of the commodity is given. They are price takers. No individual buyer can influence the price of the commodity by his decision to vary the amount that he would like to buy – he doesn’t have any bargaining power in the market.

Market Equilibrium/ Market Clearing Price

• Forces of demand and supply determine the equilibrium price and equilibrium quantity in a perfectly competitive market.

• Equilibrium is struck in the market where Quantity demanded = Quantity supplied

Move to Market Equilibrium

Market Equilibrium is a situation of zero excess demand and zero excess supply

Surplus and Shortage

Surplus (Excess Supply)

A condition in which quantity supplied is

greater than quantity demanded. Surpluses

occur only at prices above equilibrium price.

Shortage (Excess Demand)

A condition in which quantity demanded is

greater than quantity supplied. Shortages

occur only at prices below equilibrium price.

A non viable industry is the one which will not produce the product in an economy because cost of the product is too high and the consumers are not willing to pay a price that will cover the cost. In this case demand and supply curve will not intersect.

Price Supply Curve

Demand Curve

O Quantity

Market Demand and Supply

Effects of Changes in Demand and Supply on Equilibrium Price

• Changes in Demand

It takes place due to :-

- changes in price of related goods

- changes in income of the consumers

- change in taste and preference

- change in market size

- change in expectations of the consumers

• When there is an increase in demand, supply remaining constant, equilibrium price and equilibrium quantity both increases.

D1

price S

P1 D E1

E A

P

O Q Q1

Quantity Demanded and Supplied

• When there is a decrease in demand, supply remaining constant, equilibrium price and equilibrium quantity both decreases.

Dprice S

P D1 E

E1

P1

O Q1 Q


• Changes in Supply

It takes place due to :-

- changes in the cost of production

- changes in production technology

- change in excise tax

- change in subsidy

- change in price of substitute goods

- change in number of firms

• When there is an increase in supply, demand remaining constant, equilibrium price decreases and equilibrium quantity increases.

S

price D

P E S1

P1 E1

O Q Q1


• When there is an decrease in supply, demand remaining constant, equilibrium price increases and equilibrium quantity decreases.

S1

price D

P1 E1 S

P E

O Q1 Q


Simultaneous Changes in both Demand and Supply

• When there is an increase in both demand and supply in same proportion, equilibrium price remains the same and equilibrium quantity increases.

Price D1 S S1

D

E E1

P

O Q Q1



• When there is an decrease in both demand and supply in same proportion, equilibrium price remains the same and equilibrium quantity decreases.

Price D S1 S

D1

E1 E

P

O Q1 Q



• When increase in supply is less than the increase in demand , both equilibrium price and equilibrium quantity increases.

Price D1 S S1

D E1

P1

E

P

O Q Q1



• When increase in supply is more than the increase in demand , equilibrium price decreases and equilibrium quantity increases.

Price D1 S S1

D

P E

P1 E1

O Q Q1



• When decrease in demand is more than the decrease in supply, both equilibrium price and equilibrium quantity decreases.

Price D S1 S

D1 E

P

E1

P1

O Q1 Q



• When decrease in demand is less than the decrease in supply, equilibrium price increases and equilibrium quantity decreases.

Price D S1 S

D1

P1 E1 E

P

O Q1 Q



• When increase in demand is equal to the decrease in supply, equilibrium price increases and equilibrium quantity remains the same.

S1

Price S

P1 E1

P D1

E

D

O Q Quantity Demanded and Supplied


• When decrease in demand is equal to the increase in supply, equilibrium price decreases and equilibrium quantity remains the same.

S

Price S1

P E

P1 D

E1

D1

O Q Quantity Demanded and Supplied

Special Cases• Supply is perfectly Inelastic and Demand

Changes• When demand increases, supply being perfectly

inelastic equilibrium price increases while equilibrium quantity remains the same.

Price S

P1 E1

P E D1

D O Q


Special Cases• When demand decreases, supply being

perfectly inelastic equilibrium price decreases while equilibrium quantity remains the same.

Price S

P E

P1 E1 D

D1

O Q


Special Cases• Demand is perfectly Inelastic and Supply

Changes• When supply increases, demand being perfectly

inelastic equilibrium price decreases while equilibrium quantity remains the same.

Price D S

P E S1

P1 E1

O Q


Special Cases• When supply decreases, demand being

perfectly inelastic equilibrium price increases while equilibrium quantity remains the same.

Price D S1

P1 E1 S

P E

O Q


Special Cases• Supply is perfectly elastic and Demand Changes• When demand increases, supply being perfectly elastic

equilibrium price remains the same while equilibrium quantity increases.

Price

D D1

P S

E E1

O Q Q1


Special Cases• When demand decreases, supply being

perfectly elastic equilibrium price remains the same while equilibrium quantity decreases.

Price

D1 D

P S

E1 E

O Q1 Q Quantity Demanded and Supplied

Special Cases• Demand is perfectly elastic and Supply

Changes• When supply increases, demand being perfectly

elastic equilibrium price remains the same while equilibrium quantity increases.

Price S S1

P D E E1

O Q Q1


Special Cases• When supply decreases, demand being

perfectly elastic equilibrium price remains the same while equilibrium quantity decreases.

Price

S1 S

P D

E1 E

O Q1 Q Quantity Demanded and Supplied

Consumer, Producer and Total Surplus

Consumers’ Surplus (CS) CS= Maximum buying price - Price paidThe difference between the maximum price a buyer is willing and able to pay for a good or service and the price actually paid.

Producers’ (Sellers’) Surplus (PS) PS = Price received - Minimum Selling priceThe difference between the price sellers receive for a good and the minimum or lowest price for which they would have sold the good.

Total Surplus (TS) TS =CS +PSThe sum of consumers’ surplus and producers’ surplus.

Consumer Surplus

It is the difference between the maximum a consumer would pay for a good and the price actually paid.

Consumer’s Surplus is the area above the price line and below the demand curve.

Producer Surplus

It is the difference between the minimum price a producer would accept to supply a given quantity of good and the price actually received.Producer’s Surplus is the area below the price line and above the supply curve.

Total Surplus

Equilibrium

Government Intervention in the market via Price Controls

Price CeilingA government-mandated maximumprice above which legal trades cannotbe made.Price FloorA government-mandated minimumprice below which legal trades cannotbe made.

Price Ceiling

Price Floor

Dead Weight Loss Price

(dollars) D S

Floor Pricing 20

A

Equilibrium Price 15

B

0 90 130 180 Quantity of Good X

When price flooring is done at $20, only 90 units of X will be demanded and hence 90 units only will be produced. The dead loss weight is symbolized by triangles A and B

Market Failure

A situation when the price mechanism results in inefficient allocation of resources.

Market Failure through Externalities

• What is Externalities?

It is the spill over effects of production or consumption, for which no compensation is paid.

• Types of Externalities

- Positive Externalities

- Negative Externalities

Positive Externalities

A positive externality exists when an individual’s or group’s actions cause a benefit (beneficial side effect) to be felt by others.

Beekeepers whose bees pollinate nearby flowers An attractive garden which gives pleasure to

others. Beautiful buildings.

Negative Externalities• A negative externality exists when an individual’s

or group’s actions cause a cost (adverse side effect) to be felt by others.

• Releasing industrial waste in river or air• Big vehicles causing street congestion

• Littering

Effect of Externalities on Market Outcomes

When either negative or positive externalities exist, the market output is different from the socially optimal / ideal output.

In the case of a negative externality, the market is said to overproduce the good connected with the negative externality (the socially optimal output is less than the market output).

In the case of a positive externality, the market is said to under produce the good connected with the positive externality (the socially optimal output is greater than the market output).

Adjusting for Market Externalities

Negative and positive externalities can be internalized or adjusted for in a number of different ways, including persuasion, voluntary agreements, and taxes and subsidies.

Also, regulations may be used to adjust for externalities directly.

New Hampshire

Public Utilities Commission

Internalizing Externalities Persuasion Taxes and Subsidies Voluntary Agreements Regulations

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6 market equilibrium-_class