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 illustration123456PriceQuantity810SURPLUS (QSS > QDD)ESSDDP*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 Prices9.00200010000SURPLUSFalls8.50400080008.006000EQUILIBRIUMEquilibrium7.50SHORTAGERises7.00
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 EQUILIBRIUMOnce 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 CONSTANTIncrease in DemandDD curve shifts to the rightEquilibrium price and quantity increasesPrice (RM)P1P*P2Q2Q*Q1SSDD1DDDD2QuantityDecrease in DemandDD curve shifts to the leftEquilibrium price and quantity decreases
11 EFFECT OF CHANGES ON SUPPLY ASSUME THAT DEMAND IS CONSTANT QuantityPrice (RM)P2P*P1Q2Q*Q1SSSS1DDSS2Increase in SupplySS curve shifts to the rightEquilibrium price decreases and quantity increasesDecrease in SupplySS curve shifts to the leftEquilibrium price increases and quantity decreases
12 EFFECT OF CHANGES ON DEMAND AND SUPPLY SUPPLY AND DEMAND INCREASEQuantityPrice (RM)P*Q*Q1SSSS1UDDDD1Case 1: Increase at same magnitudeEquilibrium price undetermined and quantity increasesTHIS CONCEPT CAN APPLY WHEN BOTH DEMAND AND SUPPLY BOTH DECREASE.
13 EFFECT OF CHANGES ON DEMAND AND SUPPLY (CON’T) SUPPLY AND DEMAND DECREASEQuantityPrice (RM)P*Q1Q*SS1SSDDDD1Case 2: Decrease at same magnitudeEquilibrium price undetermined and quantity decreasesTHIS CONCEPT CAN APPLY WHEN BOTH DEMAND AND SUPPLY BOTH DECREASE.
14 EFFECT OF CHANGES ON DEMAND AND SUPPLY (CON’T) SUPPLY INCREASE AND DEMAND DECREASESPrice (RM)P*Q*SSSS1DDDD1QuantityP1Case 3: Changes in different magnitudeEquilibrium price decreases and quantity undeterminedTHIS CONCEPT CAN APPLY WHEN BOTH DEMAND AND SUPPLY BOTH DECREASE.
15 EFFECT OF CHANGES ON DEMAND AND SUPPLY (CON’T) SUPPLY DECREASES AND DEMAND INCREASESPrice (RM)Q*P*SSSS1DDDD1QuantityP1Case 4: Changes in different magnitudeEquilibrium price increases and quantity undeterminedTHIS CONCEPT CAN APPLY WHEN BOTH DEMAND AND SUPPLY BOTH DECREASE.
16 GOVERNMENT INTERVENTION GOVERNMENT INTERVENTION IN THE MARKET MAXIMUM PRICEMAXIMUM PRICEGOVERNMENT INTERVENTION IN THE MARKETTAXESSASUBSIDIES
17 GOVERNMENT INTERVENTION (CON’T) MAXIMUM PRICE/ CEILING PRICE Government-imposed regulations prevent prices from rising above the maximum level.AdvantageConsumers purchase at lower price.DisadvantagesEmergence of black market.Reduction in quantity produced.Producers tend to receive illegal payments from consumers.PriceQuantityDDSSP*P1The government imposes a maximum price of P1.Suppliers reduce the amount offered to Q1 but demand would rise to Q2 creating a shortage.Q*Q1Q2Shortage occursThe equilibrium price is P* and the quantity is Q*.Priceceiling
18 GOVERNMENT INTERVENTION (CON’T) MINIMUM PRICE/ FLOOR PRICE QuantityDDSSP*Q*P1Floor priceQ1Q2MINIMUM PRICE/ FLOOR PRICEGovernment-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 occursThe equilibriumprice is P* and the quantity is Q*.AdvantagesProtects producer’s incomeHigher wage rateDisadvantagesConsumers pay more. Waste of resources of productionCreates unemploymentThe 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 thequantity is 400 units1420010Tax = RM4The government imposes a sales tax of RM4 per carton.400INDIRECT TAXTax that is imposed by the government on producers or sellers but paid by or passed on to end-users.12CONSUMER’S SHAREPRODUCER’S SHARESS 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 + taxO1216400DCONSUMERS’SHAREPQPerfectly inelastic demandS+tax (RM4)1215400DPRODUCERS’ SHAREPQ11CONSUMERS’ SHAREDemand less elastic than supplyS+ taxO91213400DPQCONSUMERS’ SHAREDemand less elastic than supplyPRODUCER’ SHARES+ taxPQO18121400DIncidence of tax: elastic supplyPRODUCERS’SHARE
21 EFECT OF SUBSIDIES SUBSIDY D Price Quantity S S1 45 10 20 50 40 Subsidy = RM10SUBSIDYAn incentive from the government to encourage producers to produce more.PriceQuantityDSS14510The equilibrium price is RM50 and the quantity is 10.205040CONSUMER’S SHAREPRODUCER’S SHAREThe 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 + taxO4047501DPQCONSUMERS’ SHAREPRODUCERS’ SHAREDemand is more elastic than supplyS+ tax (RM4)435010DCONSUMERS’ SHAREPRODUCERS’ SHAREPQDemand less elastic than supply40