Market Equilibrium

Managerial Economics: Lecture 4

Ritwik Banerjee
IIM Bangalore
Lecture Overview
• Section 1: Excess Demand and Excess Supply
• Section 2: Market Equilibrium
• Section 3: Change in Demand and Supply
• Section 4: Surpluses
• Section 5: Price Controls
• Section 6: Takeaway

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 2
What determines Price of Love?

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 3
Application: Price of Roses during Valentines
Day
• At regular price, demand is greater than supply Price
𝑆'
𝑃"
• What will be the movement of price?

• Shortages put upward pressure on price

𝐷%
• Supply increases
𝑃(
• Demand decreases

• Until price reaches 𝑃" and quantity is 𝑄"

𝑄" Quantity
• Walrasian price adjustments

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 4
Excess Demand

• Excess Demand: At the prevailing price, quantity demanded is

greater than quantity supplied at a given price , then an excess demand

is said to exist in the market

• Prices rise when there is Excess Demand

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 5
Application: Price of Tomato during harvest

• During harvest, is the quantity demanded Price

of tomato same as that supplied at regular
price? 𝑆'

• What will be the movement of price during 𝑃(

this time? 𝐷%

𝑃)
• Surpluses put downward pressure on the
price Quantity

• Walrasian price adjustment

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 6
Excess Supply

• Excess Supply: At the prevailing price, quantity supplied is greater

than quantity demanded at a given price, then an excess supply is said

to exist in the market

• Prices fall when there is an Excess Supply

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 7
Lecture Overview
• Section 1: Excess Demand and Excess Supply
• Section 2: Market Equilibrium
• Section 3: Change in Demand and Supply
• Section 4: Surpluses
• Section 5: Price Controls
• Section 6: Takeaway

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 8
Market Equilibrium or Competitive Equilibrium

• A market is said to be at an equilibrium if there is no tendency of

price to change
• the price is called equilibrium price and quantity demanded is called
equilibrium quantity
• Market equilibrium is determined at the intersection of the market
demand curve and the market supply curve
• Market equilibrium : No excess demand or excess supply or market
clears

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 9
 Market Equilibrium
Price
Excess 𝑄+
• If 𝑄% , 𝑄+ represent the quantity demanded and supplied Supply
when the price is 𝑃, the equilibrium price, 𝑃, , is the 𝑃.
price such that :
𝑃,
𝑄% 𝑃, = 𝑄+ 𝑃,

, 𝑃/
• The equilibrium quantity is simply 𝑄% 𝑃 or, Excess
equivalently, 𝑄+ 𝑃, Demand
𝑄%
• At the higher price 𝑃. , a surplus, price falls.
𝑄% (𝑃, ) = 𝑄+ (𝑃, ) Quantity
• At the lower price 𝑃/ , there is shortage, price rises
• Demand and Supply intersection in this graph implicitly
assumes equilibrium in a competitive market

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 10
Market Equilibrium
• The market maker is to keep adjusting the trading price until the
“bids” and the “asks” match
• Market maker due to Leo Walras, also called a Walrasian auctioneer
• At any point in time, observed price may not be the equilibrium price
• Market forces always push the market price towards equilibrium
• Markets are never in equilibrium but tend towards equilibrium

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 11
Surprise Quiz
• When a market is in equilibrium
• Quantity demanded equals quantity supplied
• Excess demand and excess supply are zero
• The market is cleared by the equilibrium price
• All of the above

• India is a major importer of crude oil. But if the government of India

wants to make India self-sustainable thereby curbing imports with the
help of quotas, then as a result of it
• Prices of crude oil fall
• Prices of crude oil remain unchanged
• Demand of crude oil fall
• Prices of crude oil rises

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 12
Demonstration Problem - I
Price
Demand Curve 𝐷% : 𝑄= = 𝑎 − 𝑏𝑃
𝑎Q 𝐒𝐬
𝑏
Supply Curve 𝑆+ ∶ 𝑄 ' = 𝑐 + 𝑑𝑃

Equilibrium: 𝑫𝒅 = 𝑺𝒔 E
𝑃,
𝑎−𝑐
𝑃, =
𝑏+𝑑
𝐃𝐝
a
𝑎𝑑 + 𝑏𝑐 −𝑐Q c 𝑄, Quantity
𝑄, = 𝑑
𝑏+𝑑

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 13
Lecture Overview
• Section 1: Market Equilibrium
• Section 2: Excess Demand and Excess Supply
• Section 3: Change in Demand and Supply
• Section 4: Surpluses
• Section 5: Price Controls
• Section 6: Takeaway

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 14
Change in Demand : Tastes and Preferences
• Check out the following clip from the
“Hudsucker Proxy”

• The clip nicely shows how markets

coordinate prices and eliminate excess
supply and excess demand

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 15
Change in Demand : Tastes and Preferences
Price of
Hula 𝑺𝒔
hoop

$3.99 Market clearing price

$1.79

𝑫𝟏 𝑫𝟐
Quantity of
Hula hoop

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 16
Change in Equilibrium: Income

• 2000-2018: Massive increase in income and mobile phones/computers

• Assume:

• There was no change in the number of producer of phones/PC

• Only income of consumers increased

• How will this affect equilibrium?

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 17
Change in Demand : Income
Price

= 𝑎TQ
Demand Curve 𝐷% : 𝑄 = 𝑎 − 𝑏𝑃 𝑏
𝑎Q 𝐒𝐬
'
Supply Curve 𝑆+ ∶ 𝑄 = 𝑐 + 𝑑𝑃 𝑏
• Supply function does not change
𝐸X
• Demand function changes: Demand shifts outside
𝐸
• New demand curve:
𝑃,V
𝐷%T : 𝑄= = 𝑎T − 𝑏𝑃
𝐃𝟏𝐝
𝐃𝐝
𝑆+ : 𝑄 ' = 𝑐 + 𝑑𝑃

• Assume: 𝑎 > 𝑎T
c ,V 𝑎 𝑎T
−𝑐Q 𝑄 Quantity
𝑑

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 18
Comparison of Old and New Equilibrium

Before After Change

Quantity (𝑎𝑑 + 𝑏𝑐)/(𝑏 + 𝑑) (𝑎’𝑑 + 𝑏𝑐)/(𝑏 + 𝑑) Increase
Price (𝑎 − 𝑐)/(𝑏 + 𝑑) (𝑎’ − 𝑐)/(𝑏 + 𝑑) Increase

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 19
Change in Equilibrium

• Now assume:

• There was a substantial increase in the number of producer of phones/PC

• The income of consumers changed

• How will this affect equilibrium?

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 20
Change in Demand and Supply - Case 1
Price

𝐃T𝐝
𝑎Q 𝐒𝐬
𝑏 𝐃𝐝

𝑺T𝒔
𝐸T

𝑃,V 𝐸
𝑃X

c 𝑄,V a 𝑄T Quantity
−𝑐Q
𝑑

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 21
Change in Demand and Supply -Case 2
Price
𝐃𝟏𝐝

𝑎Q 𝐒𝐬
𝑏 𝐃𝐝 𝑺𝟏𝒔

𝐸X
X
𝑃,V 𝐸[
𝑃 𝐸

−𝑐Q
c 𝑄,V 𝑄X a Quantity
𝑑

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 22
Change in Demand and Supply - Case 3
Price If both Demand and
Supply curves move in
𝑎Q 𝐃𝟏𝐝 𝐒𝐬
𝑏 𝐃𝐝 𝑺𝟏𝒔 the same direction,
change in price
𝐸X depends upon the force
𝐸
𝑃,V 𝐸[ that has a higher
magnitude shift

−𝑐Q
c 𝑄,V 𝑄X a Quantity
𝑑

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 23
Bengal Famine, 1943
• 2.1 to 3 million Bengalis died
• Poverty and Famine, Amartya Sen
• Rice availability was higher in 1943 than in 1941, despite a cyclone and drop in imports: A
“boom” famine
• War time inflation
• Increased income for those related to war time production - drove up price
• Wage laborers in rural India did not follow this trend
• Government mismanagement : British government at the center disallowed interstate trade
• Hoarding: price was expected to continue to increase and famers hoarded rice
• Mass migration from rural to urban areas.
• Purchased grain from India to ship it to Europe to boost the buffer stock of grains
for future possible invasion of Greece and Yugoslavia
• Australian wheat docked in Calcutta port but was ordered not to disembark and
sail on to Europe

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 24
Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 25
Business Inside 1: Food riots in Mexico
“The Mexican tortilla crisis came after a rise in the cost of
corn, itself induced by growing ethanol consumption and
booming demand in emerging countries.” FT

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 26
Business Inside 1: General Equilibrium Effects

• Four related markets

• Ethanol
• Corn for Ethanol
• Corn for Food
• Tortilla
• Sharp increase in international crude oil prices
• Ethanol market is expanding since it is a renewable fuel

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 27
 Corn for Ethanol Market
Ethanol Market
𝑆
𝑆

𝑃^\]. 𝐸
𝑃\]. 𝐸

𝐷 𝐷
𝑄\]. 𝑄^\].
Tortilla Market Corn for Food Market
𝑆 𝑆

𝑃a`b] 𝐸
𝑃^_`` 𝐸
𝐷
𝐷
𝑄a`b] 𝑄^_``
Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 28
 Corn for Ethanol Market
Ethanol Market
𝑆
𝑆 𝑆′

𝑃\]. ′ 𝐸
𝑃^\].
𝑃\]. 𝐸
𝐷′
𝐷
𝐷
𝑄\]. 𝑄\].T 𝑄^\].
Tortilla Market Corn for Food Market
𝑆 𝑆

𝑃a`b] 𝐸
𝑃^_`` 𝐸
𝐷
𝐷
𝑄a`b] 𝑄^_``
Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 29
 Ethanol Market Corn for Ethanol Market
𝑆 𝑆’
𝑆

𝑃\]. ′ 𝐸
𝑃^\].
𝑃\]. 𝐸
𝐷′ 𝐷′
𝐷
𝐷
𝑄\]. 𝑄\].T 𝑄^\]. 𝑄^\]. ′
Tortilla Market Corn for Food Market
𝑆 𝑆

𝑃a`b] 𝐸
𝑃^_`` 𝐸
𝐷
𝐷
𝑄a`b] 𝑄^_``
Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 30
 Ethanol Market Corn for Ethanol Market
𝑆 𝑆’
𝑆

𝑃^\].T
𝑃\]. ′ 𝐸
𝑃^\].
𝑃\]. 𝐸
𝐷′ 𝐷′
𝐷
𝐷
𝑄\]. 𝑄\].T 𝑄^\]. 𝑄^\]. ′
Tortilla Market Corn for Food Market
𝑆 𝑆′ 𝑆

𝑃a`b] 𝐸 𝑃^_``T
𝑃^_``
𝐸
𝐷
𝐷
𝑄a`b]
𝑄^_``T 𝑄^_``
Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 31
 Ethanol Market Corn for Ethanol Market
𝑆 𝑆’
𝑆

𝑃^\]. ′
𝑃\]. ′ 𝐸
𝑃^\].
𝑃\]. 𝐸
𝐷′ 𝐷′
𝐷
𝐷
𝑄\]. 𝑄\].T 𝑄^\]. 𝑄^\]. ′
Tortilla Market Corn for Food Market
𝑆 𝑆′ 𝑆
𝑆

𝑃a`b]T
a`b] 𝐸 𝑃^_``T
𝑃
𝑃^_`` 𝐸

𝐷 𝐷
𝑄a`b]T 𝑄a`b] 𝑄^_``T 𝑄
^_``
Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 32
 Business Inside 2: Globalization and Supply of Soft Drinks

• Rasna Ltd.—a leader in the Indian concentrated soft drink market that sells nearly 3
billion glasses of product each year—recently announced plans to boost its exports by
30 percent
• The company currently exports products to nearly 40 countries and is now eyeing the
U.S. and U.K. markets.
• Rasna’s entry into U.S. and U.K. soft drink markets would shift the supply curves in
these markets to the right.
• This will negatively impact the bottom lines of firms that currently sell in these
markets: The increase in supply will reduce the equilibrium prices of soft drinks and
the profits of existing soft drink makers. (Ceteris paribus)

(Source: “Rasna Plans Exports to US, UK, and Africa,” Financial Express, India, May 26, 2004)

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 33
Demonstration Problem - II
• The manager of a fleet of cars currently rents them out at the market
price of $49 per day, with renters paying for their own gasoline and
oil. In a front-page newspaper article, the manager learns that
economists expect gasoline prices to rise dramatically over the next
year, due to increased tensions in the Middle East.

• What should she expect to happen to the price of the cars her
company rents?

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 34
 Solution
• Since gasoline and rental cars are
complements, the increase in gasoline prices Price S
will decrease the demand for rental cars
A
• D in Figure represent the initial demand for
rental cars, so that the initial equilibrium is at $49
point A. An increase in the price of gasoline B
will shift the demand curve for rental cars to
the left (to D’), resulting in a new equilibrium $45 D
at point B.
D’
• Thus, she should expect the price of rental
cars to fall. 100 104 108
Quantity
(thousand cars
rented per day)

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 35
Demonstration Problem - III
Suppose you are the manager of a chain of computer stores. For obvious
reasons you have been closely following developments in the computer
industry, and you have just learned that Congress has passed a two-
pronged program designed to further enhance the U.S. computer
industry’s position in the global economy. The legislation provides
increased funding for computer education in primary and secondary
schools, as well as tax breaks for firms that develop computer
software. As a result of this legislation, what do you predict will
happen to the equilibrium price and quantity of software?

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 36
 Solution
• The equilibrium quantity certainly will increase, but the market price may rise, remain the
same, or fall
• depending on the relative changes in demand and supply
• increased funding for computer education (normal good)
• reduction in taxes on software manufacturers will lead to an increase in the supply of software
• If the rightward shift in supply is small compared to the rightward shift in demand, both the
equilibrium price and quantity will increase.
• If supply increases by the same amount as demand, there will be no change in the price but
the equilibrium quantity will rise.
• If supply increases more than the increase in demand, the resulting equilibrium will entail a
lower price and a greater quantity. In all cases, the equilibrium quantity increases.

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 37
Lecture Overview
• Section 1: Market Equilibrium
• Section 2: Excess Demand and Excess Supply
• Section 3: Change in Demand and Supply
• Section 4: Surpluses
• Section 5: Price Controls
• Section 6: Takeaway

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 38
 Consumer Surplus
• Consumer Surplus is the value consumers get from a good
but do not have to pay for.
• Consumer surplus is the area above the price paid for a good
but below the demand curve.
• The shaded triangle illustrates the consumer surplus of a
consumer who buys Q0x units at a price of P0x. The
difference between each price on the demand curve and the
price P0x paid represents surplus (the value the consumer
receives but does not have to pay for).
• Example:
For instance if a student would have been willing to pay
Rs.100 for a rock concert ticket, even though she actually
only had to pay Rs.80. Rs.20 was her consumer surplus.
Note: Chapter 9

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 39
 Producer Surplus
• Producer Surplus is the amount producers receive in excess
of the amount they are willing to sell the good at.
• Producer surplus is the area above the supply curve but below
the market price of the good.
• Example:
The supply curve shows that if 800 units are produced ,
producers will have to receive $400 to be induced to produce
one more unit. producers are willing to sell each unit of output
below 800 units at a price less than $400.

But if the price is $400, producers receive an amount equal to

$400 for each unit of output below 800, even though they
would be willing to sell those individual units for a lower
price.

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 40
 Total Surplus
• Market equilibrium marked by point E, is determined at the
intersection of the market demand curve Qd and the market
supply curve Qs.
• Consumer Surplus is the area above the equilibrium price Pe and
below the market demand curve Qd.
It the excess amount the consumers were willing to pay, over how
much they actually paid.
• Producer Surplus is the area below the equilibrium price Pe and
above the market supply curve Qs.
It the excess amount the producers received, over how much they
actually required to produce.
• Total Surplus = Consumer Surplus + Producer Surplus

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 41
Lecture Overview
• Section 1: Market Equilibrium
• Section 2: Excess Demand and Excess Supply
• Section 3: Change in Demand and Supply
• Section 4: Surpluses
• Section 5: Price Controls
• Section 6: Takeaway

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 42
 Price Ceiling
• Price Ceiling is the maximum legal price that can be
charged in a market.
• Can the price ceiling be above equilibrium price?
• At Pc there is an excess demand
• Under the price ceiling of Pc, only Qs units of the good
are available, such that consumers are willing to pay PF
for another unit of the good. By law, however, they
cannot pay the firm more than Pc.
• Since price ceilings reduce the quantity available in the
market, such regulations reduce social welfare, marked by
the shaded triangle. The triangle is sometimes called
“deadweight loss”

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 43
 Price Floor
• Price Floor is the minimum legal price that can be charged in a
market.
• Can price floor be below equilibrium price?
• When the price floor is set at Pf, quantity supplied is Qs and quantity
demanded is Qd, thus a surplus evolves which translates into unsold
inventories in the product market.
• Buyers end up paying a higher price and purchasing fewer units.
Producers receive a higher price for the units they sell.

• Since the area of a rectangle is its base times its height, the cost to the
government of buying the surplus is given by the shaded area FGQsQd

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 44
Price Ceilings and Floors: Examples
• Ceiling
• Thailand oil price through market forces during the 1990s, but its Commerce
Ministry imposed a price ceiling in an attempt to hold down the rapidly rising
gasoline prices during the early 2000s.
• Price Ceiling in movie tickets in Tamil Nadu: Rs. 120
• Usury Laws in US: Ceiling on the interest rate
• Floor
• Minimum wage: e.g. MGNREGA
• In Canada Ontario, British Columbia, and Quebec have established floor
prices (called “minimum retail prices”) on beer to keep prices artificially high
in an attempt to discourage alcohol consumption and to protect Canadian
brewers from inexpensive U.S. brands.

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 45
Demonstration Problem-IV
One of the members of the Senate Foreign Relations Committee is
worried that the free market price might be too low to enable producers
to earn a fair rate of return on their investment. He asks you to explain
what would happen if the Chinese government privatized the market,
but agreed to purchase the good from suppliers at a floor price of $4.
Assume that the market demand and supply curves (in U.S. dollar
equivalent prices) are given by
Qd=10-2P and Qs=2+2P

What do you tell the senator?

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 46
Solution
Since the price floor is above the equilibrium price of $2, the floor results in
a surplus. More specifically, when the price is $4, quantity demanded is
Qd=10-2(4) =2
and quantity supplied is

Qs=2+2(4) =10
Thus, there is a surplus of 10-2 = 8 units. Consumers pay a higher price
($4), and producers have unsold inventories of 8 units. However, the
Chinese government must purchase the amount consumers are unwilling to
purchase at the price of $4.
Thus, the cost to the Chinese government of buying the surplus of 8 units is
$4 * 8 = $32.

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 47
Per unit Tax
• Supply curve shifts 𝑆]de
Price S
• Price paid by consumer
• Price received by producer
• Tax shared by producer and P2 B
consumer
P1 D A
• Deadweight loss
P3 C D

Q2 Q1 Quality

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 48
Business Inside: The Oil Market
• Oil price over thirty years
• 1974 : OPEC pushed up oil prices more
than competitive prices
• 1979 : Iranian Revolution and outbreak of
Iran-Iraq war
• 1980s: gradual fall in oil price
• 1990: Iraqi invasion of Kuwait
• 2000: Strike against Venezuela
• 2003: Outbreak of Iraq war
• 2008: The Great Recession
• 2009-11: India China Growth

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 49
Business Inside: The Oil Market
• What will happen to oil price and quantity if there is a major negative shock
in the middle east? Negative shock: Oil supply decreases by 3bb per year
• Data
• 2009-2011
• World price $80 per barrel
• World demand and total supply 32 billion barrel per year
• OPEC supply 13 billion barrel per year
• Competitive supply 19 bb/yr
• Elasticity estimates of oil demand and supply (obtained from research papers)

Short Run Long Run

World Demand -0.05 -0.30
Competitive supply 0.05 0.30
Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 50
Business Inside: The Oil Market

• Derive the short run demand curve

𝐷 − 32
32 = −0.05
𝑃 − 80
80
32 ∗ 0.05
⟹ 𝐷 − 32 = − × 𝑃 − 80
80
⟹ 𝐷 = 33.6 − 0.02𝑃
• Derive the long run demand curve D = 41.6 − 0.120𝑃
• Derive the short run competitive supply curve S = 18.05 + 0.012𝑃
• Derive the short run total supply curve S = 31.05 + 0.012𝑃
• Derive the long run competitive supply curve S = 13.3 + 0.071𝑃
• Derive the long run total supply curve S = 26.3 + 0.071𝑃

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 51
Business Inside: The Oil Market

• Middle East shock reduces oil supply by 3 bb

• Short Run
• Short run total demand curve 𝐷 = 33.6 − 0.02𝑃
• Short run total supply curve S = 28.05 + 0.012𝑃
• 𝑃 +∗ = $173
• Long Run
• Long run demand curve D = 41.6 − 0.120𝑃
• Long run total supply curve S = 23.3 + 0.071𝑃
• 𝑃=∗ = $95.81

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 52
Business Inside: The Oil Market

Short Run S𝑆′ Long Run

𝑆𝑆 L𝑆′
𝐿𝑆
P=173
P=95.8
P=80 P=80
𝐸 𝐸

𝐷 𝐷

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 53
Lecture Overview
• Section 1: Market Equilibrium
• Section 2: Excess Demand and Excess Supply
• Section 3: Change in Demand and Supply
• Section 4: Surpluses
• Section 5: Price Controls
• Section 6: Takeaway

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 54
The Effect of Demand and Supply Shifts
on Equilibrium

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 55
The Effect of Demand and Supply Shifts
on Equilibrium

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 56
 Thank You
www.ritwikbanerjee.in

Banerjee (IIM Bangalore) ME Lecture 4: Market Equilibrium PGP Term I, 2019 Slide 57