FAR EASTERN UNIVERSITY HIGH SCHOOL

Accountancy, Business and Management

Nicanor Reyes Street, Sampaloc, Manila

CHAPTER 5

Lesson 5: Market Equilibrium

Objectives

After this chapter, the students are expected to:

• explain what market equilibrium in the product is about;
• define equilibrium price and equilibrium quantity;
• determine the equilibrium price and equilibrium quantity by using the demand and
supply schedules, demand and supply curves, and demand and supply functions;
• explain why and how a shortage and a surplus occur in the product market and how
prices adjust to clear the market of a shortage or a surplus;
• discuss how changes in demand and supply affect equilibrium in the product market;
and
• apply demand and supply analysis in situations where the government implements price
controls, such as price ceilings and price floors.

Subject Matter:

What does the word equilibrium mean? To some, it may mean balance; to others it may
refer to a state of rest. In economics, the market is said to be in equilibrium when the quantity
demanded of a good and its quantity supplied are balanced. The price that exists will no longer
go up or down.

In a market economy where competition among buyers and sellers is present, it is the
forces of demand and supply that determine the prices of goods and services.

The equilibrium price (Pe) at which the quantity of a kind of good that buyers are willing
and able to buy (quantity demanded) and the quantity that sellers are able and willing to sell
(quantity supplied) are equal. Since quantity demanded and quantity supplied are the same,
these are singularly referred to as the equilibrium quantity (Qe).

Table 5.1 Market Demand and Market Supply for Rice

Price per Kilo Quantity Quantity Supplied

(in Peso) Demanded (in kilos)
(in kilos)

20 60,000 20,000
25 50,000 30,000
30 40,000 40,000
35 30,000 50,000
40 20,000 60,000
 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

Figure 5.1 Determination of Equilibrium Price and Equilibrium Quantity

The equilibrium price of rice is 30 pesos and the equilibrium quantity is 40,000 kilos. At the
price of 30 pesos, quantity demanded and quantity supplied are both equal to 40,000 kilos.

Equilibrium in the market is shown by Point E. From this point, one can determine the
equilibrium price (Pe) in the Y-axis and the equilibrium quantity (Qe) in the X-axis.

The equilibrium price and equilibrium quantity can also be determined algebraically by using
the demand and supply function.

The market demand and market supply schedules are based on the demand function
QD= 100 – 2P and supply function Qs= -20 + 2P where constants a, b, c and d are in thousands.

To solve for equilibrium price:

QD = Qs
100 – 2P = -20 + 2P
-4P = -20 – 10
P = 30; Pe = 30 pesos

To solve for equilibrium quantity; substitute 30 to P in the equation:

100 – 2 (30) = -20 + 2(30)

100 – 60 = -20 + 60
40 = 40
Qe = 40, 000 kilos

If the price that exists in the market is not equilibrium price, then the market is in
disequilibrium. Either a surplus or a shortage appears in the market so that the price
automatically adjusts upward or downward to bring the market back to equilibrium. The
market is said to be self-equilibrating.

Suppose the price of rice is 25 pesos per kilo; at this price, the quantity demanded is 50, 000
kilos while quantity supplied is 30, 000 kilos. The quantity demanded exceeds quantity supplied
by 20, 000 kilos; there is a shortage of 20, 000 kilos. On the other hand, if the price of rice is 40
pesos per kilo, quantity supplied is 60, 000 kilos, while quantity demanded is 20, 000 kilos, a
 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

surplus of 40, 000 kilos appears in the market since quantity supplied exceeds the quantity
demanded by 40, 000 kilos.

Whenever the price is lower than what it should be (Pe), a shortage results. Thus, price goes up
and as it does, quantity demanded decreases while quantity supplied increases. The price stops
increasing until the shortage disappears; that is, quantity demanded becomes equal to quantity
supplied. The price that eventually exists is the equilibrium price.

If the price is higher that its equilibrium level, a surplus results. Thus, the price goes down and
continues to go down and as it does, the quantity supplied decreases while the quantity
demanded increases until the surplus disappears. The price stops decreasing until the quantity
demanded becomes equal to the quantity supplied.

In equilibrium, the market is cleared of any surplus or any shortage.

Figure 5.2 Graphical Illustration of Market Equilibrium and Disequilibrium

EFFECTS OF CHANGES IN DEMAND AND SUPPLY ON MARKET EQUILIBRIUM

Changes in demand and/or supply will bring about changes in market conditions leading to a
new equilibrium price and a new equilibrium quantity. Because the price has changed,
consumers and sellers also alter their choices. Consumers change the quantity of the goods that
they are able and willing to buy, and sellers change the quantity that they are able and willing
to sell.

Since economics is a predictive science, one can make use of demand and supply analysis to
make forecasts about suture prices. This is best shown and understood by using graphical
illustrations.

If it is either the demand or supply that changes, there is only one definite change that results.
The following are the changes in demand or supply and the corresponding changes in
equilibrium price and equilibrium quantity.
 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

Figure 5.3 A Shift in Demand and a New Equilibrium

Figure 5. 4 A Shift of Supply and a New Equilibrium

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

Figure 5.6 A Shift in Both Curves and a New Equilibrium

Table 5.2 Effect of Simultaneous Shifts in Supply and Demand

 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

PRICE CEILINGS AND PRICE FLOORS; SHORTAGES AND SURPLUSES

What if the change in supply or demand results in a new equilibrium price that is either too low
for producers (sellers) or too high for consumers (buyers?) Some of these individuals may find
themselves not satisfied with the market outcome. The government, in this case, has to
intervene in the price system to protect the interest of these individuals.

Suppose, for instance, that after a typhoon, a certain province becomes isolated so that the
supply of food has been greatly reduced. Base on supply and demand analysis, the prices of
goods¾most importantly that of the basic goods¾are expected to increase. To protect the
consumers from unscrupulous sellers who may take advantage of the situation, the
government, through the Department of Trade and Industry (DTI), will have to impose price
control in the form of a price ceiling.

Figure 5.7 The Imposition of a Price Ceiling

As shown in Figure 5.7, Pe is the equilibrium price, while Pc is the price ceiling set by the
government.

The price ceiling, which is lower than the equilibrium price, is the highest price at which
the goods can be sold. Sellers cannot sell the goods at a higher price than that set by the
government. Sellers who are found to be selling above the price ceiling are penalized. Their
licenses to operate could also be revoked, and their stores are closed.

Since the price ceiling is lower than the equilibrium price, a shortage of the goods occurs
in the market. Buyers will want to buy more at the price ceiling than at what the sellers are
willing to sell in the market. There may be buyers who are not satisfied with what they are able
to buy at the price ceiling, and they are willing to by more. This situation leads to the so-called
black market. A black market is illegal since sellers sell goods at a price higher than the price
ceiling. Because of the desire to earn profits and the high risk of getting caught by government
authorities, sellers sell at a higher price.

Price controls may also take the form of price floors which are intended to protect
sellers from the failure of the market mechanism to provide them with a higher price. Price
floor is the opposite of a price ceiling. A price floor is higher than the equilibrium price. It is the
lowest price set by the government at which buyers can buy the good. Since at the price floor
 FAR EASTERN UNIVERSITY HIGH SCHOOL
Accountancy, Business and Management
Nicanor Reyes Street, Sampaloc, Manila

sellers are able and willing to sell more and buyers are able and willing to buy less, a surplus
results.

Figure 5.8 Imposition of a Price Floor

In the figure above, PE is the price equilibrium and PF is the price floor. The government
can also implement price ceiling and price floor on wages, rent, and interest.