Chapter III

Market Equilibrium & Market Application

Definition Market Equilibrium
Determination of Market Equilibrium
Changes in Equilibrium Price & Quantity
 Effects of a change in DD; SS is constant
 Effects of a change in SS; DD is constant
 A simultaneous change in DD & SS
Government Intervention – Price Control
 Price Ceiling (Maximum Price)
 Price Floor (Minimum Price)
 Market Equilibrium (Qd=Qs)
 Definition :
 Situation where the quantity demanded for a good is equal to the
quantity supplied. (DD=SS)
 Referred as market clearing where Qd=Qs
 Price at Qd=Qs known as equilibrium price

Price Quantity Demand Quantity Supplied Market Condition

(RM)
9.00 2000 10000 Surplus

8.50 4000 8000 Surplus

8.00 6000 6000 Equilibrium

(Qd=Qs)
7.50 8000 4000 Shortage

7.00 10000 2000 Shortage

 Continue..... Market Equilibrium (DD=SS)

• Market Demand & Market Supply Curve (refer graph)

• Surplus Qd<Qs (excess SS will put downward pressure on Price

until Equilibrium Price is achieve)
• Shortage Qd>Qs (excess DD will cause P to rise to Equilibrium
Price)
 EQUILIBRIUM PRICE AND OUTPUT

SURPLUS (QSS > QDD)

6

4
Price

E
3
P* SS
2 DD

1 SHORTAGE (QDD > QSS)

0
Q*
2 4 6 8 10
Quantity
 Continue..... Market Equilibrium (DD=SS)
• Exercise
The table below shows demand and supply schedule for onions.
Price (RM kg) Market Demand Market Supply (kg)
1.20 20 24
1.00 22 22
0.80 24 20
0.60 26 18
a. Plot the market demand and supply curve on a graph paper.
b. What is the equilibrium price and quantity?
c. Describe the situation at the price of RM0.60. What will occur?
d. Describe the situation at the price of RM1.20. What will occur?
e. Suppose the severe drought had resulted in decrease in the production of
onion by 4kg at each “price level”. Plot the new market supply curve. What is
the new equilibrium price and output?
 CHANGES IN DEMAND

Assume supply is constant

Price (RM) Increase in
Demand
SS -DD curve shifts to the
right
P2
-Equilibrium price and
quantity increase

P*

P1 DD1

DD
Decrease in Demand DD2
-DD curve shifts to the left
Q1 Q* Q2 Quantity
-Equilibrium price and quantity
decrease
 CHANGES IN SUPPLY

Assume demand is constant

Price (RM) Increase in Supply
SS2 -SS curve shifts to the right
SS -Equilibrium price decreases
and quantity increases
P2
SS1
P*

P1

DD

Decrease in Supply
-SS curve shifts to the left
Q1 Q* Q2 Quantity
-Equilibrium price increases
and quantity decreases
 CHANGES IN BOTH DEMAND AND SUPPLY

SUPPLY AND DEMAND BOTH INCREASE

Price (RM)
DD1 Case 1: Same
SS magnitude
-Equilibrium price is
constant and
quantity increases
SS1
P*

DD

Q* QQuantity
1
 CHANGES IN BOTH DEMAND AND SUPPLY
(cont.)
SUPPLY AND DEMAND BOTH INCREASE

Price (RM)
DD1
SS

SS1
P1
P*

Case 2: Different DD
Magnitude
-Equilibrium price
Q* Q1 Quantity
increases and quantity
increases
SIMULTANEOUS CHANGE IN DD & SS

•Increasing in DD > increasing in SS

both P & Q increase

 CHANGES IN BOTH DEMAND AND SUPPLY
(cont.)
SUPPLY AND DEMAND BOTH INCREASE

Price (RM)

DD1 SS

SS1

P*
P1

DD
Case 3: Different
Magnitude Q* Q1 Quantity
-Equilibrium price
decreases and quantity Both DD and SS increase
increases  Equilibrium quantity increase
 Equilibrium price is uncertain
•SIMULTANEOUS CHANGE IN DD & SS

• increasing in SS > increasing in DD

• P will fall & Q will increase

 Continue ....... Government Intervention
 Price Control • Also applied on fare of public
 Price control Act 1946 was transport, low cost houses & rent
legislated to give power for control
government to control the price of • Shortage occurs
goods & services
 Two types of price control : price
ceiling & price floor
 Ceiling Price S
• Known as a maximum price
• set by government below the E0

market price P0

• Any sales above the price is not Price ceiling

P1
allowed / maximum price

• Eg essential commodities -> rice, D

sugar, cooking oil

0 Q0 Quantity
 Continue ....... Government Intervention
 Advantage  Floor Price
• Consumers purchase products • Known as minimum price
at a lower price • Set by government above the
 Disadvantage market price
• Existence of black market - • Practices in the agricultural
illegal market (goods/services sectors
will sold at above the ceiling • Rational is to protect farmers &
price) increase their income (higher
• Reduces quantity produced – earnings)
limits profit • Surplus occurs
• Exploit consumers – consumers
are asked to pay extra money
(under table money)
 Continue ....... Government Intervention
• Effect of the floor price  Advantage
• Protects producer’s income

S
• Higher wage rate
P1 Price floor  Disadvantage
E0 / minimum price
• Exists surplus of goods
P0
• G has to buy & store the surplus
quantity, thus storage and
D
regulatory costs are incurred.
• Consumers pay more
0 Q0 Quantity
• Creates unemployment