ECO162

MICROECONOMIC
S

PREPARED BY:
NOR HAMIZA MOHD GHANI
CHAPTER OBJECTIVES:

To describe how demand and supply

interact in the market to determine prices
and quantities.

To explain how changes in demand and

supply can effect equilibrium prices and
quantities.
Definition
1. Market : a place where buyers and sellers interact to
determine the price and quantity of goods and services
exchanged

2. Market equilibrium: a situation that occur at any price

at which the quantity demanded equals the quantity
supplied

Qd = Qs
Quantity that buyers are wiiling to buy
= Quantity that sellers are willing to sell

Notes:
P*=equilibrium price
Q*=equilibrium quantity
 Market surplus and shortage
Price Qd (kg) Qs Market outcomes 1. Surplus
(RM/ (kg)
-occurs when Qd < Qs
kg)
-when the price is set
1 12 4 Qd>Qs →shortage above the equilibrium
= 12 – 4 = 8 kg price
2 10 6 Qd>Qs →shortage
= 10 – 6 = 4 kg 2. Shortage
3 8 8 Qd=Qs→Equilibrium -occurs when Qd > Qs
P*=RM3/kg; Q*=8kg -when the price is set
4 5 11 Qd<Qs →Surplus below the equilibrium
price
= 11 – 5 = 6 kg
5 4 12 Qd<Qs →Surplus
3. Market equilibrium
= 12 – 4 = 8 kg
Qd= Qs
Table: Market demand and supply for rambutan
Contd.
Price (RM/ kg)
S
Surplus
5
Surplus
4

E
P* = 3

2
Shortage
1
Shortage
D
Quantity (kg)
4 56 Q*=8 10 11 12
 EXERCISE
The following table shows demand and supply schedules for rice.
Price (RM/kg) Quantity demanded Quantity supplied (kg)
(kg)
7.00 1000 5000

6.00 2000 4000

5.00 3000 3000

4.00 4000 2000

3.00 5000 1000

a) Plot the demand (D) and supply (S) curves for rice on a graph paper. (3 marks)

b) Based on your graph, determine the equilibrium price and quantity. (2

marks)

c) At the price RM3.00 per kg, is there an excess demand or supply? How much
is the excess quantity? (2
marks)

d) State three (3) factors that may cause the demand curve for rice to shift to the
right.
Changes in demand and supply and the
impact on market equilibrium
1. Changes in demand
Price (increases), with supply
remains constant
S
-The initial equilibrium is Eo
E1 with P*=Po and Q*=Qo
P1 -suppose there is an increase
Eo in consumer’s income (normal
Po
goods) that will leads to an
increase in demand
D1 -demand curve will shift to
right from Do to D1
Do
-As a result, the
Quantity
Qo Q1 P* rises from Po to P1
Q* rises from Qo to Q1
New market equilibrium = E1
Note: DIY when demand decreases
 Contd.
2. Changes in supply
Price (increases), when demand
remains constant
So S1 -The initial equilibrium is Eo
with P*=Po and Q*=Qo
Eo -suppose there is technological
advancement in producing car
Po
E1 that will leads to an increase in
P1 supply of car
-supply curve will shift to right
from So to S1
Do
-As a result, the
Quantity
Qo Q1 P* falls from Po to P1
Q* rises from Qo to Q1
New market equilibrium = E1

Note: DIY when supply decreases

 Contd.
3. Increases in both demand and
supply with equal magnitude shift
Price in both demand and supply curve
So -The initial equilibrium is Eo with
S1 P*=Po and Q*=Qo
-suppose there is an increase in
demand for chickens during Hari
Raya. Government overcome this
Eo problem by increase the supply of
Po=P1 E1 imported chickens
-both demand and supply curve will
shift to rights from Do to D1 and So
D1 to S1 respectively
-As a result, the
Do P* remains the same
Quantity only Q* rises from Qo to Q1
Qo Q1 New market equilibrium = E1

Note: DIY when both demand and

supply decreases
Contd. 4. Increases in both demand and
supply with magnitude shift in
demand is greater than
Price magnitude shift in supply curve
-The initial equilibrium is Eo with
So P*=Po and Q*=Qo
S1 -suppose there is an increase in
demand for chickens during Hari
P1 E1 Raya. Government overcome this
Eo problem by increase the supply of
Po
imported chickens in only smaller
quantities
D1 -both demand and supply curve will
shift to rights from Do to D1 and So
Do to S1 respectively
Quantity -As a result, the
Qo Q1 P* rises from Po to P1
Q* rises from Qo to Q1
New market equilibrium = E1

Note: DIY when both demand and supply decreases

with magnitude shift in demand is greater than
magnitude shift in supply curve
Contd. 5 increases in both demand and
supply with magnitude shift in
demand is smaller than
Price magnitude shift in supply curve
-The initial equilibrium is Eo with
So P*=Po and Q*=Qo
S1 -suppose there is a smaller increase
in demand for mandarin oranges
during CNY. Government overcome
Eo this problem by increase the supply
Po
P1 of imported mandarin oranges in
E1 larger quantities
D1 -both demand and supply curve will
shift to rights from Do to D1 and So
Do to S1 respectively
Quantity -As a result, the
Qo Q1 P* falls from Po to P1
Q* rises from Qo to Q1
New market equilibrium = E1

Note: DIY when both demand and supply decreases

with magnitude shift in demand is smaller than
magnitude shift in supply curve
Application of demand and supply analysis
A.Price controls: Government
intervention
B.Impact of taxes and subsidies :
-effects on price and quantity,
incidence of tax
C.Market failures (externalities)
 Government intervention in the market:
ceiling price and floor price
Price (RM/kg)
1. Ceiling price
S -also called as maximum
price
-is set below the
equilibrium price
E
2.00 -Ceiling price is imposed
on essentials goods such
1.45
as cooking oil, flour and
Shortage sugar
D -to restrain inflation
Quantity -it will occurs shortage
Qs Qe Qd
(kg)
1. Ceiling price
Advantage Disadvantages
 Consumers pay less  Emergence of black market-
- are able to enjoy goods and producers might smuggle goods
services at cheaper price. to other neighbouring countries
since it is unprofitable to sell
those goods locally.
• To prevent the market price
from rising after a certain  Producers might engage in
level, as this would harm
illegal activities such as
consumers esp the poor bribery, corruption and
hoarding of goods.-creates
artificial shortage

 Reduced quantity produced/

creates shortage due to lower
profit
 A.Government intervention in the market:
ceiling price and floor price
Price (RM/kg)
2. Floor price
S -also called as minimum
Surplus price
-is set above the equilibrium
2.50
price
E -Floor price is initiated by
2.00 the government in the
agricultural sectors. For
example: price of paddy
-to help farmers to increase
D their income
-it will occurs surplus
Quantity
Qd Qe Qs
(kg)
2. Floor price
Advantages Disadvantages
 Consumers pay more
Protects producer’s  -unfair to consumers
income  Waste of resources of
-esp in agriculture production
- because of excess supply
sector due to climatic created in the economy.
conditions. (price  Creates unemployment
fluctuations) -due to concept of min wage.
Higher wage rate When government increase the
min wage, the cost of
-(government set a min production will increase too.so,
the producers prefer to hire
wages to prevent their foreign workers since they are
income from falling) willing to accept lower wages.
Price control from islamic
viewpoint
Islam forbid price control under normal
circumtances:
 They are unfair to both sellers and buyers
 Max price is unjust to the producers
 Min price is unjust to buyers
 Nabi Muhammad s.a.w rejected the request by
people in Madinah to interfere in the market so
that price will not increase.
 He refused to interfere because the price
increase not due to producers injustice but due
to a decrease in the supply brought into Madinah
Cont’d
Islam allow price control if
 It is proven the increase / decrease in
prices are due to injustice or manipulation
of the market
 E.g: the high price occurred due to a
planned decrease in supply by a monopolist
or hoarding by some sellers
 B.1. Impact of taxation
1. Effect of taxes on P* and Q*
Price (RM) - The initial equilibrium is Eo
with P*=12 and Q*=40
S1
So -suppose government imposed
RM2
bear a sales tax of RM 4 per carton
by the
buyer
of cigarettes
b
14 a -when a tax imposed, there are
buyer no changes in demand.
12 e f Eo movement only occurs along
seller
the demand curve
10 d c
RM2
bear Do -tax will increase cost of
by the production, thus supply will
seller Quantity
20 40 decrease
-supply curve will shift to left
from So to S1

N.M.G
Contd.
 Effect of taxes
i.Equilibrium price rises to new P*=RM14 and
equilibrium quantity falls to new Q*= 20
ii.Consumers:
-needs to buy with RM14 which is RM2 higher than before
tax
-consumer’s tax burden=abfe
iii.Producers:
-receive RM10 which is RM2 lower than before tax
-producer’s tax burden=efcd
iv.Total government revenue from tax
=4 x 20 = 80.
N.M.G
Effect of elasticities on tax burden
 Demand is inelastic to supply  Demand is more elastic than
S1 supply S1
Price (RM)
Price (RM) So

So
15 13
buyer buyer
12 12
11 seller seller
9 Do
Do
40 Quantity Quantity
40

-goods with low substitutes: -goods with high substitutes:

petrol, cigarettes toothpaste, cloth
-the buyer shared more of the -seller would share higher portion of
burden of tax since its demand the tax burden since the demand is
is inelastic more elastic than supply

N.M.G
 B.2. Impact of subsidies
2. Effect of subsidies on P* and Q*
-subsidies is an incentive from
government to encourage producers
Price or sellers to produce more
So S1 -subsidies will lower the cost of
production
-subsidies are provided for petrol,
diesel and others
1.50 seller - - The initial equilibrium is Eo with
P*=1.50 and Q*=1.2
1.00 -suppose government provided RM1
buyer per gallon of petrol
0.50 -subsidies will lower the cost of
productions.
-supply curve shift to right from So
Do to S1
Quantity
1.2 1.4
(gallon)

N.M.G
Contd.
 Effect of subsidies
i. P*falls to RM1 and Q*rises to 1.4gallon

ii. Consumers
-buy with lower price = RM1 per gallon
-enjoy by buyer =

iii.Producers
-receive RM0.50 per gallon
-enjoy by seller =

*the buyers and seller shares RM 0.50 each from the total subsidy
of RM1 per gallon

N.M.G
Effect of elasticities on subsidy
Demand is inelastic to supply
Total subsidy received by
Price seller:
SS
SS1 (RM3.00-RM2.70) x 30=RM9
3.00
Eo buyer:
2.70 (RM2.70-RM2.00) x 30=RM21

E1 Gov’s subsidy: RM30

2.00

Quantity

DD
N.M.G 30
20
Effect of elasticities on subsidy
Demand is more elastic
to supply Total subsidy received by
seller:
Price
SS
3.30 SS1 (RM3.30-RM2.70) x 40=RM24

buyer:
Eo (RM2.70-RM2.30) x 40=RM16
E1
2.70
2.30 Gov’s subsidy: RM40

DD

Quantity
20 40

N.M.G
C. Market Failures (externalities)
Externality is a cost or benefit imposed on
people other than producers and consumers
of a good or services
It is also a spillover effects or neighbourhood
effects
Negative externalities: pollution
Positive externalities: neat gardens and well
educated society

N.M.G
C. Market Failures (externalities)
• Negative externalities • Positive externalities
-Gov punish negative externalities by -subsidy will reduce production costs
imposing a tax or fine on producers and therefore will increase supply

N.M.G
-Taxation will increase the cost of -As a result
production
→P* falls
-As a result
→Q* rises
→P* rises
→Q* falls
Price (RM/kg) S1 Price (RM/kg) So
So S1
E1 Eo
P1 Po
Eo E1
Po P1

D D
Quantity (kg) Quantity (kg)
Q1 Qo Qo Q1

N.M.G
Exercise
The diagram below shows the market equilibrium for good X before
and after government imposed an indirect tax of RM2 per unit.

Price SS (after tax) a) What are the equilibrium price

SS (before tax)
and quantity before tax?

b) What are the equilibrium price

and quantity after tax?

4.8
4 c) Find the value of T.

d) Calculate the amount of tax

DD
passed on to consumer.
T
e) Why do producers have to
absorb most of the tax
burden?
70 120 Quantity

N.M.G
 answer
a) P* = RM4 , Q* = 120 units

b) P* = RM4.80 , Q* = 70 units

c) RM 2.80

d) (RM 4.80 – RM4.00) x 70 units)

= RM 56

e) Because DD curve is elastic and good X has

many close substitute goods

N.M.G
Exercise
The diagram below shows the DD and SS curves for good X. the
government imposes a per unit tax on good X and this is shown by the
shift of the SS curve from SS1 to SS2
Price
 A) what is the price and qtty after
tax? (2 marks)
SS2  B) How much is the per unit tax?
SS1
(1 mark)
 C) calculate the total amount of
tax paid
i- by producers and consumers (2
marks)
6.25
ii-to the government (1 mark)
D) Who bears ,more tax burden?
5.00 why? (2 marks)
4.00

DD

8 10 Quantity

N.M.G