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Chapter Six 074907

The document discusses market equilibrium, defined as the state where quantity demanded equals quantity supplied, resulting in no shortages or surpluses. It outlines two types of equilibrium: stable and unstable, with stable equilibrium returning to its original state after disturbances, while unstable equilibrium does not. Additionally, it covers the effects of taxes on equilibrium price and quantity, explaining how different tax types influence market dynamics.

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3 views29 pages

Chapter Six 074907

The document discusses market equilibrium, defined as the state where quantity demanded equals quantity supplied, resulting in no shortages or surpluses. It outlines two types of equilibrium: stable and unstable, with stable equilibrium returning to its original state after disturbances, while unstable equilibrium does not. Additionally, it covers the effects of taxes on equilibrium price and quantity, explaining how different tax types influence market dynamics.

Uploaded by

jonathanchisenga40
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Market

Equilibrium 6
CHAPTER
Equilibrium
 The term equilibrium simply refers to a state of
stability.
 A commodity market is said to be in equilibrium when
the quantity demanded is equal to quantity supplied.
 This simply means that whatever is demanded is
supplied at the right time and price and neither the
producer nor the supplier is rationed.
 Therefore, when a market is in equilibrium there is
neither a shortage (excess demand) nor a surplus
(excess supply).
Equilibrium in a market

 A market is said to be in equilibrium when quantity supplied


is equal to quantity demanded.
 It occurs when both the consumer (demand curve) and
producer (supply curve) co-exist interact using forces of
demand and supply (market forces) to yield the market price
and quantity (equilibrium price and quantity).
 Graphically the point of equilibrium is defined by the point
of intersection of the market demand curve and supply
curve.
 The price and quantity at the equilibrium point are referred
to as equilibrium price and equilibrium quantity respectively.
Market Equilibrium

Price ss

e
Pe

DD
0
Qe
Types of equilibrium

 There are two different types of equilibrium


1. Stable equilibrium
2. Unstable equilibrium
Stable Equilibrium
 Under stable equilibrium, any distortion in
the market system say arising from change in
the commodity price; the system will re-
organize itself such that it’s initial position.
 This occurs either when the demand and
supply curves have normal shapes or when
both are upward sloped but the supply curve
is more elastic than the demand curve
Stable Equilibrium

Price
P1

e
Pe

P2
D
s d Qe s1 Qd
Q 1 2
Unstable Equilibrium
 On other hand, under unstable equilibrium,
any distortion in the price, will instead lead to
explosion of the system.
 So the initial position is never regained.
 This occurs when either demand curve or
supply curve or both have abnormal shapes.
Unstable Equilibrium

D
P1
e
Pe
P2

d s s 2
Q2 Q2 Qe Q1 Q1 Quantity
Summary of stable equilibrium
 Stable market equilibrium can be attained when:
 The demand and supply curves have normal
shapes.
 Both the demand and supply curves are upward
slopped but the supply curve is more elastic
than the demand curve.
 Both the demand supply curves are downward
slopped but the demand curve is more elastic
than the supply curve
Summary of unstable equilibrium
 Unstable equilibrium occurs when:
 Both the demand and supply curves are
upward sloped but the demand curve is more
elastic than the supply curve.
 Both the demand and supply curves are
downward slope but the supply curve is more
elastic than the demand curve.
Mathematical Derivation of equilibrium price and quantity

Supposing that the demand and supply


functions are given as:
Qd = a – bP
Q s = -c + dP
Where, a b, c, and d are possible constants. P is
price, Qd and Qs are quantity demanded and
quantity supplied respectively.
Mathematical Derivation of equilibrium price and quantity

 At equilibrium Qd = Qs

 Now equilibrium quantity demanded and


quantity supplied we get

 -c +dP = a – bP
Mathematical Derivation of equilibrium price and quantity

Collecting like terms together we get,


 bP dP = a + c
 P(b + d) = a + c

 P = a + c /b+ d
Mathematical Derivation of equilibrium price and quantity

 Substituting for P in any of the quantity


equations, for instance the supply equation
we get:
 Qe = -c + (a + c ) d
( b +d )
Mathematical Derivation of equilibrium price and quantity

 Expanding we get:
-c ( b +d ) + (a + c )
 Qe = (b +d)
 Therefore, equilibrium quantity:
 Qe = ad - bc
b+d
Example 1

 Given the following demand and supply


functions as;
 Qd = 36 – 4P and
 Qs = 4 + 12P respectively.
 To find equilibrium quantity and price we
equate quantity demanded to that supplied
such that:
Example 1
 At equilibrium, Qd = Qs such that we get;

 36 – 4P = 4 + 12P

 Then collecting like terms together we get,

 16P = 32

 Therefore the equilibrium price is; P = 2


Example 1
Now substituting for price P = 2 in any of the quantity equations, say the
demand equations we get the level of equilibrium quantity i.e. using the demand
equation;

Qd = 36 – 4P
=36 – (4*2)
= 36 – 8

= 28

Hence equilibrium quantity is, Qe =


28
Graphically
Price

SS

B
2

D
DC

0 Qty
28
Effect of tax on equilibrium price and quantity

 Imposition of a tax, distorts a market by changing the


equilibrium price and quantity without a tax, at
equilibrium, price paid by the consumer equals that
received by the producer, but when a tax is imposed on a
commodity; the new equilibrium is difficult to define
since price paid by the consumer is different from that
received by the producer (supplier) although the new
equilibrium quantity demanded equals to that supplied.
 With existence of a tax, on a commodity, the price paid
by the consumer equals that received by the producer
plus the amount of tax.
Types of taxes
 There are two forms of tax can be imposed on a commodity
in a market.
 One type of a tax is known as quantity tax and
 The second one is value tax also called ad-valorem tax.
 Quantity tax is paid or levied on every unit sold. On the
other hand value tax is expressed in percentage form.
 For instance, if the value tax is 10 percent of the
commodity which is valued at k100, then that commodity
would now cost k110.
 We note here that the consumer pays k110 but the
producer receives k100.
Quantity Tax

 Generally if the tax rate is ‘t’, and the price


paid by the consumer is ‘P’ while that
received by the supplier is ‘Ps’
 Then under value-tax, Pc = (1 + t) Ps.
Ad-valorem Tax
• Ad-valorem tax is very common in developing countries
because people keep records and there are stringent tax rules
and in addition there is less corruption and high level of social
development.
• On the other hand, quantity-tax is common in less developed
countries because it is easy to levy, and such countries are
characterized by high levels of corruption, inconsistent tax
rules, poor book keeping and low levels of social
development.
• Specifically, quantity-tax will lead to a shift in the supply
curve upwards to the left or shift of the demand curve
inwards by the amount of tax
Effects of tax on supply
S
1
Price

S0

Pc
t
Pe
Ps

D0

Q1 Q0
Quantity
Effects on supply
 When quantity tax (per unit tax) ‘t’ is imposed, the
supply curve shifts to the left from S0 to S1.
 Now with the existence of a tax price Pc is paid by
the consumer but the producer receives only Ps
per every unit sold.
 This means that out of the total unit tax ‘t’
imposed by government the consumer contributes
(pays) amount PePe per every unit purchased,
while the producer pays PsPs per unit sold.
Effects of tax on demand

Price
S0

Pc
Pe
t

Ps
D0

0 D1

Q1 Qe
Quantity
Effects on demand
 The demand curve shifts inwards by the amount
of tax’t’.
 Pe and Qe are the initial equilibrium price and
quantity respectively.
 After imposing tax, Q1 is the new quantity
demanded that equals the new quantity supplied.
 Pc is the price paid by the consumer but the
producer or seller receives Ps, the differennce
 Pc-Ps = t: the per unit tax.
End of lecture

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