Transcript PRINCIPLE OF ECONOMICS

Microeconomics
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CHAPTER
3 Market Equilibrium
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DEFINITION OF MARKET
EQUILIBRIUM
Market equilibrium is a situation where
quantity demanded and quantity
supplied are equal and there is no
price or quantity to change.
QDD = QSS
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EQUILIBRIUM PRICE AND
OUTPUT
Market equilibrium is determined by the
intersection of the the demand curve and the
supply curve.
Equilibrium price and quantity refers to the price
and quantity that consumers and suppliers are
willing to buy and sell.
Market equilibrium can be determined using a
demand and supply model, graphical illustration
and through mathematical equation.
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GRAPHICAL ILLUSTRATION OF
EQUILIBRIUM PRICE AND OUTPUT
A Graphical illustration
6
SURPLUS (QSS > QDD)
5
Price
4
3
E
P*
SS
2
DD
1
SHORTAGE (QDD > QSS)
Q*
0
2
4
6
8
10
Quantity
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GRAPHICAL ILLUSTRATION OF
EQUILIBRIUM PRICE AND OUTPUT(CON’T)
(1)
Price (RM)
(2)
Quantity
Demanded
(units)
(3)
Quantity
Supplied
(units)
(4)
Market
Condition
(5)
Market
Prices
9.00
2000
10000
SURPLUS
Falls
8.50
4000
8000
SURPLUS
Falls
8.00
6000
6000
EQUILIBRIUM
Equilibrium
7.50
8000
4000
SHORTAGE
Rises
7.00
10000
2000
SHORTAGE
Rises
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MATHEMATICAL EQUATION OF
EQUILIBRIUM PRICE OUTPUT (CON’T)
The market demand and supply functions are given below:
Market demand, QDD
= 38000 – 4000P (equation 1)
= – 26000 + 4000P (equation 2)
Market supply, QSS
To find market equilibrium price and quantity, QDD = QSS
QDD = QSS
38000 – 4000P
= – 26000 + 4000P
8000P = 64000
P = RM8.00
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MATHEMATICAL EQUATION OF
EQUILIBRIUM PRICE OUTPUT (CON’T)
Substitute P = 8 into equation 1 and 2 to obtain the
quantity.
QDD
QSS
=
=
=
=
38000 – 4000(8)
6000 units.
– 26000 + 4000(8)
6000 units.
(equation 1)
(equation 2)
So, the equilibrium quantity, Q = 6000 units.
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SHOCKS IN EQUILIBRIUM
Once the market reaches equilibrium level, it
remains there so long as no pressure is put on
the prices.
Market equilibrium will change when there is a
shock that would shift the demand or supply
curve.
The shock that shifts the supply and demand
curves are due to changes in non-price factors.
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2008
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EFFECT OF CHANGES ON
DEMAND
ASSUME THAT SUPPLY IS CONSTANT
Increase in
Demand
Price (RM)
SS
DD curve shifts to
the right
P1
Decrease in
Demand
DD curve shifts to
the left
Equilibrium price
and quantity
increases
P*
DD1
P2
Equilibrium price
and quantity
decreases
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DD
DD2
Q2
Q*
Q1
Quantity
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EFFECT OF CHANGES ON SUPPLY
ASSUME THAT DEMAND IS CONSTANT
Price (RM)
Increase in Supply
SS2
SS curve shifts to the
right
SS
P2
Decrease in
Supply
P*
SS curve shifts to
the left
P1
Equilibrium price
increases and
quantity
decreases
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SS1
Equilibrium price
decreases and
quantity increases
DD
Q2
Q*
Q1
Quantity
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EFFECT OF CHANGES ON
DEMAND AND SUPPLY
SUPPLY AND DEMAND INCREASE
Price (RM)
DD1
Case 1: Increase at
same magnitude
SS
P*
SS1U
Equilibrium price
undetermined and
quantity increases
DD
Quantity
Q*
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Q1
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EFFECT OF CHANGES ON
DEMAND AND SUPPLY (CON’T)
SUPPLY AND DEMAND DECREASE
Price (RM)
Case 2: Decrease at
same magnitude
SS1
SS
P*
Equilibrium price
undetermined and quantity
decreases
DD
DD1
Q1
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Q*
Quantity
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EFFECT OF CHANGES ON
DEMAND AND SUPPLY (CON’T)
SUPPLY INCREASE AND DEMAND DECREASES
Price (RM)
Case 3: Changes in
different magnitude
SS
SS1
Equilibrium price decreases
and quantity undetermined
P*
P1
DD1
Q*
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DD
Quantity
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EFFECT OF CHANGES ON
DEMAND AND SUPPLY (CON’T)
SUPPLY DECREASES AND DEMAND INCREASES
Price (RM)
SS1
Equilibrium price increases
SS
and quantity undetermined
P1
P*
DD1
DD
Q*
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Case 4: Changes in
different magnitude
Quantity
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GOVERNMENT INTERVENTION
MAXIMUM PRICE
MAXIMUM PRICE
GOVERNMENT INTERVENTION IN
THE MARKET
TAXES
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SASUBSIDIES
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GOVERNMENT INTERVENTION
(CON’T)
Price
Disadvantages
Advantage
Consumers purchase
at lower price.
MAXIMUM PRICE/
CEILING PRICE
Government-imposed
regulations prevent prices
from rising above the
maximum level.
SS
Suppliers reduce the amount
offered to Q1 but demand
would rise to Q2 creating a
shortage.
P*
• Emergence of
black market.
• Reduction in
quantity
produced.
• Producers tend
to receive illegal
payments from
consumers.
Price
ceiling
P1
Shortage occurs
Q1
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Q*
Q2
DD
The government imposes a
maximum price of P1.
The equilibrium price is P*
and the quantity is Q*.
Quantity
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GOVERNMENT INTERVENTION
(CON’T)
Price
SS
Surplus occurs
Advantages
• Protects
producer’s
income
P1
Floor price
Suppliers increase the amount
offered to Q2 but demand drop to
Q1 creating a surplus.
P*
The government imposes a
minimum price of P1
• Higher
wage rate
The equilibrium
price is P* and
the quantity is
Q*.
MINIMUM PRICE/ FLOOR PRICE
Government-imposed regulations
prevent prices from falling below a
minimum level.
DD
Q1
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Q*
Q2
Disadvantages
Consumers pay more. Waste of
resources of production
Creates unemployment
Quantity
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EFECT OF TAXATION
INDIRECT TAX
Tax that is imposed by the government
on producers or sellers but paid by or
passed on to end-users.
SS1
Price
SS
The equilibrium price is RM12 and the
quantity is 400 units
14
12
10
CONSUMER
’S SHARE
The government imposes a sales tax of
RM4 per carton.
PRODUCER
’S SHARE
SS curve shift to the left from SS to SS1
and new equilibrium is RM14 and 200
units.
The tax amount of RM4 is shared
equally between buyer and seller.
DD
200 400
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Perfectly inelastic demand
Demand less elastic than supply
P
P
D
S + tax (RM4)
S + tax
15
S
CONSUMERS’
SHARE
CONSUMERS’
SHARE
12
S
16
12
PRODUCERS’ SHARE
11
D
400
0
Q
Demand less elastic than supply
P
400
O
Q
Incidence of tax: elastic supply
P
S + tax
S + tax
S
S
13
CONSUMERS’ SHARE
12
121
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PRODUCER’ SHARE
D
PRODUCERS’
SHARE
D
9
O
400
Q
O
400
Q
EFECT OF SUBSIDIES
SUBSIDY
S
Price
An incentive from the government to
encourage producers to produce
more.
S1
The equilibrium price is RM50 and
the quantity is 10.
50
45
40
CONSUME
R’S SHARE
The government provides a subsidy
of RM10 per unit.
PRODUCER
’S SHARE
SS curve shift right from SS to SS1
and new equilibrium is RM45 and
20 units.
The subsidy amount of RM10 is
shared equally between buyer and
seller.
D
10
20
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EFECT OF PRICE ELASTICITY
ON SUBSIDIES
Demand is more elastic than supply
Demand less elastic than supply
P
P
S + tax (RM4)
S
50
S + tax
S
CONSUMERS’
SHARE
50
47 CONSUMERS’ SHARE
43
40
PRODUCERS’ SHARE
PRODUCERS’ SHARE
D
40
D
O
10
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Q
0
10
Q
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