Chapter 3 Market Equilibrium PDF

Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 1  CHAPTER 3 MARKET EQUILIBRIUM Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T)...

Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 1  CHAPTER 3 MARKET EQUILIBRIUM Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 2  DEFINITION OF MARKET EQUILIBRIUM A market equilibrium is a situation when quantity demanded and quantity supplied are equal and there is no tendency for price or quantity to change. QDD = QSS Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 3  EQUILIBRIUM PRICE AND OUTPUT SURPLUS (QSS > QDD) 6 5 4 Price E 3 P* SS 2 DD 1 SHORTAGE (QDD > QSS) 0 Q* 2 4 6 8 10 Quantity Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 4  EQUILIBRIUM PRICE AND OUTPUT Price Quantity Quantity Market Market Prices Demanded Supplied Condition 5 2 10 SURPLUS Falls 4 4 8 SURPLUS Falls 3 6 6 EQUILIBRIUM Equilibrium 2 8 4 SHORTAGE Rises 1 10 2 SHORTAGE Rises Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 5  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 Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 6  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 Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 7  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* Q1 Quantity Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 8  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 increases and quantity Q* Q1 Quantity increases Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 9  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 Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 10  MAXIMUM PRICE MINIMUM PRICE GOVERNMENT INTERVENTION IN THE MARKET TAXES SUBSIDIES Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 11  GOVERNMENT INTERVENTION IN MARKETS MAXIMUM PRICE/CEILING PRICE Advantage: Government-imposed regulations that Price Consumers purchase at S prevent prices from rising above a lower price maximum level Suppliers reduce the amount offered to Q1 but demand would rise to Q2 creating a shortage The equilibrium price is P* and the quantity is Q* P* The government imposes a maximum price of P1 P1 Price Disadvantages: Emergence of black market ceiling Reduction in quantity Shortages occur produced D Producers tend to receive illegal payments from Q1 Q* Q2 Quantity consumers Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 12  GOVERNMENT INTERVENTION IN MARKETS (cont.) MINIMUM PRICE/FLOOR PRICE Price Government-imposed regulations S that prevent prices from falling below Surplus occurs a minimum level Advantages: P1 Floor Price Protects the producer’s income Higher wage rate P* Suppliers increase the The amount equilibrium offered to Q2 but Disadvantages: pricedemand is P* and theto Q drop 1 quantity is Q*. creating a surplus Consumers pay more The government imposes Waste of resources a minimum of production price of P1 D Creates unemployment Q1 Q* Q2 Quantity Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 13  EFFECT OF TAXATION S1 INDIRECT TAX Price Tax that is imposed by the S government on producers or sellers but paid by or passed on to end-users The equilibrium price is RM12 and the 14 quantity is 400 CONSUMER’S SHARE The government imposes a sales tax 12 of RM4 per carton PRODUCER’S SHARE 10 SS curve shift to left from S to S1 and new equilibrium is RM14 and 200 units The tax amount of RM4 is shared equally between buyer and seller D 200 400 Quantity Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 14  Demand less elastic than supply Perfectly inelastic demand P P S + tax (RM4) D 15 S + tax S 16 S CONSUMERS’ SHARE CONSUMERS’ 12 SHARE 12 PRODUCERS’ SHARE 11 D 0 400 Q O 400 Q Demand is more elastic than supply Incidence of tax: elastic supply P S + tax P S + tax S S 13 12 CONSUMERS' SHARE 121 PRODUCERS’ D SHARE PRODUCERS’ 18 SHARE D 9 O 400 Q O 400 Q Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 15  EFFECT OF SUBSIDIES S SUBSIDY Price An incentive from the government to encourage producers to produce more S1 The equilibrium price is RM50 and the quantity is 10 50 The government provides a subsidy of CONSUMER’S SHARE RM10 per unit 45 PRODUCER’S SS curve shifts to the right from S to SHARE S1 and new equilibrium is RM45 and 40 20 units The subsidy amount of RM10 is shared equally between buyer and seller D 10 20 Quantity Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 16  EFFECT OF PRICE ELASTICITY ON SUBSIDIES Demand is more elastic than supply Demand less elastic than supply P P S S+ tax (RM4) 50 S + tax S CONSUMERS’ SHARE 50 CONSUMERS'S SHARE 47 43 PRODUCERS’ PRODUCERS’SHARE ’ SHARE 40 SHARE D 40 D O 10 Q 0 10 Q Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 17  MARKET FAILURE  Market failure exists when a free market is unable to deliver an efficient allocation of resources which leads to a loss of economic efficiency.  Causes of market failure 1. Externalities 2. Existence of monopoly power 3. Public goods 4. Incomplete information Principles of Economics second edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 3: 18