Chapter 4 - Market Equilibrium PDF

CHAPTER 4 MARKET EQUILIBRIUM  LEARNING OUTCOMES At the end of the chapter, you should be able to: ❑ Define market equilibrium price and quantity ❑ Explain market equilibrium and disequilibrium ❑ Describe price control, i.e. maximum price and minimum price, and discuss t...

CHAPTER 4 MARKET EQUILIBRIUM  LEARNING OUTCOMES At the end of the chapter, you should be able to: ❑ Define market equilibrium price and quantity ❑ Explain market equilibrium and disequilibrium ❑ Describe price control, i.e. maximum price and minimum price, and discuss the effects of price control on market equilibrium.  INTRODUCTION ❑ The concept of market equilibrium which combine the demand and supply together. ❑ The demand curve is downwards sloping due to the law of demand whereas the supply curve slopes upwards according to the law of supply. ❑ Equilibrium refers to the state where selected inter- related variables have no tendency to change in the model in which they constitute. ❑ In the market equilibrium is said to be attained where quantity demanded is equal to quantity supplied.  DEFINITION OF MARKET EQUILIBRIUM ❑ Market ⎯ a place whereby both buyers and sellers interact to determine the equilibrium price and quantity of goods and services exchanged. ❑ 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. Q D = QS The price and quantity consumers willing to buy = The price and the quantity sellers willing to sell DETERMINATION OF EQUILIBRIUM PRICE AND EQUILIBRIUM QUANTITY All Rights Reserved 4– 6  DETERMINATION OF EQUILIBRIUM PRICE AND EQUILIBRIUM QUANTITY (cont.) Surplus/Excess SS There would be a downward pressure for the price to decrease towards P* Shortage/Excess DD There would be upward pressure for the price to increase towards P* All Rights Reserved 4– 7  DETERMINATION OF EQUILIBRIUM PRICE AND EQUILIBRIUM QUANTITY (cont.) Shortage ❑ A situation when Qdd > Qss ❑ E.g.: At USD2, the buyers are willing to buy 8 units of pens but the sellers are willing to sell only 4 units of pens. ❑ There is a shortage of 4 units of pens. ❑ Therefore, there is a tendency for price to increase as demanders compete against each other for the limited supply of pens. All Rights Reserved 4– 8  DETERMINATION OF EQUILIBRIUM PRICE AND EQUILIBRIUM QUANTITY (cont.) ❑ There are two effects as price increases to USD3: (a)The Qdd falls because the buyers find substitutes of pen. (b)The Qss increases as sellers find it is profitable to increase supplies of pen. ❑ The process will continue until the shortage eliminated. ❑When the Qdd and Qss are equal and there is no further increase in price, the process has achieved an equilibrium level. All Rights Reserved 4– 9  DETERMINATION OF EQUILIBRIUM PRICE AND EQUILIBRIUM QUANTITY (cont.) Surplus ❑ A situation when Qss > Qdd. ❑ E.g.: At USD5, the sellers are willing to sell 8 units of pens and the buyers are willing to buy only 4 units of a pens. ❑ There is a surplus of 4 units of pens. ❑ There are two effects as price decreases to USD3. (a) Sellers will supply less because now it is unprofitable to supply more due to the price cut. (b) When price decreases, it may attract new buyers. ❑ The process will continue until the surplus is eliminated and the equilibrium level is achieved. All Rights Reserved 4– 10  CONSUMER SURPLUS ❑ Consumer surplus measures the amount a consumer gains from a purchase by computing the difference between the price he actually pays and the price he would have been willing to pay. ❑ If, for example, a consumer would have been willing to pay $8 for a bushel of wheat but the price is only $3, the consumer surplus gained by the purchase is $5. CONSUMER SURPLUS  PRODUCER SURPLUS ❑ Producer surplus is an analogous concept. ❑ A producer willing to sell a good for $2 but receiving a price of $5 gains a producer surplus of $3. PRODUCER SURPLUS  Government Set Prices ❑In most markets, prices are free to rise or fall with changes in supply or demand, no matter how high or low those prices might be. However, government occasionally concludes that changes in ❑supply and demand have created prices that are unfairly high to buyers or unfairly low to sellers. ❑Government may then place legal limits on how high or low a price or prices may go.  Price Ceiling ❑Government sets a maximum legal price a seller may charge for a product or service and any price above it is illegal. ❑The rationale for establishing price ceilings specific products is to enable consumers to obtain some essential goods or services that they could not afford at the equilibrium price. GOVERNMENT INTERVENTION IN THE MARKET (cont.)  GOVERNMENT INTERVENTION IN THE MARKET (cont.) (b) Floor Price (Minimum Price) ❑ A minimum price fixed by the government to prevent the prices from falling below minimum level. ❑ The floor price is set especially for agriculture sectors in order to protect farmers in the event the prices of commodities are too low in a free market. ❑ E.g.: The price of paddy is usually fixed at a price above the equilibrium price so that the income of farmers are protected. ❑ The concept of minimum wage rate is also one of floor prices. ❑ Minimum wage is the minimum payment made by employers to workers to protect employees from exploitation.  TRY IT BY YOUR SELF 1. Explain the following concepts: a) Market equilibrium b) Equilibrium price c) Equilibrium quantity d) Surplus e) Shortage f) Price ceiling g) Price floor