CHAPTER 3

MARKET EQ
U I LI B R I U M
 OBJECTIVE
• By the end of the class students should be
able to determine the equilibrium price and
1 quantity

• Students should be able to identify the effect

of changes in demand and supply to the
2 equilibrium price and quantity

• Students should be able to explain the ceiling

price (maximum price) and the floor price
3 (minimum price)
 DEFINITION OF MARKET EQULIBRIUM
0 Market – a place where buyers and sellers interact to
determine the price and quantity of goods and services
exchanged
0 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

The price and quantity consumers willing to buy = The

price and the quantity sellers willing to sell
 EQUILIBRIUM PRICE AND OUTPUT
Price Qdd Qss Market Condition
(RM) (Units) (Units) Surplus (+) or Shortage (-)
1. SURPLUS
1 10 2 Qdd>Qss Shortage • Occurs when Qss > Qdd
2 - 8= - 8 units • When the price is set
above the equilibrium
2 8 4 Qdd > Qss Shortage
level
4 – 8 = - 4 units
2. SHORTAGE
3 6 6 Qdd = Qss Equilibrium • Qdd > Qss
P*=RM 3 Q*= 6 units • When the price is set
below the equilibrium
4 4 8 Qss > Qdd Surplus level
8 – 4 = 4 units 3. MARKET EQUILIBRIUM
5 2 10 Qss > Qdd Surplus • Qdd = Qss
10 – 2 = 8 units

Table 1 : Market Demand and Supply for Good A

 Surplus/Excess SS
•There would be a
downward pressure
for the price to
Price (RM) decrease towards P*

QSS > QDD SS

SURPLUS
5
4
E* At E* there is
P*3 no tendency
2 for market
price to
1 QDD > QSS change
Shortage/Excess DD
SHORTAGE
DD 0 2 4 Q*6 8 10
• There would be Quantity (Units)
upward
pressure for the
price to increase
towards P*
 SHORTAGE

 A situation when Qdd > Qss

 Ex: At RM2, the buyers are willing to buy 8 units of Good A but
the sellers willing to sell only 4 units of Good A.
 There is a shortage of 4 units of Good A
 Therefore, there is a tendency for price to increase as buyers
compete against each other for the limited supply of Good A
 There are two effects as the price increases to RM3
a) The Qdd falls as buyers drop out of the market and
choose substitute goods
b) The Qss increases as supplier find themselves receiving
a higher price for their product and shift to this
production
 The process will continue until the shortage is eliminated
 When the Qdd and Qss are equal and there is no further
increase in price, the process has achieved an equilibrium
level
 SURPLUS

 A situation when Qss > Qdd

 Ex: At RM5, the sellers are willing to sell 8 units of Good A and
buyers are willing to buy only 4 units of a Good A
 There is a surplus of 4 units of Good A
 The sellers will compete amongst themselves for sales by
cutting down the prices

 There are two effects as price decrease to RM3

a) Sellers will supply less because now it is unprofitable to
supply more due to the price cut
b) When the price decreases, it may attract new buyers
 The process will continue until the surplus is eliminated and the
equilibrium level is achieved
 Try this out!
The following table shows demand and supply schedule for rice
Price (RM/kg) Quantity Quantity Supplied
Demanded (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 and supply curves for rice in a graph paper
b) Determine the equilibrium price and quantity
c) At the price of RM3.00 per kg, state whether there is a surplus or
shortage. How much is the surplus or shortage
 EFFECTS OF CHANGES IN DEMAND AND SUPPLY
ON EQUILIBRIUM PRICE AND QUANTITY

0 The market equilibrium will change when there is a shift in

the demand or supply curve
0 The shift in the demand and supply due to determinants of
demand and supply that have been discussed in chapter 2
0 There are three situations to be discussed:
1) The demand curve shifts and supply remains constant
2) The supply curve shifts and demand remains constant
3) Both the demand and supply curves shift
simultaneously
 a) Demand Increases and Supply Constant

Price

S •The initial equilibrium level at Eo

with P* = Po and Q* = Qo
•Suppose there is an increase in
E1
P1 consumer’s income level,
Eo therefore the demand for normal
Po goods will increase
•The DD curve for normal goods
SHORTAGE will shift to the right from Do to
D1
D1
Do •As a result:
Q0 Q1 Quantity a) P* increases from Po to P1
b) Q* increases from Qo to Q1
c) E* is at E1
 a) Demand Decreases and Supply Constant

Price

S •The initial equilibrium level at Eo

SURPLUS with P* = Po and Q* = Qo
Eo •Suppose there is an increase in
Po the price of car, therefore the
E1 quantity demanded for petrol will
P1
decrease (complement goods)
•The DD curve for petrol will shift
Do to the left from Do to D1
D1 •As a result:
a) P* decreases from Po to P1
Q1 Qo Quantity
b) Q* decreases from Qo to Q1
c) E* is at E1
 c) Supply Increases and Demand Constant

Price

So
•The initial equilibrium level at Eo
S1 with P* = Po and Q* = Qo
SURPLUS •Suppose the cost of production
Eo decreases that causes supply of
Po cloth to increase
E1
P1 •The SS curve for cloth will shift to
the right from So to S1
•As a result:
D a) P* decreases from Po to P1
Q0 Q1 Quantity b) Q* increases from Qo to Q1
c) E* is at E1
 d) Supply Decreases and Demand Constant

Price

S1
•The initial equilibrium level at Eo
So with P* = Po and Q* = Qo
•Suppose there is bad weather that
E1 causes supply of vegetables to
P1 decrease
Eo
Po •The SS curve for vegetables will
SHORTAGE shift to the left from So to S1
•As a result:
D a) P* increases from Po to P1
Q1 Qo Quantity b) Q* decreases from Qo to Q1
c) E* is at E1
e) Increase in Demand Proportionate to Increase in Supply

Price •The initial equilibrium level at E

with P* = P and Q* = Q
S •Suppose there is an increase in
S1 tastes and preferences of
chocolate cakes and at the same
time there is a reduction in the
E E1
P COP of chocolate cakes
•Both the DD and SS curves for
chocolate cakes will shift to the
D1 right from D to D1 and from S to
D S1 respectively
•As a result:
Q Q1 Quantity
a) P* remains at P
b) Only Q* increases from Q to Q1
c) E* is at E1
f) Decrease in Demand Proportionate to Decrease in Supply

Price
•The initial equilibrium level at E
S1 S with P* = P and Q* = Q
•Suppose the income level
decreases and there is an increase
in the tax rate
E1 E •Both the DD and SS curves for
P
normal goods will shift to the left
from D to D1 and from S to S1
D respectively
D1 •As a result:
Q1 Q Quantity a) P* remains at P
b) Only Q* decreases from Q to Q1
c) E* is at E1
g) Decrease in Demand Proportionate to Increase in Supply

Price •The initial equilibrium level at

E with P* = P and Q* = Q
S •Suppose there is a reduction in
S1 demand for traditional Malay
E cookies and at the same time
P the supply for that cookies
increases due to reduction in
E1 the COP
P1
•The DD curve shift to the left
D from D to D1 and the SS curve
D1 shift to the right from S to S1
•As a result:
Q Quantity
a) P* decreases from P to P1
b) Q* remains at Q
c) E* is at E1
h) Increase in Demand Proportionate to Decrease in Supply

Price
•The initial equilibrium level at E
S1 with P* = P and Q* = Q
S •Suppose there is an increase in
E1 the demand for coffee and at the
P1 same time the supply for coffee
reduce due to bad weather
E •The DD curve shift to the right
P
from D to D1 and the SS curve shift
D1 to the left from S to S1
D •As a result:
Q Quantity a) P* increase from P to P1
b) Q* remains at Q
c) E* is at E1
 Try this out!
QUESTION 1
Suppose there is an increase in income level. What would be the
effect on the equilibrium price and quantity on the normal goods
and inferior goods
QUESTION 2
Suppose there is an increase in the price of substitute goods (i.e.
increase in the price of tea). What would be the effect on the
demand for coffee
QUESTION 3
Suppose there is an increase in the price of complement goods (i.e.
cars). What would be the effect on the demand for petrol.
 GOVERNMENT INTERVENTION IN THE MARKET

0 Why does the government intervene in the market in the first

place? For whom the government wants to protect?
0 Government controls and fixes prices of certain goods and
services
 Ex: sugar, rice, cooking oil, and etc
 There are two types of price controls
o There are two types of price control:
 Ceiling Price (Maximum Price)
 Floor Price (Minimum Price)
 a) Ceiling Price

 Government imposes regulation that prevents the prices from rising above a
maximum level as set by government
 Also referred to as the maximum price
 When government indicates that there is an increase in essential commodities such
as sugar and rice, government will impose a ceiling price on these commodities
 The price is set below the equilibrium price and sellers are not allowed to increase the
price

Price
S Fixing the price
E*
P* below the
Ceiling Price/ equilibrium
P1
Max Price creates shortage
(Qdd> Qss)
SHORTAGE D
O Q* Quantity
Advantages Disadvantages
The excess demand leads to black
marketeering or illegal market
Consumers can buy goods at Ex: producer will smuggle the goods
lower prices to the neighboring countries and
sell at higher price to get more in
return

Ex: If the P* of 1 kg of Producer reduces the production

because of the lower price and cause
chicken is RM8.50 per kg production to decline
and the ceiling price is
RM7.50 per kg, the
consumer has a benefit of
RM1 for each kg of chicken
Producers make no profit from
supplying at the price below
equilibrium price

Producers may engage in bribes and

other illegal activities
Ex: Producers may hoard sugar and
create artificial shortage to force
government to increase the price
 b) Floor Price

 Government imposed regulation that prevents the prices from falling below
minimum level set by government
 Also known as minimum price
 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
 Ex: The price of paddy is usually fixed at a price above the equilibrium price
so that the income of farmers are protected
 Minimum wage rate is also one of the floor prices
 Minimum wage is the lowest paid by their employers to workers to protect
from exploitation
 It has the potential to reduce poverty by increasing wages paid especially to
low skilled labor
 Price SURPLUS
S
Floor Price/
P1 Minimum Price
E*
P*

O Q* Quantity

Fixing price above the equilibrium level creates

surplus (Qss > Qdd)
 Advantages Disadvantages

The income of producers are protected

and government purchases any surplus Consumers have to pay more for
of goods goods and services

Government may store/keep any There would be overflow of these

surplus of goods for future use commodities leads to waste of
resources

Increase in wage rate leads to

Lower paid workers are better off with unemployment problems where the
increase in wage rate ss of labor is more than the DD for
labor