Market Equilibrium Bharathi 1 The Market Mechanism o

Market Equilibrium - Bharathi 1

The Market Mechanism o Market Mechanism Summary 1) Supply and demand interact to determine the equilibrium price. 2) When not in equilibrium, the market will adjust to a shortage or surplus and return to the equilibrium. 3) Markets must be competitive for the mechanism to be efficient. 2

MARKET DEMAND & SUPPLY Price P QD Rs. 5 10 4 20 3 35 2 55 1 80 MARKET 200 DEMAND B x 2, 000 U 4, 000 Y 7, 000 E 11, 000 R 16, 000 S MARKET P QS 200 SUPPLY Rs. 5 60 S 12, 000 4 50 E 10, 000 3 35 L 7, 000 2 20 L 4, 000 E 1, 000 1 5 R x R S EQUILIBRIUM 3

MARKET DEMAND & SUPPLY Price S Rs. 5 Demand P QD 4 Rs. 52, 000 Rs. 44, 000 Rs 3 Rs. 37, 000 2 Rs. 11, 000 2 Rs. 16, 000 1 Supply PQ S Rs. 5 12, 000 Rs. 4 10, 000 Rs. 3 7, 000 Rs. 2 4, 000 Rs. 1 1, 000 Market Equilibrium 1 o Price D 2 4 6 78 10 12 14 16 Q 4 Quantity

The Market Mechanism Y S Price (Rs. per unit) P E D O Q Quantity X 5

The Market Mechanism Price (Rs. per unit) S Surplus P 1 If price is above equilibrium Point-Supply exceeds Demand. P D Q Quantity 6

The Market Mechanism Price (Rs per unit) S Surplus P 1 Assume the price is P 1 , then: 1) Quantity Supplied is > Quantity Demanded 2) Producers lower price. 3) Quantity supplied decreases 4) Equilibrium is restored P 2 D Q 1 Q 3 Q 2 Quantity 7

The Market Mechanism Price (Rs. per unit) S E P 3 Assume the price is P 2, then: 1) Quantity Demanded is greater than quantity Supplied 2) Producers raise price. 3) Quantity supplied increases 4) Equilibrium is restored P 2 Shortage Q 1 Q 3 D Q 2 Quantity 8

Change in Supply Price P D 1 S 2 S 1 P 2 P 1 o Q 2 Q 1 Quantity Q

Change in Demand Price P D 1 D 2 S 1 P 2 P 1 o Q 1 Q 2 Q

D P D 1 Q D 1 A D 1 S P 2 P 1 D Q P S B D 2 P 2 “Increase in Demand” S P Q 2 Q 1 Q 2 Q Four Possibilities S D D C S 1 P 2 “Decrease in Demand” Q P D S 2 S 1 P 2 P 1 “Increase in Supply” Q 1 Q 2 Q 1 11 “Decrease in Suply”

Change in Supply = Change in Demand D 1 D 2 S 3 D 3 S 1 S 2 P Q 12

Effects of Government Intervention Price Controls o If the Government decides that the equilibrium price is too high, they may establish a maximum allowable ceiling price. 13

TAX SHIFTING AND THE ELASTICITIES OF DEMAND SUPPLY o When a product is taxed, who ultimately shoulders the tax burden depends upon the elasticity of demand supply of the product taxed. o Usually the tax burden is shared between producers and consumers. o Consumers pay more of the tax, if demand is relatively less elastic than supply o Producers pay more of the tax if demand is relatively more elastic than supply. 14

Price Ceilings and Price Floors o Price Ceiling n is a legally established maximum price which a seller can charge or a buyer must pay. o Price Floor n is a legally established minimum price which a seller can charge or a buyer must pay. 15

Price Ceilings o When the Government imposes a price ceiling (i. e. , a legal maximum price at which a good can be sold) two outcomes are possible: n The price ceiling is not binding. n The price ceiling is a binding constraint on the market, creating shortages. 16

A Binding Price Ceiling Price S Price Ceiling PE PC Shortage QS QE QD D Quantity/time 17

Market Impacts of a Price Ceiling o A Binding Price Ceiling creates. . . n Shortages (QD > QS) n Shortages create : o o Queuing Discrimination criteria set by sellers Bundled pricing with other goods Bribery/corruption 18

Price Floors o When the Government imposes a price floor (i. e. , a legal minimum price at which a good can be sold) two outcomes are possible: n The price floor is not binding. n The price floor is a binding constraint on the market, creating surpluses. 19

A Binding Price Floor Price S Surplus PF Price Floor PE D QD QE QS Quantity/time 20

Market Impacts of a Price Floor o A Binding Price Floor creates. . . n Surpluses (QS > QD) n Surpluses create : o Discrimination criteria set by buyers n Examples: o Agricultural Price Supports 21

INCOME FLOW IN AN ECONOMY 22

The Circular Flow of Income Financial System (I) nt ( 3 se s ha Pu rc G (S) ) IM ) ( s ort rts (X p Im xpo E I+ ing Inv est (G ) me 2 + mp C+I C Sav Co u ns n tio C) Rest of the World 4 Go 1 Consumers +G+ ver nm C+I ent Investors (X – I Government M) le ab os s Taxe s sfer Tran sp Di In co m e( 5 6 Firms (produce the domestic product) e (Y ss Gro Incom ational DI ) ) N 23

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