CHAPTER 4

MARKET EQUILIBRIUM

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 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

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 MARKET EQUILIBRIUM
Price (RM)

Quantity

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 MARKET EQUILIBRIUM

 Shortage
– The difference between the quantity demanded
and the quantity supplied in a market where
quantity demanded is greater than the quantity
supplied

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 MARKET EQUILIBRIUM

 Surplus
– The difference between the quantity demanded
and the quantity supplied in a market where
quantity supplied is greater than the quantity
demanded

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 EQUILIBRIUM PRICE AND
OUTPUT

SURPLUS (QSS > QDD)

6

4
Price

E
3
P* SS
2 DD

1 SHORTAGE (QDD > QSS)

0
Q*
2 4 6 8 10
Quantity

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 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

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 CHANGES IN DEMAND
Assume supply is constant
Price (RM) Increase in Demand
-DD curve shifts to the right
SS -Equilibrium price and
quantity increase
P2

P*
P1 DD1

DD
Decrease in Demand DD2
-DD curve shifts to the left
Q1 Q* Q2 Quantity
-Equilibrium price and
quantity decrease

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 CHANGES IN SUPPLY

Assume demand is constant

Increase in Supply
Price (RM)
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

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 CHANGES IN BOTH DEMAND
AND SUPPLY
SUPPLY AND DEMAND BOTH INCREASE
Case 1: Same magnitude
Price (RM)
DD1 -Equilibrium price is
constant and quantity
SS
increases

SS1
P*

DD

Q* Q1 Quantity

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 CHANGES IN BOTH DEMAND AND
SUPPLY (cont.)
SUPPLY AND DEMAND BOTH INCREASE
Case 2: Different
Magnitude
Price (RM)
DD1 -Equilibrium price
SS increases and
quantity increases
SS1
P1
P*

DD

Q* Q1 Quantity

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 CHANGES IN BOTH DEMAND
AND SUPPLY (cont.)
SUPPLY AND DEMAND BOTH INCREASE Case 3: Different
Magnitude
Price (RM)
-Equilibrium price
DD1 SS decreases and
quantity increases
SS1

P* Both DD and SS increase

P1  Equilibrium quantity increase
 Equilibrium price is uncertain

DD

Q* Q1 Quantity

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CEILING PRICE FLOOR PRICE

GOVERNMENT INTERVENTION
IN THE MARKET

TAXES SUBSIDIES

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 Ceiling price
– Government-imposed regulations that prevent
prices from rising above a maximum level
– Examples of commodities with government
imposed ceiling prices in Malaysia include
sugar, rice, cooking oil, chicken, etc..
– This can lead shortage

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 GOVERNMENT
INTERVENTION IN MARKETS
Price
S

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
ceiling
Shortages occur

D
Q1 Q* Q2 Quantity

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 Advantages
– Consumers purchase at lower price

 Disadvantages
– Emergence of black market
– Reduction in quantity produced
– Producers tend to receive illegal payments
from consumers

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 Floor price
– Government-imposed regulations that prevent
prices from falling below a minimum level
– The practice of fixing floor prices is initiated in the
agriculture sectors
– For example, the government controls the price of
paddy to help the farmers increase their income
and wage rate paid to workers by employers
– This can lead to surplus

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 GOVERNMENT INTERVENTION IN
MARKETS (cont.)

Price
S
Surplus occurs Suppliers increase the amount
offered to Q2 but demand drop to
Q1 creating a surplus
P1
Floor Price
The equilibrium price is P* and
P* the quantity is Q*.

The government imposes a

minimum price of P1

D
Q1 Q* Q2 Quantity

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 Advantages
– Protects the producer’s income
– Higher wage rate

 Disadvantages
– Consumers pay more
– Waste of resources of production
– Creates unemployment

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 EFFECT OF TAXATION
S1
INDIRECT TAX
Price
S Tax that is imposed by the
government on producers or sellers
but paid by or passed on to end-users
The equilibrium price is RM12
14 and the quantity is 400
CONSUMER’S
SHARE The government imposes a
12 sales tax of RM4 per carton
PRODUCER’S
SHARE SS curve shift to left from S to S1 and
10 new equilibrium is RM14 and 200 units

The tax amount of RM4 is shared

equally between buyer and seller

D
200 400 Quantity

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 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
CONSUMER’S The government provides a
SHARE subsidy of RM10 per unit
45
PRODUCER’S
SHARE
SS curve shifts to the right from S to S1
40 and new equilibrium is RM45 and 20 units

The subsidy amount of RM10 is shared

equally between buyer and seller

10 20 Quantity

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 CLASS ACTIVITY

The following schedules show the demand and

supply for a product
Price Schedule 1 Schedule 2
Consumer X Consumer Y Consumer Z Producer A Producer B Producer C
10 40 40 60 20 20 20
20 35 35 50 25 30 25
30 30 30 40 30 40 30
40 25 25 30 35 50 35
50 20 20 20 40 60 40
60 15 15 10 45 70 45
70 10 10 0 50 80 50
80 0 0 0 55 90 55

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 CLASS ACTIVITY

a) Calculate the market demand and supply.

b) Daw the market demand and supply curves,
then determine the market equilibrium price
and quantity.
c) At the equilibrium price, how many is the
quantity demanded by consumer X and
quantity supplied by producer C?
d) At the price of RM40, state whether there is a
surplus or shortage. How much is the surplus
and shortage?
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