Market Equilibrium

• Equilibrium is position of rest or state of balance.

• An equilibrium is defined as a situation where the

plans of all consumers and firms in the market
match and the market clears.
• The price at which equilibrium is reached is called
equilibrium price.
• The quantity bought and sold at this price is called
equilibrium quantity.
• Therefore, (p*, q*) is an equilibrium

qD(p*) = qS(p*)
• If at a price, market supply is greater than market
demand, we say that there is an excess supply in
the market.

• if market demand exceeds market supply at a price,

it is said that excess demand.
Invisible Hand

• Adam Smith used the concept Invisible hand that in

a perfectly competitive market an ‘Invisible Hand’ is
at play which changes price whenever there is
imbalance in the market.
Market Equilibrium: Fixed
Number of Firms
• In perfect competition market both the buyers and
sellers are price takers. So that the price of a
product is determined by its supply and demand
forces.

• At equilibrium price, quantity demanded and

supplied will be equal. Both buyers and sellers
objectives are satisified.
• Market equilibrium is determined by the demand
and market supply forces.
• Here market demand refers to aggregate demand
and market supply refers to aggregate supply.
• The market supply curve slopes upwards from left
to right and market demand curve slopes
downwards from left to right.
• These two curves intersect at a point. This point
shows that demand is equal to supply i.e QD = QS.
• This can be shown with the help of demand and
supply schedule.

Price of Commodity Market Demand Market Supply

( In Rs.) (in units ) (in units )
10 100 20
20 80 40
30 60 60
40 40 80
50 20 100
 Y D S
Excess
N supply M
P2
E
P
Price
P1

S Excess demand D

0 M1 M2 M3 X

Quantity Demanded
And supplied
• Thus its clear from the table and diagram if price is
above or below the equilibrium price, the invisible
hand will operate to bring the price level at which
the quantity supplied will be equal to quantity
demanded.
Wage determination In the
Labour market

• The wage rate is determined at the intersection of

the demand and supply curves of labour where the
demand for and supply of labour balance.

• In the labour market, households are the suppliers

of labour and the demand for labour comes from
firms.
• Marginal Revenue Product of Labour (MRPL).
For each extra unit of labour, she gets an additional

benefit equal to marginal revenue times marginal

product which is called Marginal Revenue Product
of Labour.
• W = MRPL
MRPL = MR × MPL
 Y
D S

E
Wages

D
S

0 L X
Labour
• In the diagram on OX axis we measure labour and
on OY axis we measure Wage. DD is Demand curve
of labour and SS is supply curve of labour. Point ‘E’
is equilibrium point where the demand and supply
intersect each other and therefore OW is the wage
rate in a perfectly competitive market.
Shifts in Demand and
Supply

• We have studied market equilibrium under the

assumption that tastes and preferences of the
consumers, prices of the related commodities,
incomes of the consumers, technology, size of the
market, prices of the inputs used in production, etc
remain constant.
• But there is change in one or more of these factors
either the supply or the demand curve or both may
shift, thereby affecting the equilibrium price and
quantity.
 Demand Shift (Right)

Price SSo
Initially, the market
G equilibrium is at E. Due to
P2 the shift in demand to the
Po right, the new equilibrium is
at G as shown in panel
E
DD2
DDo

0 Qo Q2 Q’’o Quantity
 Demand Shift (Left)

Price SSo
Initially, the market
E equilibrium is at E. Due to
P0 the leftward shift, the new
P1 equilibrium is at F, as shown
F in diagram.

DD0
DD1

0 Qo1 Q1 Qo Quantity
Supply shift (Left)

Y SS2

SSo Initially, the market

equilibrium is at E. Due to
G the shift in supply curve to
P2 the left, the new
E
equilibrium point is G as
Po
shown in diagram.

DDo

0 q”o q1 qo X
Supply shift (Right )

Y SSo

SS1 Initially, the market

equilibrium is at E. Due to
E the rightward shift the new
Po equilibrium point is F, as
F
shown in diagram
P1

DDo

0 qo q1 X
Simultaneous Shifts of
Demand and Supply
• What happens when both demand and supply curves
shift simultaneously?
• The simultaneous shifts can happen in four possible
ways:
• (i) Both supply and demand curves shift rightwards.
• (ii) Both supply and demand curves shift leftwards.
• (iii) Supply curve shifts leftward and demand curve
shifts rightward.
• (iv) Supply curve shifts rightward and demand curve
shifts leftward.
Impact of Simultaneous
Shifts on Equilibrium
Shift in Demand Shift in supply Quantity Price
Leftward Leftward Decreases May Increase or
decrease or
remain unchanged

Rightward Rightward Increases May Increase or

decrease or
remain unchanged

Leftward Rightward May Increase or Decreases

decrease or
remain unchanged
Rightward Leftward May Increase or Increases
decrease or
remain unchanged
Demand and Supply shift
Right
Y Initially, the equilibrium is at
E where the demand curve
SSo
DD0 and supply curve SS0
SS1 intersect.
E In the diagram, both the
F
P supply and
the demand curves shift
rightward leaving price
unchanged but a higher
DD1
DDo equilibrium quantity.

0 Q Q1 X
Demand shift left & Supply
shift right
SSo
Y SS1
In The diagram, the supply
E curve shifts rightward and
P1 demand curve shifts leftward
Leaving quantity unchanged but
P F a lower equilibrium price.
DDo

DD1

0 Q X
Market Equilibrium: Free
Entry and Exit
• In the long run, equilibrium price will always be
equal to minimum of AC because of free entry and
exit of firms in a perfect competitive market.
• Therefore all the firms earn zero profit or normal
profit.
• The equilibrium is determined by the intersection
of consumers’ demand curve and the P = min AC
line.
• At equilibrium point ‘E’, quantity supplied by each
firm is ‘X’ at the price ‘P’.
Y
D

E
P P = min A C

0 Q X
• In the above diagram , on OX axis quantity is
measured and OY axis price is measured. Point ‘E’ is
the equilibrium point where price will be equal to
min of AC.
Price Ceiling

• The government imposed upper limit on the price of a

good or service is called price ceiling.

• It is generally imposed on necessary items like wheat,

rice, kerosene, sugar and it is fixed below the market
determined price.

• Since at market determined price some section of the

population will not be able to afford to buy these goods.
 • Let us examine the effect of price ceiling on the
market equilibrium through the example of market
for wheat.
Price
SS

P1

Pc
DD

0 q1 q q2 Quantity
• The equilibrium price and quantity are p* and q*
respectively. Imposition of price ceiling at pc gives
rise to excess demand in the wheat market.
• When the government imposes price ceiling at Pc
which is lower than the equilibrium price, there will
be more demand for wheat in the market.

• Though the intention of he government was to help

the consumers, it could end up creating shortage of
wheat.
• To meet the shortage of wheat Ration coupons are
issued to the consumers so that no individual can
buy more than a certain amount of wheat.

• This stipulated amount of wheat is sold through

ration shops which are also called fair price shops.
Price Floor
• The government imposed lower limit on the price
that may be charged for a particular good or service
is called price floor.

• The government imposes a lower limit on the

purchase price for some of the agricultural goods
and the floor is normally set a higher level than the
market price.
• This is done to ensure reasonable price for farm
products.
 • Let us examine the effect of price floor on the
market equilibrium through the example of market
for agriculture product.
Price

SS
Pf
P

DD

0 q1 q qf Quantity
• Figure shows the market supply and the market
demand curve for a commodity on which price
floor is imposed. The market equilibrium here
would occur at price p* and quantity q*.
• But when the government imposes a floor higher
than the equilibrium price at pf , the market
demand is q1 whereas the firms want to supply qf
thereby leading to an excess supply in the market
equal to q1 qf.
• In the case of agricultural support, to prevent price
from falling because of excess supply, government
needs to buy the surplus at the predetermined
price.