PREPARED BY: ROSMAH BT ABD GHANI @ ISMAIL

CHAPTER 4: MARKET EQUILIBRIUM

ROSMAH

Definition
1. Market : a place where buyers and sellers interact to determine the price and quantity of goods and services exchanged Market equilibrium: a situation that occur at any price at which the quantity demanded equals the quantity supplied
Qd = Qs
Quantity that buyers are willing to buy = Quantity that sellers are willing to sell

2.

Notes: PE=equilibrium price QE=equilibrium quantity

ROSMAH

Determinants of PE & QE
CORN

P $5 4 3 2 1

Surplus QDQSMarket outcomes 1. -occurs when Qd < Qs -when the price is set above 1060 the equilibrium price QD < QS Surplus - Excess supply 2050 3535 QD = QS 5520 Equilibrium QD > QS Shortage 2. Shortage 80 5 -occurs when Qd > Qs
-when the price is set below the equilibrium price - Excess demand

PE = RM3 QE = 35 kg

ROSMAH

Price of Corn

P
CORN

$5

P $5 4 3 2 1

QDQS 1060 2050 3535 5520 80 5

E
3

D
10 20 30 40 50 60 70 80 Quantity of Corn
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Price of Corn

$5

surpl us
E

QD < QS Surplus

shortage

QD > QS D Shortage
Q
ROSMAH

10 20 30 40 50 60 70 80 Quantity of Corn

Example :
Table: Market demand and supply for Rambutan

Price Qd (RM) (kg)

Qs (kg)

Market outcomes

1 2 3 4 5

12 10 8 5 4

4 6 8 11 12

ROSMAH

Example :
Table: Market demand and supply for Rambutan

Price Qd (RM) (kg)

Qs (kg)

Market outcomes Qd>Qs shortage Qd>Qs shortage Qd=QsEquilibrium Qd<Qs Surplus Qd<Qs Surplus

1 2 3 4 5

12 10 8 5 4

4 6 8 11 12

= 12 4 = 8 kg = 10 6 = 4 kg PE= RM3/kg; QE= 8kg = 11 5 = 6 kg = 12 4 = 8 kg

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Price (RM/ kg) 5

Surplus
4 PE = 3 2 1 E

Shortage

D
4 56 QE=8 10 11 12

Quantity (kg)

ROSMAH

Price (RM/ kg)

5 4

12-4= 8kg Surplus

E 10-6= 4kg
Shortage

PE = 3

2 1

D
4 6

QE=8

10

12

Quantity (kg)

Contd.
Price (RM/ kg) Surplus 5 Surplus 4 E S

PE = 3
2 1

Shortage

Shortage
D 4 56 QE=8 10 11 12
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Quantity (kg)

Exercises
Question 1

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QUESTION 2 Table 2 shows the quantities of corn demanded and supplied at various prices.
Price per ton (RM) 80 90 100 110 Quantity Supplied (ton) 600 800 1000 1200 Quantity Demanded (ton) 1200 1100 1000 900 Surplus/shortage (ton) _________ _________ _________ _________

a. Complete Table 2 by specifying whether there will be a shortage or surplus and the size of it. (2 marks) b. On a graph paper, draw the demand and supply curves for corn. (2 marks) c. What is the equilibrium price and quantity of corn? (1 mark)
ROSMAH

QUESTION 3 The following table gives the demand and supply schedules for good A.
Price per unit (RM) 3.00 6.00 9.00 12.00 15.00 Quantity Demanded (units) 600 500 400 300 200 Quantity Supplied (Units) 200 300 400 500 600

a. Plot the demand and supply curves for good A. b. What are the equilibrium price and quantity

(2marks) (1mark)

c. Is there a surplus or shortage at the price of RM6.00? How much is the surplus or shortage? (2 marks) d. Give three (3) factors that can shift supply curve to the right. (3 marks)
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QUESTION 4 Below is the demand and supply schedule for a product.

Price (RM) per box 100 200 300 400 500 600 Quantity demanded (units) 100 90 80 60 50 40 Quantity supplied (units) 60 70 80 90 100 110

a. Draw a diagram to show the demand and supply curves for a product.(2 marks) b. What is the equilibrium price and quantity for a product? (2 marks)

c. What will happen if the products price level is set at RM200 per unit? By how much? (3 marks) d. What if the price of the product is set at RM600 per unit? By how much?(3 marks)
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Changes in PE & QE

i. in DD , SS constant ii. DD constant, SS iii. both changes

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i. in DD , SS constant
P S0
P1 P0 E1

o DD
Eq point (Qd=Qs) initial Eq : E = E0 PE = P0 QE = Q0 factors influences in DD (non-P factors) suppose, there is an in consumers income DD curve will shift to the right (D0D1) new Eq : E = E1 PE = P1 QE = Q1 supply curve constant (S0) As a result, the PE rises from Po to P1 QE rises from Qo to Q1 New market equilibrium = E1
ROSMAH

E0

D1 D0 Q0 Q1 Q

o DD
P S0
P0 P1

E0 E1

D0 D1 Q1 Q0 Q

Eq point (Qd=Qs) initial Eq : E = E0 PE = P0 QE = Q0 factors influences in DD (non-P factors) suppose, there is an in number of buyers DD curve will shift to the left (D0D1) new Eq : E = E1 PE = P1 QE = Q1 supply curve constant (S0) As a result, the PE falls from Po to P1 QE falls from Qo to Q1 New market equilibrium = E1
ROSMAH

ii. DD constant, in SS
P S0 S1
P0 P1 E0

o SS
Eq point (Qd=Qs) initial Eq : E = E0 PE = P0 QE = Q0 factors influences in SS (non-P factors) suppose, there is an in cost of production ( in cost of raw material) SS will , SS curve will shift to the right (S0S1) new Eq : E = E1 PE = P1 QE = Q1 demand curve constant (D0) As a result, the PE falls from Po to P1 QE rises from Qo to Q1 New market equilibrium = E1
ROSMAH

E1

D0 Q0 Q1 Q

o SS
P S1 S0
E1

P1
P0

E0

D0 Q1 Q0 Q

Eq point (Qd=Qs) initial Eq : E = E0 PE = P0 QE = Q0 factors influences in SS (non-P factors) suppose, there is an in cost of production ( wages ) SS will , SS curve will shift to the left (S0S1) new Eq : E = E1 PE = P1 QE = Q1 demand curve constant (D0) As a result, the PE rises from Po to P1 QE falls from Qo to Q1 New market equilibrium = E1
ROSMAH

iii. both changes

P

o SS = DD, P constant
Eq point (Qd=Qs) initial Eq : E = E0 PE = P0 QE = Q0 suppose there is an increase in demand for chickens during Hari Raya. DD increase DD curve will shift to the right (D0D1) Government overcome this problem by increase the supply of imported chickens SS will , SS curve will shift to the right (S0S1) new Eq : E = E1 PE = P0 QE = Q1 demand curve constant (D0) As a result, the PE constant QE rises from Qo to Q1 New market equilibrium = E1

S0 S1
E0 E1 D1 D0

P0

Q0

Q1

o SS > DD, P
Eq point (Qd=Qs) initial Eq : E = E0 PE = P0 QE = Q0 suppose there is an increase in demand for chickens during Hari Raya. DD increase DD curve will shift to the right (D0D1) Government overcome this problem by the supply of imported chickens in larger quantities SS will , SS curve will shift to the right (S0S1) new Eq : E = E1 PE = P1 QE = Q1 demand curve constant (D0) As a result, the PE falls from P0 to P1 QE rises from Qo to Q1 New market equilibrium = E1

S0 S1
E0

P0 P1

E1 D1 D0

Q0

Q1

S0
E1 E0

S1

P1 P0

D1

D0 Q1 Q

Q0

Eq point (Qd=Qs) initial Eq : E = E0 PE = P0 QE = Q0 suppose there is an increase in demand for chickens during Hari Raya. DD increase DD curve will shift to the right (D0D1) Government overcome this problem by the supply of imported chickens in only smaller quantities SS will , SS curve will shift to the right (S0S1) new Eq : E = E1 PE = P1 QE = Q1 demand curve constant (D0) As a result, the PE rises from P0 to P1 QE rises from Qo to Q1 New market equilibrium = E1

o SS < DD, P

Application of demand and supply analysis A. Price controls: Government intervention B. Impact of taxes and subsidies : -effects on price and quantity, incidence of tax C. Market failures (externalities)

ROSMAH

Government intervention in the market:

1. CEILING PRICE 2. FLOOR PRICE

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CEILING PRICE

Price (RM/kg)

1.
S

E
2.00 1.45 Shortage

Ceiling price -also called as maximum price -is set below the equilibrium price -Ceiling price is imposed on essentials goods such as cooking oil, flour and sugar - to help consumers when P of goods & services are extremely high in the market. -to restrain inflation -it will occurs shortage

D
Quantity

Qs

Qe Qd

(kg)

ROSMAH

1. Ceiling price
Advantage Consumers pay less Disadvantages Emergence of black market Reduced quantity produced due to limits profits in the controlled market. Exploit consumersProducers tend to receive illegal payments from consumers

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FLOOR PRICE

Price (RM/kg)

2.
S Surplus

Floor price -also called as minimum price -is set above the equilibrium price -Floor price is initiated by the government in the agricultural sectors. For example: price of paddy -to help farmers to increase their income

2.50

2.00

D
Quantity

-it will occurs surplus

Qd

Qe Qs

(kg)

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2. Floor price
Advantages Protects producers income Higher wage rate Disadvantages Consumers pay more Waste of resources of production Creates unemployment

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Differences between ceiling price & floor price

Criteria
DEFINITION

Floor price
-Minimum price - P is not allowed to fall - Surplus
-Protects producers income - Higher wage rate

Ceiling price
-Maximum price - P is not allowed to rise -Shortage
- Consumers pay less

ADVANTAGES

DISADVANTAGES -Consumers pay more

- Waste of resources production - Creates unemployment

-Emergence of black market - Reduces qty produced - Exploit consumers

ROSMAH

Impact of taxation
P of G&S will rise by the same amount as the tax

imposed. Types of tax :

Direct tax imposed directly on to a person e.g. income tax, company tax Indirect tax imposed on a person but that person can shift the burden of paying tax to someone else e.g. sales tax, import tax.

Government imposed indirect tax (IT) IT tax that imposed by the government on

producers or sellers but paid by or passed on to the end-users/consumer. producers will reduce the supply of G&S.

Impact of taxation
RM2 bear by the buyer

1. Effect of taxes on P* and Q*

S1 S0
E0

- The initial equilibrium is Eo with P*=12 and Q*=40

14

A B

- suppose government imposed a sales tax of RM 4 per carton of cigarettes

- when a tax imposed, there are no changes in demand. movement only occurs along the demand curve - tax will increase cost of production, thus supply will decrease Q - supply curve will shift to left from So to S1 -

12 E 10 F

Buyer
Seller

D0 40

20
RM2 bear by the seller

RM2 bear by the buyer

S1 S0
E0

14 D buyer 12 E 10 F seller

A B

D0
40

20
RM2 bear by the seller

Effect of taxes i.Equilibrium price rises to new P*=RM14 and equilibrium quantity falls to new Q*= 20 ii.Consumers: -needs to buy with RM14 which is RM2 higher than before tax -consumers tax burden=ABED iii.Producers: -receive RM10 which is RM2 lower than before tax -producers tax burden=BCFE iv.Total government revenue from tax =4 x 20 = 80.(FCAD)

ROSMAH

RM2 bear by the buyer

Consumers S1 S0
E0

Producers Sells: RM12

Before tax

pays : RM12

14 D

A
B

After tax

pays : RM14

buyer
12 E 10 F seller

Sells: RM14 But, sellers needs to pay RM4 to the government (RM14-RM4=RM10)

Burden RM2 RM2 of tax =(RM14-RM12) =(RM12-RM10)

C

D0 40

20
RM2 bear by the seller

TOTAL GOVERNMENT REVENUE FROM TAX=4 x 20 = RM 80

Exercise: A specific tax was imposed on the sale of potatoes. The diagram below shows the SS & DD curves for potatoes.
P S1 S0
101 8 A B

Based on the diagram, answer the following questions. a. The price paid by the buyers before tax is RM______ b. The price paid by the buyers after tax is RM______ c. The amount of tax per unit is RM____________ d. Calculate the amount of tax per unit shared by the: i. Consumer_________ ii. Producer__________ e. The movement form point A to point B is called__________

D0 10 20 Q

Effect of elasticities on tax burden

the equal sharing of the tax burden does not

occur all the time. Its depends on the elasticity of DD & SS.

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DD is perfectly inelastic P S2 D S1

Before tax Consumers pay : RM12 producers sells : RM12

After tax Consumers pay : RM16 producers sells : RM16 sellers needs to pay RM4 to the government (RM16-RM4=RM12) * So buyers needs to pays the entire tax Consumers Burden of tax : RM(16-12=4)

16
12 Qd

40

DD is perfectly elastic P S2 S1 D Consumers pay : RM12 producers sells : RM12 Consumers pay : RM12 producers sells : RM12 But, sellers needs to pay RM4 to the government (RM12-RM4)=RM8 sellers pays the entire tax Producers /sellers Burden of tax : RM(16-12=4)

12

8
40

Qd

Demand is inelastic to supply

Price (RM) S1 So 15

Demand is more elastic than supply

Price (RM) 13 S1 So

buyer
12 11

buyer seller

seller
Do 40

12 9 Do 40

Quantity

Quantity

-goods with low substitutes: petrol, cigarettes

-the buyer shared more of the burden of tax since its demand is inelastic

-goods with high substitutes: toothpaste, cloth -seller would share higher portion of the tax burden since the demand is more elastic than supply

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B.2. Impact of subsidies

Price

So

S1

1.50 1.00 0.50

Buyer Seller Do 1.2 1.4

Quantity (gallon)

2. Effect of subsidies on P* and Q* -subsidies is an incentive from government to encourage producers or sellers to produce more -subsidies will lower the cost of production -subsidies are provided for petrol, diesel and others - - The initial equilibrium is Eo with P*=1.50 and Q*=1.2 -suppose government provided RM1 per gallon of petrol -subsidies will lower the cost of productions. -supply curve shift to right from So to S1

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Contd.

Effect of subsidies i. P*falls to RM1 and Q*rises to 1.4gallon

ii. Consumers -buy with lower price = RM1 per gallon -enjoy by buyer =
iii.Producers -receive RM0.50 per gallon -enjoy by seller = *the buyers and seller shares RM 0.50 each from the total subsidy of RM1 per gallon

ROSMAH

Effect of elasticities on subsidy

Demand is inelastic to supply

Price So S1

Demand is more elastic than supply So Price

S1

1.50 0.80 0.50

Buyer

1.50 1.00 Do 1.2 0.50 Quantity (gallon)

Buyer Seller Do Quantity (gallon)

Seller

1.2

-buyer enjoy more subsidy than seller

-seller enjoy more subsidy than buyer

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C. Market Failures (externalities)

Externality is a cost or benefit imposed on

people other than producers and consumers of a good or services It is also a spillover effects or neighbourhood effects Negative externalities: pollution Positive externalities: neat gardens and well educated society

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C. Market Failures (externalities)

Negative externalities -Gov punish negative externalities by imposing a tax or fine on producers -Taxation will increase the cost of production -As a result P* rises Positive externalities -subsidy will reduce production costs and therefore will increase supply -As a result P* falls Q* rises

Q* falls
Price (RM/kg) E1 P1 Po Eo S1 So Po P1 E1 Price (RM/kg) Eo So S1

D Q1 Qo Quantity (kg) Qo Q1

D Quantity (kg)

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