Market Equilibrium

[Image of market equilibrium graph]

• 1. Market Equilibrium: It is a situation where the quantity demanded equals quantity supplied ($Q_d = Q_s$). At this point, there is no tendency for the price to change.
• 2. Excess Demand: Occurs when market price is below the equilibrium price. Here, $Q_d > Q_s$, leading to competition among buyers and upward pressure on price.
• 3. Excess Supply: Occurs when market price is above the equilibrium price. Here, $Q_s > Q_d$, leading to competition among sellers and downward pressure on price.

(i) Price above Equilibrium: There is Excess Supply. Sellers will lower prices to clear unsold stock. As price falls, demand extends and supply contracts until equilibrium is restored.

(ii) Price below Equilibrium: There is Excess Demand. Buyers will bid up prices. As price rises, supply extends and demand contracts until equilibrium is restored.

• 5. Fixed Number of Firms: Price is determined by the intersection of Market Demand and Market Supply curves.
• 6. Effect of Free Entry: If current price > min AC, firms earn supernormal profits. This attracts new firms $\rightarrow$ Supply shifts right $\rightarrow$ Price falls until it equals minimum Average Cost (AC).
• 7. Long Run Equilibrium Price: Firms supply at a price equal to the minimum of Long Run Average Cost ($P = \text{min } AC$).
  Equilibrium Quantity: Determined by market demand at this price ($Q = D(P)$).
• 8. Equilibrium Number of Firms ($n_0$): Determined by dividing total market quantity ($Q_0$) by the supply of a single firm ($q_{0f}$).
  $$n_0 = \frac{Q_0}{q_{0f}}$$

• 9. Change in Income (Normal Good):
  • (a) Increase: Demand shifts right $\rightarrow$ Price rises, Quantity rises.
  • (b) Decrease: Demand shifts left $\rightarrow$ Price falls, Quantity falls.
• 10. Increase in Price of Shoes (Complement to Socks):
  Since shoes and socks are complements, an increase in shoe price reduces demand for socks.
  Effect on Socks: Demand curve for socks shifts left $\rightarrow$ Price of socks falls, Quantity bought/sold decreases.

• 11. Coffee and Tea (Substitutes): If Price of Coffee $\uparrow$ $\rightarrow$ Demand for Tea shifts Right $\rightarrow$ Price of Tea $\uparrow$, Quantity of Tea $\uparrow$.
• 12. Increase in Input Price: Cost of production rises $\rightarrow$ Supply curve shifts Left $\rightarrow$ Equilibrium Price rises, Quantity falls.
• 13. Substitute Price Increase: If Price of Y (Substitute) $\uparrow$ $\rightarrow$ Consumers switch to X $\rightarrow$ Demand for X shifts Right $\rightarrow$ Price of X $\uparrow$, Quantity of X $\uparrow$.

• 14. Fixed vs Free Entry: With free entry, the supply curve is perfectly elastic (horizontal) at $P = \text{min } AC$. A shift in demand changes quantity more than in the fixed number case, but price remains unchanged (in long run).
• 15. Both Shift Right:
  • Demand Right + Supply Right $\rightarrow$ Quantity definitely increases.
  • Effect on Price is ambiguous (depends on magnitude of shifts).
• 16. Directional Effects:
  • (a) Same Direction (Both Right): Q rises; P indeterminate.
  • (b) Opposite (D Right, S Left): P rises; Q indeterminate.

• 17. Difference: In Labour Market, Households are suppliers and Firms are demanders (opposite of goods market).
• 18. Optimal Labour: Determined where Value of Marginal Product of Labour equals Wage Rate ($VMP_L = W$).
• 19. Wage Rate Determination: Determined by the intersection of Market Demand for Labour and Market Supply of Labour.

[Image of price ceiling graph with shortage]

• 20. Price Ceiling (India): Example: Essential medicines, Kerosene, Wheat (PDS).
  Consequence: Excess Demand (Shortage), Black Marketing, Rationing.
• 21. Demand Shift Effect: With free entry, supply is perfectly elastic (horizontal). Thus, a demand shift changes quantity purely, with zero change in price. With fixed firms, supply is upward sloping, so demand shift affects both P and Q (quantity effect is smaller).

Given: $q_D = 700 – p$, $q_S = 500 + 3p$ (for $p \ge 15$).

Reason for zero supply below Rs 15: Rs 15 represents the minimum Average Variable Cost (AVC). Below this price, firms cannot cover variable costs and will shut down.

Equilibrium Calculation ($Q_D = Q_S$):

Equilibrium Quantity ($q$):

Equilibrium Price = Rs 50 | Quantity = 650 units

Given: $q_D = 700 – p$. Single firm supply $q_{Sf} = 8 + 3p$ (for $p \ge 20$).

• (a) Significance of p=20: This is the minimum Average Cost (AC) (Break-even price). In the long run with free entry, price equals min AC.
• (b) Equilibrium Price: Rs 20. With free entry/exit, competition drives profit to zero, settling price at min AC.
• (c) Calculation:
  Total Quantity ($Q_0$) at $p=20$:
  $$Q_0 = 700 – 20 = 680$$
  Supply per firm ($q_{0f}$) at $p=20$:
  $$q_{0f} = 8 + 3(20) = 68$$
  Number of Firms ($n_0$):
  $$n_0 = \frac{680}{68} = 10$$

(a) Initial Equilibrium ($1000 – p = 700 + 2p$):

(b) Input Price Increase ($S’ = 400 + 2p$):

Price rises, Quantity falls. (Conforms to expectation).

(c) Tax of Rs 3 per unit:

Supply equation changes. Sellers need $P_{old} + 3$ to supply same quantity.
Inverse Supply was: $q = 700 + 2p \Rightarrow 2p = q – 700 \Rightarrow p = 0.5q – 350$.
New Supply Price ($P_t$) = $(0.5q – 350) + 3$.
New Supply Eq ($p$): $p = 0.5q – 347 \Rightarrow 2p = q – 694 \Rightarrow q_S = 694 + 2p$.

New Equilibrium ($1000 – p = 694 + 2p$):

Price rises by Rs 2 (to 102). Quantity falls to 898.

Rent Control (Price Ceiling): Government fixes maximum rent below the equilibrium level.

Impact:

1. Shortage: Demand for apartments exceeds supply (Excess Demand).
2. Black Market: Landlords may ask for illegal side payments (“Pagdi”).
3. Quality Deterioration: Landlords reduce maintenance to cut costs.