MARKET EQUILIBRIUM

DETERMINATION OF EQUILIBRIUM PRICE

In the given diagram DD is the demand curve and SS is the supply curve. The equilibrium occurs at
point where the demand curve (DD) intersects the supply curve (SS). The equilibrium price is Op*
and equilibrium quantity is Oq*.
Let us consider the following two situations.
Op2 > Op*
At price Op2 quantity demanded Oq2’ is less than quantity supplied Oq2, denoting excess supply
(q2’q2). This excess supply will give rise to competition among sellers as each seller wants to sell the
commodity and reduce their excess unwanted stock. This competition among sellers will push the
price down.
With fall in price the quantity demanded for the commodity tends to increase and quantity supplied
tends to fall.
As a result of the above changes excess supply will be corrected and finally the equilibrium is
restored with Op* as equilibrium price and Oq* as equilibrium quantity.
Op1 < Op*
At price Op1 quantity demanded Oq1 is more than quantity supplied Oq1’., denoting excess demand
(q1’q1). This excess demand will give rise to competition amongst buyers as each buyer wants to buy
the commodity. This competition among the buyers will pull the price up.
With rise in price the quantity demanded for the commodity tends to fall and quantity supplied
tends to rise.
As a result of the above changes excess demand will be corrected and finally the equilibrium is
restored with Op* as equilibrium price and Oq* as equilibrium quantity.
Effects of Change in Demand
Increase in Demand
Original equilibrium occurs at the point E where the demand curve DD intersects the supply curve
SS.
The equilibrium price is OP and the equilibrium quantity is OQ.
When demand increases demand curve shifts to the right to D 1D1.
New equilibrium point is E1.
The equilibrium price increases from OP to OP 1 and the equilibrium quantity from OQ to OQ 1.

Decrease in Demand

Original equilibrium occurs at the point E where the demand curve DD intersects the supply
curve SS.
The equilibrium price is OP and the equilibrium quantity is OQ.
When demand decreases, demand curve shifts to the left to D 1D1
New equilibrium point is E1.
The equilibrium price decreases from OP to OP 1 and the equilibrium quantity from OQ to OQ 1.
Change in Demand and Equilibrium Price: Some Exceptional Situations

When Supply of Commodity is Perfectly Elastic

Increase in Demand
 The original equilibrium occurs at E where
perfectly elastic supply curve S intersects the
demand curve DD

Demand curve shifts rightward D1D1 due to

increase in demand

New equilibrium point is E1

Equilibrium price remain unchanged at OP.

Equilibrium quantity increases from OQ to
OQ1.

Decrease in Demand

The original equilibrium occurs at E where perfectly

elastic supply curve S intersects the demand curve
DD.

The Equilibrium Price is OP and equilibrium quantity

is OQ.

Demand curve shifts leftward D1D1 due to decrease

in
demand.

New equilibrium point is E1.

Equilibrium price remain unchanged at OP. Equilibrium quantity decreases from OQ to OQ 1

When Supply of Commodity is Perfectly Inelastic

Increase in Demand
The original equilibrium occurs at E where
perfectly inelastic supply curve S intersects
the demand curve DD.

The Equilibrium Price is OP and the

equilibrium quantity is OQ.

Demand curve shifts rightward D1D1 due to

increase in demand.
 New equilibrium point is E1

Equilibrium quantity remain unchanged at

OQ. Equilibrium price increases from OP to
OP1

Decrease in Demand

The original equilibrium occurs at E where

perfectly inelastic supply curve S intersects
the demand curve DD.

The Equilibrium Price is OP and the

equilibrium quantity is OQ.

Demand curve shifts leftward D1D1 due to

decrease in demand

New equilibrium point is E1

Equilibrium quantity remain unchanged at

OQ. Equilibrium price decreases from OP
to OP1
Effects of Change in Supply

Increase in Supply
`

Original equilibrium occurs at the point where the demand curve DD intersects the supply curve S
The equilibrium price is OP and the equilibrium quantity is OQ.
When supply increases supply curve shifts to S1S1.
New equilibrium point is E1.
Equilibrium price decreases from OP to OP 1 and equilibrium quantity increases from OQ to OQ 1
Decrease in Supply

New equilibrium point is E2

Equilibrium price increases from OP to

OP2
Equilibrium quantity decreases from
OQ
to OQ2
Change in Supply and
Equilibrium Price: Some
Exceptional Situations When
Demand for Commodity is Perfectly Elastic
Increase in Supply

The original equilibrium occurs at E

where perfectly elastic demand curve D
intersects the supply curve SS.

The Equilibrium Price is OP and

equilibrium quantity is OQ.

Supply curve shifts rightward S1S1 due

to increase in supply.

New equilibrium point is E1

Equilibrium price remain unchanged at
OP. Equilibrium quantity increases from
OQ to OQ1

Decrease in Supply

The original equilibrium occurs at E where perfectly

elastic demand curve D intersects the
supply
curve SS.

The Equilibrium Price is OP and the

equilibrium quantity is OQ.

Supply curve shifts leftward S1S1 due to

decrease in supply.
New equilibrium point is E1

Equilibrium price remain unchanged at OP.

Equilibrium quantity decreases from OQ to
OQ1

When Demand for Commodity is Perfectly Inelastic

Increase in Supply

The original equilibrium occurs at E where

perfectly inelastic demand curve D
intersects the supply curve SS.

The Equilibrium Price is OP and the

equilibrium quantity is OQ.

Supply curve shifts rightward S1S1 due to

increase in supply.

New equilibrium point is E1

Equilibrium quantity remains unchanged at

OQ. Equilibrium price decreases from OP to
OP1

Decrease in Supply

The original equilibrium occurs at E where

perfectly inelastic demand curve D
intersects the supply curve SS.

The Equilibrium Price is OP and the

equilibrium quantity is OQ.

Supply curve shifts leftward S1S1 due to

decrease in supply.

New equilibrium point is E1.

Equilibrium quantity remains unchanged at

OQ. Equilibrium price increases from OP to
OP1
Effects of Simultaneous Change in Both Demand and
Supply a) Increase in Demand > Increase in Supply
Original equilibrium occurs at E where the demand curve DD intersects the supply curve SS.
The equilibrium price is OP and equilibrium quantity is OQ.
The demand curve shifts to D1D1 due to increase in demand and supply curve shifts to S 1S1 due to
increase in supply.
New equilibrium point is E1
Due to greater pressure of demand equilibrium price tends to increase from OP to OP 1
Equilibrium quantity increases from OQ to OQ1.

b) Increase in Demand < Increase in Supply

In the given diagram the original equilibrium point is E and new Equilibrium Point is E 1
Due to greater pressure of supply, equilibrium price tends to fall from OP to OP 1
Equilibrium quantity increases from OQ to OQ.
c) Increase in Demand = Increase in Supply
 In the given diagram original equilibrium point is E. New equilibrium point is E1.
Equilibrium price remains unchanged at OP
Equilibrium quantity increases from OQ to OQ1

Price Ceiling

Price ceiling means maximum price that the seller can charge from the buyers.

In the given diagram the equilibrium occurs at point E where the demand curve DD intersects the
supply curve SS. The equilibrium price is OP.

Now if the government feels that free market equilibrium price is too high to be able to purchase the
commodity by common and poor consumers, then government can intervene the market.

Suppose the government fixes the maximum price at OP 1 which is below the equilibrium price to
safeguard the interest of the consumers.

At price OP1 the quantity demanded is OQD whereas quantity supplied is OQs. Thus, it is clear
that supply is less than demand and will give birth to the situation of shortages.

The problem can be tackled through Rationing.

Through rationing system government attempts to make available a minimum quota of the
commodity to all the consumers.
Thus, quantity control can be enforced along with price control.

If the price control enforcing government machinery is weak, black market may develop. A
black market is a situation whereby goods are sold at a price above the legal ceiling price
Price Floor

In a free market the equilibrium occurs at E where demand curve DD intersects the supply curve

SS. The equilibrium price is OP .

If the market price is too low, the government may declare the price OP 1 which is above the
equilibrium price in order to safeguard the interest of the producers.

At price OP1 the quantity demanded is OQD and the Quantity supplied is OQS.
This creates a situation of surplus in the market.
Consumers would not be willing to purchase the whole amount of the commodity that the
producers are willing to sell.
The minimum price can therefore be enforced only when the government is prepared to buy the
surplus amount.

Consequences of Price Support (or Price Floor) Policy

a) The government can dispose off the surplus purchased in the following ways • It can be
sold at subsidized rate to the persons below the poverty line through public
distribution system
• It can be used to give wages in terms of food grains for ‘food for work’ programme. •
 It can be exported.

b) Government has to purchase the surplus from the farmers. As a result of it, the stocks in the
government warehouses go on increasing which increases the financial burden of the
government.

c) Tax payers have to pay more tax to finance the government’s food grains purchases as well
as storage cost.

d) Income of the farmers increases as a result of the minimum support price.