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Understanding Market Equilibrium and the Market Mechanism

Learn how supply and demand interact to determine equilibrium price, how markets adjust to shortages or surpluses, and the role of competition for efficiency. Explore concepts like tax shifting, price ceilings/floors, and government intervention in markets.

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Understanding Market Equilibrium and the Market Mechanism

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  1. - Bharathi Market Equilibrium

  2. The Market Mechanism • Market Mechanism Summary 1) Supply and demand interact to determine the equilibrium price. 2) When not in equilibrium, the market will adjust to a shortage or surplus and return to the equilibrium. 3) Markets must be competitive for the mechanism to be efficient.

  3. MARKET DEMAND & SUPPLY Price Price P QS P QD MARKET DEMAND MARKET SUPPLY 200 B U Y E R S 200 S E L L E R S 10 20 35 55 80 2,000 4,000 7,000 11,000 16,000 12,000 10,000 7,000 4,000 1,000 Rs.5 4 3 2 1 Rs.5 4 3 2 1 60 50 35 20 5 x x EQUILIBRIUM

  4. P QD P QS MARKET DEMAND & SUPPLY Price S Rs.5 4 Rs3 2 1 Price Supply Price Demand 2,000 4,000 7,000 11,000 16,000 12,000 10,000 7,000 4,000 1,000 Rs.5 Rs.4 Rs.3 Rs.2 Rs.1 Market Equilibrium Rs.5 Rs.4 Rs.3 Rs.2 Rs.1 D 7 o Q 2 4 6 8 10 12 14 16 Quantity

  5. S D The Market Mechanism Y Price (Rs. per unit) P E Quantity X O Q

  6. S Surplus P1 If price is above equilibrium Point-Supply exceeds Demand. P D Q The Market Mechanism Price (Rs. per unit) Quantity

  7. Price (Rs per unit) S Surplus P1 Assume the price is P1 , then: 1) Quantity Supplied is > Quantity Demanded 2) Producers lower price. 3) Quantity supplied decreases 4) Equilibrium is restored P2 D Quantity Q1 Q3 Q2 The Market Mechanism

  8. Price (Rs. per unit) S Assume the price is P2, then: 1) Quantity Demanded is greater than quantity Supplied 2) Producers raise price. 3) Quantity supplied increases 4) Equilibrium is restored P3 P2 Shortage D Quantity Q1 Q3 Q2 The Market Mechanism E

  9. Change in Supply P D1 S1 S2 P2 Price P1 o Q2 Q1 Q Quantity

  10. Change in Demand D2 S1 D1 P P2 Price P1 o Q1 Q2 Q

  11. P D Q D Q P D1 A D1 S S B D1 P2 D2 P1 P1 P2 Q2 Q1 Q1 Q2 “Decrease in Demand” “Increase in Demand” Four Possibilities Q S Q P P S D D D S2 C S1 S1 P2 S1 P2 P1 P1 Q2 Q1 Q1 Q2 “Increase in Supply” “Decrease in Suply”

  12. Change in Supply = Change in Demand D2 S3 D1 S1 D3 S2 P Q

  13. Effects of Government Intervention Price Controls • If the Government decides that the equilibrium price is too high, they may establish a maximum allowable ceiling price.

  14. TAX SHIFTING AND THE ELASTICITIES OF DEMAND AND SUPPLY • When a product is taxed, who ultimately shoulders the tax burden depends upon the elasticity of demand and supply of the product taxed. • Usually the tax burden is shared between producers and consumers. • Consumers pay more of the tax, if demand is relatively less elastic than supply • Producers pay more of the tax if demand is relatively more elastic than supply.

  15. Price Ceilingsand Price Floors • Price Ceiling • is a legally established maximum price which a seller can charge or a buyer must pay. • Price Floor • is a legally established minimum price which a seller can charge or a buyer must pay.

  16. Price Ceilings • When the Government imposes a price ceiling (i.e., a legal maximum price at which a good can be sold) two outcomes are possible: • The price ceiling is not binding. • The price ceiling is a binding constraint on the market, creating shortages.

  17. A Binding Price Ceiling Price S Price Ceiling PE PC Shortage D QS QE QD Quantity/time

  18. Market Impactsof a Price Ceiling • A Binding Price Ceiling creates. . . • Shortages (QD > QS) • Shortages create : • Queuing • Discrimination criteria set by sellers • Bundled pricing with other goods • Bribery/corruption

  19. Price Floors • When the Government imposes a price floor (i.e., a legal minimum price at which a good can be sold) two outcomes are possible: • The price floor is not binding. • The price floor is a binding constraint on the market, creating surpluses.

  20. A Binding Price Floor Price S Surplus PF Price Floor PE D QS QD QE Quantity/time

  21. Market Impactsof a Price Floor • A Binding Price Floor creates. . . • Surpluses (QS > QD) • Surpluses create : • Discrimination criteria set by buyers • Examples: • Agricultural Price Supports

  22. INCOME FLOW IN AN ECONOMY

  23. Rest of the World Firms (produce the domestic product) Income (Y) Gross National The Circular Flow of Income Financial System C + I 3 2 Investment (I) Consumption (C) C + I + G Imports (IM) Purchases (G) Saving (S) Exports (X) 4 Investors Government C + I + G + Consumers 1 Government (X – IM) Disposable 5 Taxes Transfers 6 Income (DI)

  24. THANK YOU bharathi.hrd@gmail.com

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