Market EquilibriumClass 12 Introductory Microeconomics Case Study Questions

An equilibrium is defined as a situation where the plans of all consumers and firms in the market match and the market clears. In equilibrium, the aggregate quantity that all firms wish to sell equals the quantity that all the consumers in the market wish to buy; in other words, market supply equals market demand. The price at which equilibrium is reached is called equilibrium price. If at a price, market supply is greater than market demand, we say that there is an excess supply. If market demand exceeds market supply at a price, it is said that excess demand exists. In Figure 5.1, if the prevailing price is p₁, the market demand is q₁ whereas the market supply is q₁'. Therefore, there is excess demand in the market. Some consumers who are unable to obtain the commodity will be willing to pay more than p₁. The market price would tend to increase. Similarly, if the prevailing price is p₂, the market supply (q₂) will exceed the market demand (q₂') at that price giving rise to excess supply. Some firms will not be able to sell the quantity they want to sell; so, they will lower their price.

Let us consider the example of a market for wheat. Suppose the market demand curve and the market supply curve for wheat are given by: qᴰ = 200 - p for 0 ≤ p ≤ 200 qˢ = 120 + p for p ≥ 10 where qᴰ and qˢ denote the demand for and supply of wheat (in kg) respectively and p denotes the price of wheat per kg in rupees. Since at equilibrium price market clears, we find the equilibrium price (p*) by equating market demand and supply: qᴰ(p*) = qˢ(p*), which gives 200 - p* = 120 + p*. Rearranging terms, 2p* = 80, so p* = 40. The equilibrium quantity (q*) is obtained by substituting the equilibrium price into either the demand or the supply curve's equation. q* = 200 - 40 = 160. Thus, the equilibrium quantity is 160 kg. At a price less than p*, say p¹ = 25, qᴰ = 200 - 25 = 175 and qˢ = 120 + 25 = 145. Therefore, at p¹ = 25, qᴰ > qˢ, which implies that there is excess demand at this price.

Suppose the market demand curve shifts rightward to DD₂ with the supply curve remaining unchanged at SS₀. This shift indicates that at any price the quantity demanded is more than before. Therefore, at price p₀ now there is excess demand in the market. In response to this excess demand some individuals will be willing to pay higher price and the price would tend to rise. The new equilibrium is attained at G where the equilibrium quantity q₂ is greater than q₀ and the equilibrium price p₂ is greater than p₀. A rightward shift can be caused by an increase in consumers' income for a normal good. With an increase in income, consumers are able to spend more money. For a normal good, we would expect the demand for the good to increase at each price as a result of which the market demand curve will shift rightward. This income increase does not have any impact on the supply curve. The result is that at the new equilibrium, the price of the good is higher and the quantity demanded and sold is also higher.