Market Equilibrium — Notes

In a perfectly competitive market with a fixed number of firms, the equilibrium price is the price at which quantity demanded equals quantity supplied (qd = qs); the equilibrium quantity is the quantity bought and sold at that price. Both are found by setting demand equal to supply.

Example (imagined Ratnapuri mangoes): qd = 200 − 5p and qs = 20 + 4p give 180 = 9p, so p = 20 and q = 100.

At a price below equilibrium, quantity demanded exceeds quantity supplied: there is excess demand (90 quintals at Rs 10), and competition among buyers raises the price. At a price above equilibrium, quantity supplied exceeds quantity demanded: there is excess supply (90 quintals at Rs 30), and sellers with unsold stock cut the price. In both cases the price moves towards equilibrium.

This movement, produced by the separate decisions of many buyers and sellers without central direction, is described as the work of an invisible hand.

• Demand rises (curve shifts right): price rises and quantity rises (20 to 25 and 100 to 120 in Ratnapuri). Demand falls: both fall.
• Supply rises: price falls and quantity rises (15 and 125). Supply falls: price rises and quantity falls.

A change in the good's own price is a movement along a curve; a change in income, tastes, input prices or other conditions shifts the curve.

With free entry and exit, price tends to the minimum average cost in the long run; this chapter keeps the number of firms fixed.

When demand and supply both shift, the outcome depends on the relative size of the shifts.

• Both rise by the same amount: price unchanged (20), quantity rises (145).
• Demand rises more than supply: price rises (25), quantity rises (165).
• Supply rises more than demand: price falls (15), quantity rises (170).
• Demand rises by 50 and supply falls by 40: price rises to 30, quantity unchanged (100).

The wage of labour is determined in the same way, where labour demand equals labour supply.

A price ceiling is a maximum price set by the government. It has an effect only if it is below the equilibrium price, where it creates excess demand, a shortage. Governments use ceilings on essential goods to keep them affordable. Consequences: rationing (for example by ration cards), queues, the possibility of a black market and lower quality.

Imagined Chandanpur gas cylinders: free price Rs 800, 400 cylinders. At a ceiling of Rs 600: demand 600, supply 300, shortage 300. A ceiling above 800 (for example Rs 900) has no effect.

A price floor is a minimum price set by the government. It has an effect only if it is above the equilibrium price, where it creates excess supply, a surplus. Governments use floors to support producers, for example a support price for a crop or a minimum wage. If the government buys the surplus it holds a buffer stock, which costs money to buy and store.

Imagined Dhanpur millet: free price Rs 40, 340 thousand kg. At a floor of Rs 50: demand 300, supply 400, surplus 100 thousand kg, costing Rs 5000 thousand to buy. A floor below Rs 40 has no effect.

A minimum wage is a floor on the price of labour. In the imagined Kareempur weaving cluster the wage that clears the market is Rs 150 a day, with 300 weavers employed. A minimum wage of Rs 180 gives labour demand of 240 and labour supply of 390, so 150 weavers who would like to work are not employed. Weavers who keep their jobs gain; those who lose them, and employers paying more, lose.

Controls help some people and burden others, so their effects are weighed on both sides.