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Principles of Economics second edition

Oxford Fajar Sdn. Bhd. (008974-T) 2010

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Ch. 3: 1

CHAPTER

MARKET EQUILIBRIUM

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

All Rights Reserved


Ch. 3: 2

DEFINITION OF MARKET
EQUILIBRIUM
A market equilibrium is a situation when
quantity demanded and quantity supplied
are equal and there is no tendency for price
or quantity to change.

QDD = QSS

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

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Ch. 3: 3

EQUILIBRIUM PRICE AND OUTPUT

SURPLUS (QSS > QDD)

6
5
Price

4
3

E
P*

SS

DD

SHORTAGE (QDD > QSS)

1
0
2

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

Q*
6
Quantity

10

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Ch. 3: 4

EQUILIBRIUM PRICE AND OUTPUT

Price

Quantity
Demanded

Quantity
Supplied

Market
Condition

Market Prices

10

SURPLUS

Falls

SURPLUS

Falls

EQUILIBRIUM

Equilibrium

SHORTAGE

Rises

10

SHORTAGE

Rises

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

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Ch. 3: 5

CHANGES IN DEMAND
Assume supply is constant
Increase in
Demand

Price (RM)
SS

-DD curve shifts to the


right

P2

-Equilibrium price and


quantity increase

P*
DD1

P1
DD2

Decrease in Demand
-DD curve shifts to the left
-Equilibrium price and quantity
decrease

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

DD

Q1

Q*

Q2

Quantity

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Ch. 3: 6

CHANGES IN SUPPLY
Assume demand is constant
Increase in Supply

Price (RM)

SS2

-SS curve shifts to the right

SS

-Equilibrium price decreases


and quantity increases

P2
SS1

P*
P1
DD
Decrease in Supply
-SS curve shifts to the left

Q1

Q*

Q2

Quantity

-Equilibrium price increases


and quantity decreases
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010

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Ch. 3: 7

CHANGES IN BOTH DEMAND AND


SUPPLY
SUPPLY AND DEMAND BOTH INCREASE
Price (RM)
DD1

Case 1: Same
magnitude

SS

-Equilibrium price is
constant and
quantity increases

SS1

P*

DD
Q*

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

Q1

Quantity

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Ch. 3: 8

CHANGES IN BOTH DEMAND AND


SUPPLY (cont.)
SUPPLY AND DEMAND BOTH INCREASE
Price (RM)

DD1

SS
SS1

P1
P*

DD

Case 2: Different
Magnitude
-Equilibrium price
increases and quantity
increases
Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010

Q*

Q1

Quantity

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Ch. 3: 9

CHANGES IN BOTH DEMAND AND


SUPPLY (cont.)
SUPPLY AND DEMAND BOTH INCREASE
Price (RM)

DD1

SS
SS1

P*
P1
DD
Case 3: Different
Magnitude
-Equilibrium price
decreases and quantity
increases

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

Q*

Q1

Quantity

Both DD and SS increase


Equilibrium quantity increase
Equilibrium price is uncertain
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Ch. 3: 10

MAXIMUM PRICE

MINIMUM PRICE

GOVERNMENT INTERVENTION IN THE


MARKET

TAXES

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

SUBSIDIES

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Ch. 3: 11

GOVERNMENT INTERVENTION IN
MARKETS
Price

MAXIMUM PRICE/CEILING PRICE

Advantage:
Consumers purchase at
lower price

Government-imposed regulations that


S prevent prices from rising above a
maximum level
Suppliers reduce the amount offered to Q1 but
demand would rise to Q2 creating a shortage
The equilibrium price is P* and the
quantity is Q*

P*

The government imposes a


maximum price of P1

Price
ceiling

P1
Shortages occur

D
Q1

Q*

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

Q2

Quantity

Disadvantages:
Emergence of black market
Reduction in quantity
produced
Producers tend to receive
illegal payments from
consumers
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Ch. 3: 12

GOVERNMENT INTERVENTION IN
MARKETS (cont.)
MINIMUM PRICE/FLOOR
PRICE

Price
Surplus occurs

Government-imposed regulations
that prevent prices from falling below
a minimum level
Advantages:

P1

Floor Price

Protects the producers income


Higher wage rate

Suppliers increase the


The
equilibrium
amount
offered to Q2 but
Disadvantages:
pricedemand
is P* and
theto Q
drop
1
quantity
is
Q*.
creating a surplus

P*

Consumers pay more

The government
imposes
a minimum
Waste of resources
of production
price of P1
Creates
unemployment
D

Q1

Q*

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

Q2

Quantity
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Ch. 3: 13

EFFECT OF TAXATION
INDIRECT TAX

S1
Price

Tax that is imposed by the


government on producers or sellers
but paid by or passed on to end-users

The equilibrium price is RM12 and the


quantity is 400

14
12
10

CONSUMERS
SHARE

The government imposes a sales tax


of RM4 per carton

PRODUCERS
SHARE

SS curve shift to left from S to S1 and


new equilibrium is RM14 and 200 units

D
200

400

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

The tax amount of RM4 is shared


equally between buyer and seller

Quantity
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Ch. 3: 14

Demand less elastic than supply


P

Perfectly inelastic demand


P

S + tax (RM4)

15

S + tax
S

16

12
11

CONSUMERS
SHARE

CONSUMERS
SHARE

12

PRODUCERS SHARE

D
400

Demand is more elastic than supply


P

400

Incidence of tax: elastic supply


P

S + tax

S + tax

S
13
12

121 PRODUCERS

CONSUMERS' SHARE

SHARE

18

PRODUCERS
SHARE

400

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

400

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Ch. 3: 15

EFFECT OF SUBSIDIES
SUBSIDY

An incentive from the government to


encourage producers to produce more

Price

S1
50
45
40

The equilibrium price is RM50 and the


quantity is 10
The government provides a subsidy of
RM10 per unit

CONSUMERS
SHARE

SS curve shifts to the right from S to


S1 and new equilibrium is RM45 and
20 units

PRODUCERS
SHARE

The subsidy amount of RM10 is shared


equally between buyer and seller

D
10

20

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

Quantity
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Ch. 3: 16

EFFECT OF PRICE ELASTICITY ON


SUBSIDIES

Demand is more elastic than supply


P

S+ tax (RM4)

50

S + tax

50
47

Demand less elastic than supply

CONSUMERS
SHARE

CONSUMERS'S SHARE

43
PRODUCERS
SHARE

40

PRODUCERS SHARE

40
D
O

10

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

10

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Ch. 3: 17

MARKET FAILURE
Market failure exists when a free market is unable to

deliver an efficient allocation of resources which


leads to a loss of economic efficiency.
Causes of market failure
1. Externalities
2. Existence of monopoly power
3. Public goods
4. Incomplete information

Principles of Economics second edition


Oxford Fajar Sdn. Bhd. (008974-T) 2010

All Rights Reserved


Ch. 3: 18

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