Equilibrium Price Flashcards
What is equilibrium price?
Equilibrium price is the price determined by the industry on the basis of market forcecs of demand and supply.
How is equilibrium price determined?
- Equilibrium price is the price determined by the industry on the basis of market forcecs of demand and supply.
- The price is determined where the market demand equals market supply of a commodity.
- It is the price where the consumers are willing to buy the commodity and the firms are willing to supply the good.
- Hence, the equilibrium price is determined at Rs. 3 where the market demand DD = market supply SS at 3 units
Demand Curve slope
Supply Curve slope
Movement or shift? Direction?
Increase in Demand/Supply
Decrease In Demand/Supply
Expansion of Demand
Expansion of Supply
Contraction of Demand
Contraction of Supply
Expansion Contraction of Demand and Supply
(Visualise)
Similtaneous changes in both demand and supply
(Visualise)
3 Cases
- DD UP = SS UP - Price Remains Same
- DD UP > SS UP - Price Rises
- DD UP < SS UP - Price Falls
What is price celing? And what are its consequences?
Price control or ceiling or rationing means that a ceiling (maximum price limit) has been imposed on the prices of such commodities for which the government feels it is necessary as the maraket prices are too high for the consumers to afford.
Producers/Sellers of the commodity cannot charge more than the ceiling price.
Equilibrium price may be theoretically fixed at a price :-
- More than equilibrium price - Market Unaffected
- Equal to equilibrium price - Market Unaffected
- Less than equilibrium price - Justified Use
Suppose government imposes price ceiling at OP1 per unit. The equilibrium price would become illegal to be charged by the sellers. At lower price, OP1, quantity demanded will expand to OQ1. But at this reduced price, suppliers will only be willingg to supply OQ1 quantity of goods. Hence quantity supplied will contract to OQ0. Hence, there will be a shortage of this commodity (equal to quantity demanded - quantity suppied = OQ1 - OQO), and there will be excess demand
Coencequences:-
- Shortages - The quantity actually sold and bought in the market will shrink. A large chunk of consumer’s demand will go unfullfilled.
- Black Marketing - Is a direct coensequence. Implies situation under whcih restricted commodity is sold unlawfully at price higher thaan ceiling price
- Rationing - Implies that a ceiling is imposed on the quantity which can be bough and consumed by a consumer.
- Dual-Price Policy - Gov may allow product to be sold at two different prices. Fixed or quota quantity at a lower price and open market price who can afford to pay the prevailing market price.
What is price floor? What are its coencequences?
Price control or ceiling or rationing means that a floor (minimum price limit) has been imposed on the prices of such commodities wher ethe producers are unable to sustain/satisfy their cost-output conditions.
Producers/Sellers will be able to sell their commodity at a minimum floor price.
Equilibrium price may be theoretically fixed at a price :-
- Lower than equilibrium price - Market Unaffected
- Equal to equilibrium price - Market Unaffected
- More than equilibrium price - Justified Use
Suppose government imposes price ceiling at OP1 per unit. The equilibrium price would no longer be legally obtainable. At higher price, OP1, quantity demanded will contractto OQ0. But at this increased price, suppliers will be willing to supply OQ1quantityof goods. Hencequantity suppliedwillexpandto OQ1. Hence, there will be asurplusof this commodity (equal to quantity supplied - quantity demanded = OQ1 - OQO), and there will beexcess supply
Coencequences:-
- Surplus - The quantity actually bought and supplied in the market will shrink. A large chunk of producer’s stock will remain unutilised.
- Buffer Stock - In order to maintain the support price, the government would have to design some programme to enable producers to dispose of their surplus stock, such as buffer stock.
- Subsidies - To offset the loss to consumers, government may subsidise product, i.e. government will purchase at support price and sell teh commodity to consumers below cost of procurement.
At a given price, there is excess demand. How will equilibrium be attained? What are the chain effects?
Visualise Supply Also
Since there is excess demand, we assume that the initial price is OP in diagram. Excess demand at given price shown in figure
In given diagram, the excess demand represented by line segment will create a competition among buyers, which will increase price from OP to OP1. This can be explained with the following:-
- As buyers will be willing to pay more, price will increase from OP to OP1. As we know, an inverse relationship exists between price and quantity demanded, hence an increase in price to OP1 will lead to a fall in quantity demanded from OQ1 TO OQ.
- Since price has increased, and, as we kknow there exists a direct relationship between price and quantity supplied, so rise in price to OP1 will lead to a rise in quantity supplied from OQ0 to OQ.
Hence, equilibrium price will be achived at OP1.
Market for a good is in equilibrium. Demand increases. How will equilibrium price be achieved? Explain the chain effects.
Since market for good is equilibrium, we assume that initial price is OP as shown in diagram.
- Due to increase in demand, the demand curve will shift rightward from DD to D1D1
- With new demand curve, there is excess demand at initial price OP.
- Due to this excess demand, consumers will be willing to pay more, hence the price wil rise.
- Due to this rise in price there is contraction in demand, i.e. an upward movement along the same demand curve from OQ to OQ1.
- Similarly there is expansion in supply, i.e. an upward movement along the same supply curve from OQ to OQ1.
- Hence, finally equilibrium price rises from OP to OP1 and equilibrium quantity rises from OQ to OQ1
