Micro Economics, market equilibrium

1. MARKET EQUILIBRIUM
Prof. Prabha Panth,
Osmania University,
Hyderabad

2. Market Equilibrium
• Does Demand determine P, or does Supply determine P?
• Marshall:- both are needed to determine Market P.
• Like the two blades of a pair of scissors to cut paper.
• In a free market, the forces of supply and demand
interact to determine equilibrium quantity and
equilibrium price.
• This Price will rule in the market and acceptable to both
buyers and sellers.
• At this Equilibrium P, the total market supply will equal
the total market demand.
• No excess demand or supply. QD = QS, market is cleared.
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3. Example: Market Equilibrium for X
Price/ Kg Qty Demanded Qty Supplied
Rs. 10 25 Kgs 5 Kgs
Rs. 12 20 Kgs 10 Kgs
Rs.14 15 Kgs 15 Kgs
Rs. 16 10 Kgs 20 Kgs
Rs.18 5 Kgs 25 Kgs
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4. • From the table we see that:
• As Price of X rises, Demand for X falls,
• And Supply increases.
• At lower prices, Qd > Qs. Since D > S, it drives up
the price
• At high prices, Qs > Qd. Since S > D, the market
price falls.
• Finally at one price, i.e. Rs.14, Qs = Qd
• Here Qd = Sd = 15 Kgs of X
• Therefore this is the Equilibrium Price, Pe Rs.14,
and the Equilibrium Quantity, Qe 15 Kgs of X.
• This can also be shown in the form of a diagram.
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5. Prabha Panth 5
P of X
Q of X
0
S
S D
D
E S = D
D1 S1
D2S2
Pe
Qe
D1 < S1, excess supply
S2 < D2, excess demand
Figure 1. Market Equilibrium for X
Equilibrium in a market is a
condition, wherein the
Demand forces are
balanced by Supply forces
to arrive at a Unique
market price and Unique
market quantity.
This price will rule in the
perfect competitive
market, and all P.C. firms
will follow this price,
ceterus paribus.
This equilibrium point
a) Exists
b) Is Stable,
c) And Unique,

6. Market Equilibrium
• If the Demand equation and Supply equation are given, then
we can also determine the market price and quantity.
• For e.g. Let D = 40 – 4P
Let S = 10 + 2P
What is the equilibrium P and Q?
At equilibrium D = S, so 40 – 4P = 10 + 2P
or 40 – 10 = 2P + 4P or 30 = 6P
and P = 30/6 = 5 So equilibrium P = Rs.5
To get equilibrium Q, substitute P = 5 in D,
we get, 40 – (4 x 5) = 40 – 20 = 20 Q
Similarly, if we take the S equation, 10 + 2P = 10 + (2 x 5) = 20 Q
D = S, at P = Rs.5. This is the Market clearing Price or Equilibrium Price.
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7. Existence of Stability
• Will there always be an equilibrium point in the Perfectly competitive
market?
• Under certain conditions there may not be. See Figs. 2 and 3.
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Fig. 2 Negative Q
D
- Qe Q
S
S
D
P
Pe
0
In Figure 2, D curve is downward
sloping, and S is a rising curve.
S curve lies above D-curve in the
positive quadrant.
So they do not intersect in the
positive quadrant, but in the negative.
At E, D = S, and P = Pe.
But Q is negative: Qe, (negative Q has
no meaning).
So here no equilibrium exists.
E

8. • It is also possible that the D and S curves may
take the following shapes:
• Here the downward sloping D curve cuts the
rising S- curve in the negative quadrant.
• Now P is negative, but Q is
positive.
• Negative P has no
meaning.
• So here also no
equilibrium exists.
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S
S
DP
- Pe
0
D
Qe
Q
Figure 3

9. Uniqueness of Equilibrium
• Will there be only one equilibrium P and Q in the market? Again it
depends on the nature of the D and S curves. If they cut at multiple points,
there could be more than one equilibrium point. No unique Equilibrium.
In figure 4, the S curve is also
downward sloping,
It cuts the D-curve at two points
E and F.
Are both these points of equilibrium?
Can there be two prices P1 and P2, and
two quantities Q1 and Q2?
If D and S take these shapes, there is no
Unique equilibrium in this market.
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S
DP
0
D
Q
S
P1
P2
Q1 Q2
E
F
Figure 4

10. • In Fig. 5, the D curve is
upward sloping.
• This could be due to
Giffen goods, or luxury
goods.
• The supply curve
intersects the D curve at
multiple points: - E, F, G,
H.
• Here also there is no
unique equilibrium.
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S
D
P
0
D
Q
S
E
F
G
H
Figure 5

11. Stability Problem
• In our usual examples of Market Equilibrium, D has a
negative slope, and S has a positive slope.
• Also D and S cut each other in the positive quadrant.
• Any deviation of Market P from equilibrium P, leads to
market forces that bring P and Q back to equilibrium.
• If D > S, P , and if S > D, then P, until equilibrium P
and Q are reached.
• Hence this is called a “Stable equilibrium.”
• But will the single equilibrium always be stable?
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12. • In certain conditions, the equilibrium could be
unstable.
• If D and S curves do not have their traditional
slopes, i.e. if D is rising, and S is falling.
• D curve will have positive slope for Giffen
goods and luxury goods.
• S curve will have negative slope if the firm is
having decreasing costs, i.e. MC is falling.
• Here the P will move away from the original
equilibrium.
• Unstable Equilibrium (Figure 6).
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13. Unstable Equilibrium
• D curve is rising, and S
curve is a falling curve.
• They intersect at Point E,
this is a unique and
existing equilibrium.
• But if P increases to P1,
then, D > S. This
encourages sellers to
increase their P and Q.
Leads away from E.
• If P falls to P2, then there
is excess supply.
• To encourage demand,
sellers will lower prices.
But D falls still further.
• Moves away from E.
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P of X
Q of X
0
D
D
S
S
E S = D
D1S1
D2 S2
Pe
Qe
D2 < S2, excess supply
D1 > S1, excess demand
P1
P2
Figure 6

14. Questions
1. What is meant by Market Equilibrium?
2. What conditions are necessary for equilibrium
to exist?
3. Is market equilibrium always unique?
4. Does market equilibrium always exist?
5. When will Market equilibrium be stable? What
leads to instability of market equilibrium?
(use diagrams to illustrate your answers)
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