Market Equilibrium

Maryan Joy Lopez

SST 307

Consumers and producers react differently to price changes. Higher prices tend to reduce demand while

encouraging supply and lower prices increases demand while discouraging

supply.The law of demand and supply suggest

that in a free market, there will be a single price which brings demand and

supply into balance.

Market Equilibrium

Shifts to Both Demand And

Supply Curves

Changes in the underlying factors that affect demand and supply will

cause shifts in the position of the demand or supply curve at every price.

Whenever this happens, the original equilibrium price will no longer equate

demand with supply, and price will adjust to bring about a return to

equilibrium.

Equilibrium Price

Demand Increases

New Equilibrium

Price

The illustration shows what happens when demand increases. Originally, the market was in equilibrium at price P0 and quantity Q0. If demand increases, the demand curve shifts to the right from D0 to D1. The quantity demanded associated with the price P0 is

now QD.Because this is greater than the quantity producers are providing (still Q0 as determined off the supply

curve), a shortage exists. The market moves from the original equilibrium price P0 to the new equilibrium price P1 and from the original equilibrium quantity

Q0 to the new equilibrium quantity, Q1.

Equilibrium Price

New Equilibrium

Price

Increase in Supply

The impact of an increase in supply is illustrated above. Originally, the equilibrium price and quantity

are P0 and Q0, respectively. An increase in supply shifts the supply curve to the right from S0 to S1. The

supply increase immediately creates a surplus because at P0, the new quantity supplied QS is greater than the

quantity demanded, which is still at Q0.Because there is a surplus, the good’s price falls from P0 to the new equilibrium price P1, and the quantity demanded and quantity supplied move to the new equilibrium quantity Q1, which is greater than the

original equilibrium quantity Q0.

Equilibrium Price remains

constant

The illustration above shows a simultaneous decrease in both demand and supply — the demand curve shifts

left from D0 to D1, and the supply curve shifts left from S0 to S1. The original equilibrium price and

quantity are P0 and Q0, corresponding to the intersection of the original demand and supply curves.Given the shifts to D1 and S1, the equilibrium quantity decreases from Q0 to Q1 while the equilibrium price

has not changed — P0 = P1. But note that in this illustration, the demand and supply curves shift by the

same amount.

The Dynamics of Demand and Supply

Shifts in DemandAn increase in demand shifts the demand curve to the right, and

raises price and output.A decrease in demand shifts the

demand curve to the left and reduces price and output.

Demand shifts to the right

Demand shifts to the left

Shifts in SupplyAn increase in supply shifts the supply curve to the right, which

reduces price and increases output.A decrease in supply shifts the

supply curve to the left, which raises price but reduces output.

Supply shifts to the right

Supply shifts to left

From that we can conclude that;1. As the Demand Increases and Supply remains constant = Higher Prices2. As the Demand Decreases and Supply remains constant = Lower Prices3. As the Supply Increases and Demand remains constant = Lower Prices4. As the Supply Decreases and Demand remains the constant = Higher Prices

Factors affecting Shifts in Demand

1.Changes in Income2. Change in taste3.Changes in prices of related goods

and services4.Change in Demand vs. Change in

quantity Demand

Factors Affecting Shifts in Supply

1.Price of Inputs and Production Technology

2.Prices of other products from the same Production process

3.Change in supply and change in quantity supplied

Violations of the Law of Supply and

Demand

Price Floors and Price Ceilings are Price Controls, examples of government intervention in the free market which changes the

market equilibrium.

Price Floors are minimum prices set by the government for certain commodities and

services that it believes are being sold in an unfair market with too low of a price and

thus their producers deserve some assistance. Price floors are only an issue when they are set above the equilibrium

price, since they have no effect if they are set below market clearing price. 

When they are set above the market price, then there is a possibility that there will be

an excess supply or a surplus. If this happens, producers who can't foresee trouble ahead will produce the larger quantity where the new price intersects their supply curve. Unbeknownst to them, consumers will not

buy that many goods at the higher price and so those goods will go unsold.

An example of a price floor is minimum wage laws; in this case, employees are the suppliers of labor and

the company is the consumer. When the minimum wage is set above the equilibrium market price for

unskilled labor, unemployment is created (more people are looking for jobs than there are jobs

available). A minimum wage above the equilibrium wage would induce employers to hire fewer workers

as well as allow more people to enter the labor market, the result is a surplus in the amount of labor available. The equilibrium wage for a worker would be dependent upon the worker's skill sets along with

market conditions.(needs source)

Price Floor

Price Ceilings are maximum prices set by the government for particular goods and services that they believe are being

sold at too high of a price and thus consumers need some help purchasing

them. Price ceilings only become a problem when they are set below the

market equilibrium price.

When the ceiling is set below the market price, there will be excess demand or a supply shortage. Producers

won't produce as much at the lower price, while consumers will demand more because the goods are

cheaper. Demand will outstrip supply, so there will be a lot of people who want to buy at this lower price but

can't. Still, if the demand curve is relatively elastic, then the net effect to consumer surplus will be

positive. Producers are truly harmed, as their surplus is doubly hit with a reduction in the number of firms

willing to take that lower price, and those who remain in the market have to take a lower price.

Price Ceiling

Thank You