6. EQUILIBRIUM PRICE DETERMINATION
Under perfect competition equilibrium price and quantity is
determined by the interaction of market demand and market
supply curve of a commodity (Mkt DD = Mkt SS)
Market equilibrium is a situation when market supply curve and
market demand curve of a commodity intersect each other
Equilibrium price is the price which is determined by the equality of
market demand and market supply of a commodity
Equilibrium quantity is the quantity which is determined by the
equality of market demand and market supply of a commodity
Market Price is the price prevailed in the market (Under PC)
9. EXCESS DEMAND
It is a situation in which market demand is greater than market supply.
This situation arises when market price is below the equilibrium price
Equilibrium price is OP which is determined by the equality of demand and supply at point E
When market price is OP1 there arises Excess demand of AB
Due to excess demand there is competition among the buyers which leads the price to increase
As price increases there is contraction in demand & upward movement along the demand curve as
shown by the arrow mark
At the same time due to increase in price , there is extension in supply & upward movement along
the supply curve as shown by the arrow mark
This action and reaction between the buyer and seller will continue till demand = supply i.e
equilibrium is restored (at E)
10. EXCESS SUPPLY
It is a situation in which market supply is greater than market demand
This situation arises when market price is above the equilibrium price
Equilibrium, price is OP which is determined by the equality of demand and supply at point E
When market price is OP1 there arises Excess supply of AB
Due to excess supply there is competition among the sellers which leads the price to
decrease
As price decreases there is contraction in supply & downward movement along the supply
curve as shown by the arrow mark
At the same time due to decrease in price , there is extension in demand & down ward
movement along the demand curve as shown by the arrow mark
This action and reaction between the buyer and seller will continue till demand = supply and
equilibrium is restored (at E)
11. Excess Supply Fall in price
Excess Demand Rise in price
P* : Equilibrium Price
12. Effect of Increase in Demand on Equilibrium
• D (20) = S (20)
• D (30) S (20) EXCESS Demand PRICE RISES Contraction of
DD & Expansion of SS continue till equilibrium is established (D =S)
• Equilibrium price and quantity both will increase.
13. Effect of CHANGE in Demand on EQUILIBRIUM PRICE AND QUANTITY I
(a) When Market Demand increases and Market Supply remain constant
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In this diagram market demand curve and supply curve are DD and SS respectively . Both intersect at point
E and E is called the point of equilibrium . Accordingly the equilibrium price is OP and quantity is OQ
When demand increase the new demand curve shifts right ward as D1D1
At the prevailing price there is excess demand & Due to excess demand there is competition among the
buyers which leads the price to increase. As price increases there is contraction in demand , so there is
upward movement along the demand curve as shown by the arrow mark
At the same time due to increase in price , there is extension in supply, so there is upward movement along
the supply curve as shown by the arrow mark
• This action and reaction between the buyer and seller will continue till both demand and supply are equal at
point E1 and equilibrium is restored and new equilibrium is E1 and new equilibrium price is OP1 and
quantity is OQ1
So equilibrium price and quantity both will increase
14. Effect of Decrease in Demand
• D (20) = S (20)
• D (10) S (20) EXCESS Supply PRICE FALLS Expansion of DD
& Contraction of SS continue till equilibrium is established (D =S)
• Equilibrium price and quantity both will decrease.
15. Effect of CHANGE in Demand on EQUILIBRIUM PRICE AND QUANTITY II
• When Market Demand decreases and Market Supply remain constant
In this diagram market demand curve and supply curve are DD and SS respectively. Both intersect at point
E and E is called the point of equilibrium. Accordingly the equilibrium price is OP and quantity is OQ
• When demand decrease the new demand curve shifts left ward as D1D1.
At the prevailing price there is excess supply. Due to excess supply there is competition among the sellers
which leads the price to decrease
As price decreases there is contraction in supply , so there is down ward movement along the supply
curve as shown by the arrow mark. At the same time due to decrease in price , there is extension in
demand, so there is down ward movement along the demand curve as shown by the arrow mark
This action and reaction between the buyer and seller will continue till both demand and supply are equal
at point E and equilibrium is restored . Equilibrium price and quantity both will decrease
16. Effect of Increase in both demand & supply at the same time
(i) Increase in DD = Increase in SS
• DD (20) = SS (20) Equilibrium – no excess demand or supply
• DD (30) = SS(30) Equilibrium – no excess demand or supply
• No Change in Equilibrium Price BUT qty bought & sold will increase i.e Equilibrium qty will increase
(ii) Increase in DD > Increase in SS
• DD (20) = SS(20) Equilibrium – no excess demand or supply
• DD (30) SS (25) Excess demand Price increases Contraction of demand & Expansion of Supply – this will continue till
the equilibrium is reached i.e. DD = SS .
• Thus both Equilibrium Price & Qty will increase
(ii) Increase in DD < Increase in SS
• DD (20) = SS(20) Equilibrium – no excess demand or supply
• DD (25) SS (30) Excess supply Price decreases Expansion of demand & Contraction of Supply – this will
continue till the equilibrium is reached i.e. DD = SS .
• Equilibrium Price falls but equilibrium Qty increases
20. Price Ceiling
• P S
• Pe E (D=S)
• P1 Price Ceiling
• D>S Shortage
• Qs Qd
• It is fixed by the Govt when market determined price (specially for essential goods) is very high
& Consumers are suffering.
• PRICE CEILING – It is the MAXIMUM Price of a commodity (generally essential goods ) fixed by the GOVT below equilibrium price.
It is fixed to protect the interest of the consumers. Effect :
• Shortage of goods First cum first served basis may be followed & a group of consumers will remain unsatisfied
• Black marketing – Goods are sold illegally at higher price than the price fixed by the govt
• Rationing – Available goods will be shared equally by all through RATION SYSTEM (PDS)
21. Floor Price
• P D Excess Supply S
• P2 Floor Price
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• Pe
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• Qd Qs
It is fixed when market determined price is too low to make producers satisfied.
• FLOOR PRICE : Minimum Price fixed by the GOVT above equilibrium price to protect the interest of the producers
• Excess Supply in the market Govt will procure extra goods from market at support price & maintain BUFFER STOCK
• Excess supply will be wiped out from the market & producers will be able to sell their
• product at FLOOR Price . Buffer Stock can be considered as a tool to
• maintain floor price.
