Market Equilibrium | Sahithyan's Notes

Market equilibrium occurs at the point where the demand curve and supply curve intersect.

At equilibrium:

Q_d = Q_s

The intersection determines:

Equilibrium price
The price at which quantity demanded equals quantity supplied.
Equilibrium quantity
The quantity demanded and supplied at the equilibrium price.

E the equilibrium point, where D and S intersect, at price Pₑ and quantity Qₑ.

Surplus

A surplus occurs when the market price is above the equilibrium price.

Q_s > Q_d

Producers want to sell more than consumers want to buy.

As a result, there is downward pressure on price, causing the price to fall toward equilibrium.

Shortage

A shortage occurs when the market price is below the equilibrium price.

Q_d > Q_s

Consumers want to buy more than producers want to sell.

As a result, there is upward pressure on price, causing the price to rise toward equilibrium.

Summary

Situation	Relationship	Result
Price above equilibrium	$Q_s > Q_d$	Surplus → Price falls
Price below equilibrium	$Q_d > Q_s$	Shortage → Price rises
Equilibrium	$Q_d = Q_s$	Market clears

Changes in Equilibrium

There are four basic types of changes:

Increase in demand
Decrease in demand
Increase in supply
Decrease in supply

Change	Curve Shift	Equilibrium Price	Equilibrium Quantity
Increase in Demand	Demand curve shifts right	↑	↑
Decrease in Demand	Demand curve shifts left	↓	↓
Increase in Supply	Supply curve shifts right	↓	↑
Decrease in Supply	Supply curve shifts left	↑	↓

Market Price Changes

Market price can increase because of:

Increase in demand
Decrease in supply

Market price can decrease because of:

Decrease in demand
Increase in supply

Simultaneous Changes in Demand and Supply

Sometimes demand and supply change at the same time.

Increase in Demand + Increase in Supply

Quantity must increase.

Price may:

Increase
Decrease
Remain unchanged

The final effect on price depends on the relative size of the two shifts.

Increase in Demand + Decrease in Supply

Price must increase.

Quantity is indeterminate.

Quantity may:

Increase
Decrease
Remain unchanged

The final effect depends on the relative size of the demand and supply changes.

Interrelated Markets

Markets are connected to one another.

A change in one market can affect another market, especially when goods are substitutes or complements.

Consumer Surplus

Consumer surplus is the difference between the maximum price consumers are willing to pay and the price they actually pay.

On a linear demand curve it is the area of the triangle between the demand curve and the equilibrium price.

CS = \frac{1}{2} \times Q^* \times (P_{\max} - P^*)

Here:

$Q^*$: equilibrium quantity
$P_{\max}$: choke price, the price at which quantity demanded is 0
$P^*$: equilibrium price

Producer Surplus

Producer surplus is the difference between the price producers receive and the minimum price they are willing to accept.

On a linear supply curve it is the area of the triangle between the equilibrium price and the supply curve.

PS = \frac{1}{2} \times Q^* \times (P^* - P_{\min})

Here:

$P_{\min}$: the price at which quantity supplied is 0

Worked Examples

Consumer Surplus Calculation

Demand is $Q_d = 80 - 2P$ and supply is $Q_s = -20 + 3P$ . Find the consumer surplus.

Solution Reveal Hide

Set $Q_d = Q_s$ .

80 - 2P = -20 + 3P

So $P^* = 20$ and $Q^* = 40$ .

Inverse demand is $P = 40 - 0.5Q$ , so $P_{\max} = 40$ .

CS = \frac{1}{2} \times 40 \times (40 - 20) = 400

The consumer surplus is Rs. 400.

Producer Surplus Calculation

Demand for bread is $Q_d = 110 - P$ and supply is $Q_s = -40 + 2P$ . Find the producer surplus.

Solution Reveal Hide

Set $Q_d = Q_s$ .

110 - P = -40 + 2P

So $P^* = 50$ and $Q^* = 60$ .

Inverse supply is $P = 20 + 0.5Q$ , so $P_{\min} = 20$ .

PS = \frac{1}{2} \times 60 \times (50 - 20) = 900

The producer surplus is 900.