Lesson 05
DEMAND, SUPPLY & EQUILIBRIUM ANALYSIS (CONTINUED)
EQUILIBRIUM CAN SHIFT IF
• Demand Curve Shifts.
• Supply Curve Shifts.
• Both Shift.
This gives rise to eight possibilities. These eight possibilities can be summarized as following:
D Æ , S ~, PÇ QÇ
D ~ , S Æ , PÈ QÇ
D Æ , S Æ , P ? QÇ
D Å , S ~ , PÈ QÈ
D ~ , S Å , PÇ QÈ
D Æ , S Å , PÇ Q ?
D Å , S Æ , PÈ Q ?
D Å , S Å , P ? QÈ
The symbol “Æ” or “Ç” shows increase and the symbol “Å” and “È” shows a decrease while the
symbol “~” shows that the particular thing remains same.
NOTE: (Graphical illustration of all these possibilities is given in the video lecture)
Points to note in these 8 possibilities:
1. Whenever the demand curve shifts the new equilibrium is obtained by moving along the supply
curve.
2. Whenever supply curve shifts, the new equilibrium is obtained by moving along the demand
curve.
3. Whenever both demand and supply curves shifts, we will move first on the demand curve and
then along the supply curve.
THE MARKET FOR BUTTER
Question: What will happen to the equilibrium price and quantity of butter in each of the following
cases?
a. A rise in the price of the margarine. D Æ , S Å
b. A rise in the demand for milk. S Æ; D Å ( if milk is a substitute )
c. A rise in the price of bread. D Å
d. A rise in the demand of bread. D Æ
e. An expected rise in the price of butter in near future. S Å D Æ
f. A Tax on butter production. S Å
g. An invention of a new, but expensive, process of removing all cholesterol from butter , plus the
passing of law which states that all producers must use this process. D Æ S Å
GOVERNMENT’S ROLE IN PRICE-DETERMINATION & EQUILIBRIUM ANALYSIS
Identification problem is the problem of how to identify demand & supply curve. This problem arises
when both price and quantity.
Government can impact on equilibrium by two fundamental ways. The government may intervene in
the
market and mandate a maximum price (price ceiling) or minimum price (price floor) for a good or
service.
PRICE CEILING:
A price ceiling is the maximum price limit that the government sets to ensure that prices don’t rise
above that limit (medicines for e.g.).
Introduction to Economics –ECO401 VU
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If a price ceiling is placed below the market-clearing price, as Pc, the market-clearing or equilibrium
price of Pe becomes illegal. At the ceiling price, buyers want to buy more than sellers will make
available. In the graph, buyers would like to buy amount Q4 at price Pc, but sellers will sell only Q1.
Because they cannot buy as much as they would like at the legal price, buyers will be out of
equilibrium. The normal adjustment that this disequilibrium would set into motion in a free market, an
increase in price, is illegal; and buyers or sellers or both will be penalized if transactions take place
above Pc. Buyers are faced with the problem that they want to buy more than is available. This is a
rationing problem.
PRICE FLOOR:
A price floor is the minimum price that a Government sets to support a desired commodity or service
in
a society (wages for e.g.).
Price ceilings are not the only sort of price controls governments have imposed. There have also been
many laws that establish minimum prices, or price floors. The graph illustrates a price floor with price
Pf. At this price, buyers are in equilibrium, but sellers are not. They would like to sell quantity Q2, but
buyers are only willing to take Q3. To prevent the adjustment process from causing price to fall,
government may buy the surplus, If it does not buy the surplus, government must penalize either
buyers
or sellers or both who transact below the price floor, or else price will fall. Because there is no one
else
to absorb the surplus, sellers will.
Introduction to Economics –ECO401 VU
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RATIONING & SUPPLY SHOCKS (ALTERATION OF EQUILIBRIUM PRICE BY THE
GOVT)
There are two ways for this:
1. Through Tax :
Tax (to be paid by the producer) will increase the Supply Price, Supply Curve shifts left ward, Price
increases & quantity decreases.
2. Through Subsidy :
Subsidy (given to the producer) will decrease the Supply Price, Supply Curve shifts rightward, Price
decreases & quantity increases.
SOCIAL COST
Social cost is the cost of an economic decision, whether private or public, borne by the society as a
whole.
MARGINAL SOCIAL COST
Marginal social cost is the change in social costs caused by a unit change in output.
