NCERT Solutions class 12 Microeconomics Chapter 5: Market Equilibrium

In a perfectly competitive market with a fixed number of firms, the price will be determined by the supply and demand that exists in the market. Since the demand and supply will be the same, the price of any commodity will be at equilibrium. This is known as the equilibrium price.

 

When the equilibrium price is greater than the minimum average cost of the firms, more firms will enter the market and produce more quantities of the given commodity. This is due to the high-profit levels that can be gained due to the market’s condition. But in the longer run, the market price will start to fall because of the rise in supply caused by the rush. Therefore, the market equilibrium price will decline, and the profit levels will return to normal.

 

In a perfectly competitive market, when free entry and exit are allowed, the equilibrium price will be the same as the minimum average cost in the long run. All the firms will earn zero to normal economic profit.

 

Market equilibrium is referred to as that state in the market where supply is equal to demand. When a market is at equilibrium, the corresponding price will not change unless there is an external factor which is instrumental in changing the supply or the demand. Under the condition of market equilibrium, the price at which a product is sold is known as the equilibrium price.

 

When the market demand for a product/commodity is greater than the market supply, it can be understood that there is an excess demand for that commodity in the market.

 

When the market supply for a commodity is greater than the market demand, it can be understood that there is an excess supply for that commodity in the market.

 

i) When the price of a product prevailing in the market is above the equilibrium price, supply will be more than demand. Since the product can be sold at a price greater than the equilibrium price, the firm will produce more quantities of the given product and increase the supply. But the demand will be low since the competing firms will also increase their production and supply, creating excess supply.

ii) When the price of a product prevailing in the market is below the equilibrium price, supply will be less than demand. Since the product can only be sold at a price lower than the equilibrium price, the firm will produce fewer quantities of the given product and decrease the supply. The competing firms will also do the same, and therefore the supply will not adequately meet the demand creating excess demand.

 

When free entry and exit are permitted, the market price will remain the same as the minimum average cost. Therefore, firms will enter or exit the market. Since there is no profit to be gained by producing the given commodity, no company will be incentivised to enter the market. This is how an equilibrium number of firms is determined in such a market.

 

(a) An increase in the income of the consumers is likely to increase the equilibrium price. Since the consumers have more money to spend, the demand for a given commodity will increase, and the quantity of the product produced will also increase.

(b) A decrease in the income of the consumers is likely to decrease the equilibrium price. Since the consumers have less money to spend, the demand for a given commodity will decrease, and the quantity of the product produced will also decrease.

 

Shoes and Socks are complementary goods, and a change in one product’s price will affect how the other product’s supply. Since shoes and socks are usually bought together, when there is an increase in the price of shoes, the demand for socks will face a decline. Due to the decline in demand for shoes and socks, the number of socks sold and bought will decrease.

 

Coffee and tea are regarded as substitutes for each other, and therefore, any price change in coffee will result in changing the demand for tea. It can be said that when the coffee price increases, it will increase the demand for tea and when the coffee price decreases, the demand for tea is reduced.

Diagrammatically it can be represented as:

In the above diagram, when the price of coffee increases (from P to P1), the demand for tea increases which is shown by (Q to Q1).

In the above diagram, when the price of coffee decreases from (P to P1), there is a decrease in demand for tea (Q to Q1).

 

Coffee and tea are regarded as substitutes for each other, and therefore, any price change in coffee will result in changing the demand for tea. It can be said that when the coffee price increases, it will increase the demand for tea and when the coffee price decreases, the demand for tea is reduced.

Diagrammatically it can be represented as:

In the above diagram, when the price of coffee increases (from P to P1), the demand for tea increases which is shown by (Q to Q1).

In the above diagram, when the price of coffee decreases from (P to P1), there is a decrease in demand for tea (Q to Q1).

 

Change in input price brings about changes in equilibrium price and quantity of the commodity produced in the following ways:

1. When input price is increased: In case a firm increases the input price, the cost of production will increase, this will result in a decline in profit, and hence supply will take a hit. The supply curve will move left while the demand curve will remain the same. The equilibrium price will increase with reduced output.

2. When input price is decreased: In case a firm decreases the input price, the cost of production will reduce which will encourage the firm to produce more and increase supply. This will result in the supply curve moving right with the demand curve remaining still. The equilibrium price will be lower with increased output.

 

As X and Y are substitutes for each other, any change in the price of the substitute will have an immediate effect on the price of the other. In this case, if the price of Y increases, then it will result in an increase in demand for X and due to this increase in demand, there will be a rise in equilibrium price and the quantity of output of the good X.

 

When the number of firms is fixed in a market, an increase in demand will result in an increased equilibrium price and increased output. Similarly, if entry-exit is allowed, then there will be a decrease in the equilibrium price. There will be more entry of firms as all will be looking to earn a super normal profit. But the entry of more firms causes a decrease in profit, and all firms will start earning normal profits.

 

A rightward shift in both the demand and supply curves can occur in three situations, as explained below:

1. When both the demand and supply curve increase equally, then there will be no change in the equilibrium price, although there will be a change in the equilibrium point.

This can be depicted with a diagram as follows:

2. When the demand curve increases at a faster rate than the supply curve, there will be a higher equilibrium price and higher output.

3. When the demand curve increases at a slower rate than the supply curve, there will be a fall in equilibrium price and a rise in output.

 

In a perfectly competitive labour market, the wage rate will be determined by the point of intersection of the demand and supply of labour. The demand for labour is determined by the marginal product of labour. The rate at which demand equals supply is called as equilibrium wage rate.

 

 

 

The points of differentiation between the labour market and the goods market are as follows:

1. In a goods market, consumers make the demand for goods, whereas, in a labour market, firms make the demands.

2. In a goods market, firms perform the supply of goods, whereas, in a labour market, households provide the supply of labour.

3. Firms act as suppliers in a goods market, whereas households act as suppliers in the labour market.

 

In a perfectly competitive market, the optimal amount of labour is determined by considering the cost and benefit that is obtained by employing the additional labour. A firm will hire labourers till that point, where the cost of employing additional labour becomes equal to the benefits derived from it. At that point, it can be said that the marginal cost of labour is equal to the marginal benefit of labour, or the wage rate is equal to the marginal revenue product.

It can be represented as follows:

W = VMPL

Where,

W = Wage rate

VMPL = Value of Marginal Product of Labour

 

Price ceiling refers to the act of lowering prices as compared to the prevailing market price. This is done to help families below the poverty line survive with essential items. In India, a price ceiling is implemented on various food items such as wheat, rice and sugar and on fuels such as kerosene oil.

The consequences of the price ceiling are as follows:

1. As the price is artificially imposed by the government, it will lead to excess demand for the goods.

2. The amount of goods allotted is fixed per individual, and it may not be sufficient to meet the requirement. The shortage is detected, which makes the consumer dissatisfied.

3. It has been often seen that the quality of goods that are sent for supply is not fit for consumption due to adulteration.

4. Due to unfulfilled requirements from the allotted quota, people get ready to pay more for additional goods, which leads to black marketing leading to a man-made shortage in the market.

 

In the short run, the number of firms is fixed, while in the long run, there is no restriction on the number of firms, and free entry-exit is permitted. The following inference can be made from the situation when the market is running with a fixed number of companies (short run).

1. When demand increases, both equilibrium price and quantity are raised

2. When demand decreases, there is a fall in equilibrium price and quantity

The market situation, when the long run is taking place with free entry and exit of firms, is as follows:

1. When demand increases, there is no change in equilibrium price but the output increases.

2. When demand decreases, there is no change in equilibrium price, but the production quantity is reduced (less).

 

From the question, we can see that

qd = 700 − p

qs = 500 + 3p for p ≥ 15

= 0 or 0 ≤ p 15

It can be inferred from the given data that market supply is 0 as the price range defined is less than the minimum average variable cost. There will not be any output, and the supply curve becomes 0.

Now, when the equilibrium state is known

qd = qs (At equilibrium)

700 – p= 500+ 3p

3p + p = 200

4p= 200

Or p= 50 (equilibrium price)

Now, the equilibrium quantity can be calculated as qS

qs= 500 + 3P

= 500+ 3x 50

= 500+ 150

= 650

The total equilibrium quantity produced is 650 units.

 

As per the question

qsf = 8 + 3 p for p ≥ Rs 200

= 0 for 0 ≤ p < Rs 20.

qd = 700 – p (Keeping the same value as the previous question)

(a) No firm is going to produce any output for the price range of 0 to 20 as this is below the minimum average variable cost. Losses will be incurred if any output is done at the price range of 0-20. At the price of Rs. 20, the price line will be equal to the minimum of the average variable cost.

(b) In the long run, the firms will be earning zero profit, and also, there is the freedom of entry and exit of firms. So the minimum price for which the market will be in equilibrium for X will be Rs. 20, as it is the minimum average variable cost and any price lower than that will result in the exit of the firm.

(c ) The equilibrium price is Rs. 20 as established. Now equilibrium quantity will be calculated.

As per question

qs = 8 + 3p

= 8 + 3(20)

= 68

Therefore, 68 units are supplied.

We have

qd = 700 – p

= 700 – 20

= 680

So, the number of firms can be calculated as

No. of Firms = qd / qs

= 680/68

= 10

 

(a) As per the question,

qd = 1,000 − p

qs = 700 + 2p

At equilibrium point qd = qs

1000- p = 700 + 2p

3p = 300

p= 300/3

= 100

Equilibrium price = Rs. 100

Now qd  = 1000- p

= 1000-100

= 900

Equilibrium quantity = 900 units

(b) As per the question,

qs = 400 + 2p

We know at equilibrium qd = qs

Therefore

1000-p = 400+2p

3p = 600

p = 200

The equilibrium price is Rs. 200

qs = 400 + 2p

= 400 + 2(200)

= 400+ 400

= 800

Equilibrium units = 800

The equilibrium quantity is reduced as the cost of production increases, and it moves the supply curve to the left. This shift brings about an increase in equilibrium price and a reduction in equilibrium quantity.

(c) As per the question

qs= 700 + 2 (p – 3) As a tax of Rs. 3 added to salt production,

At equilibrium point qd = qs

1000 – p = 700 + 2 (p – 3)

1000 – p = 700 + 2p – 6

3p = 1000 – 694

p = 102

Hence, equilibrium price = 102

qd = 1000 – p

= 1000 – 102

= 898

Hence, equilibrium quantity = 898 units

 

When the government intervenes in the market for apartments and imposes control on rent, it will bring down the prices. Due to the drop in prices, the demand for apartments will grow. The imposition of a price ceiling will facilitate more people to afford an apartment who would not otherwise be able to pay the rent. It will also make some builders indulge in black marketing.

• Market Equilibrium – It is a market situation where the demand for the commodity is equivalent to its supply.

• Equilibrium Price – It corresponds to the quantity between the market demand and the market supply of a good.

• Equilibrium Quality – It corresponds to the equilibrium price in the marketplace.