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MARKET EQUILIBRIUM & GOVERNMENT INTERVENTION
CHAPTER 4
Chapter 4 ::: MARKET EQUILIBRIUM AND GOVERNMENT INTERVENTION
DEFINITION OF MARKET EQUILIBRIUM
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Condition when the quantity demanded equals the quantity supplied  DD = SS. Thus there is no tendency to price
and quantity to change.
When supply and demand come together, we get conflict. The amazing thing is that this conflict is resolved
harmoniously. Though buyers want to buy a lot at low prices and sellers only want to sell a lot at high prices, the
market reconciles these different desires.
The interaction of supply and demand determines an equilibrium price: a stable price. Both buyers and sellers realize
they have no real control over the price.
Buyers look at the price and decide how much to buy. Sellers look at the price and decide how much to sell.
The result? Buyers find they can buy what they want to buy and sellers discover they can sell what they want to sell.
This will only be true at the equilibrium price.
DETERMINATION OF MARKET EQUILIBRIUM PRICE
The
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Quantity
demanded
700
500
350
200
Price for
shoes (RM)
4
8
12
16
Quantity
supplied
100
200
350
500
100
20
550
supply and demand curve in the market
No tendency for Price and Quantity to change
Price and Quantity are stable
Shortage takes place when demand exceeds supply
When the price increase, Qd decrease but the Qs increase
Surplus is a condition when supply exceeds demand.
When the price decrease, Qd increase but the Qs decrease
EXCESS IN DEMAND AND SUPPLY
i. Excess in Demand (shortage)
 Shortage is the differences between the quantity demanded and the quantity supplied in a market where
quantity demanded is greater than quantity supplied (Qd > Qs).
 Based on the above table, at the price RM 4, the demand for shoes are 700 units. But the supplier just can
produce only for 100 units. There is a shortage of 600 units (700-100) of shoes.
 Thus, the buyers will compete amongst themselves for the limited quantity.
 The sellers who recognize the high demand among the buyers will see the opportunity to increase their prices.
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MARKET EQUILIBRIUM & GOVERNMENT INTERVENTION
CHAPTER 4
 As the prices rises, the quantity demanded by buyers declines (following the law of demand) and the quantity
supplied by sellers increases (following the law of supply) until it reaches an equilibrium where there is no
shortage.
ii. Excess in Supply (surplus)
 Surplus is a difference between the quantity demanded and the quantity supplied in a market where the quantity
supplied is greater than the quantity demanded (Qs > Qd).
 As the above table, at the price RM 20, the quantity supply for shoes are greater than quantity demanded. Thus,
there is a surplus of 450 units of shoes (550- 100).
 As a surplus exists, the sellers will compete amongst them to sell their products by cutting down their prices and
the price declines.
 When the price falls, the Qd by buyers increases and the Qs decreases until it reaches an equilibrium where the
surplus is no longer exists.
EFFECTS OF A CHANGE IN DEMAND AND SUPPLY ON THE EQUILIBRIUM PRICES
i.
Effects the changes in Demand on the market equilibrium.
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ii.
Dd increase, Ss constant
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Dd decrease, Ss constant
Effects the changes of Supply on the market equilibrium.
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Ss increase, Dd constant
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Ss decrease, Dd constant
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MARKET EQUILIBRIUM & GOVERNMENT INTERVENTION
iii.
CHAPTER 4
Simultaneous change in demand and supply.
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Dd increase = Ss increase
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Dd decrease = Ss decrease
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Dd increase = Ss decrease
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Dd decrease = Ss increase
GOVERNMENT INTERVENTION IN THE MARKET
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When government set the prices in the market, there will be an implication on the market equilibrium price, quantity,
supply and demand.
Two types of government are:
 Tax and subsidy
 Price control (Price floor- minimum price) & (Price ceiling- maximum price)
TAX AND SUBSIDY
I. TAX
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Two types of tax
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MARKET EQUILIBRIUM & GOVERNMENT INTERVENTION
CHAPTER 4
Indirect taxes
 The imposition of indirect tax will cause the producer to reduce the supply
 Supply curve will shift to left
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How much the price will increase, quantity will decrease and how much that tax is actually borne by the producer
and buyers depend on the relative price elasticity of demand of the product.
a)
If demand more elastic than supply. (substitute goods)
Assume government imposed tax about RM 5. The producer
will reduce the quantity supply by shifting the supply curve
to the left. P0 = 10, PT = 11, Q0 = 100, QT = 80.
Producer’s share of tax = P X Q
=
=
Consumer’s share of tax = P X Q
=
=
Revenue collected by govt =
b)
If demand less elastic than supply. (necessity goods)
Assume government imposed tax about RM 1. The producer
will reduce the quantity supply by shifting the supply curve
to the left. P0 = 3, PT = 3.60, Q0 = 100, QT = 95.
Producer’s share of tax = P X Q
=
=
Consumer’s share of tax = P X Q
=
=
Revenue collected by govt =
II.
SUBSIDY
Producer Subsidies
 The aim of a producer subsidy is to increase the domestic production of a good.
 An incentive from the government to encourages producers to produce more.
 Given a subsidy:
 Producer will increase the supply, supply curve will shift right, the price will decrease and the quantity will increase
 Price would be low
 Local producers can compete with the outsiders
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MARKET EQUILIBRIUM & GOVERNMENT INTERVENTION
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CHAPTER 4
Also based on the price elasticity of demand:
a)
If the demand more elastic than supply
Assume subsidy given by the government is about RM 1.
The producer will increase the quantity supply by shifting
the supply curve to the right. P0 = 3, PB = 2.60, Q0 = 100,
QB = 150.
Producer’s enjoy =
Consumer’s enjoy =
b)
If the demand less elastic than supply
Assume subsidy given by the government is about RM 2.
The producer will increase the quantity supply by shifting
the supply curve to the right. P0 = 5, PB = 3.5, Q0 = 80,
QB = 100.
Producer’s enjoy =
Consumer’s enjoy =
PRICE CONTROL
 Another way government can interfere the market by controlling price of certain good and services
 Determine by government regulation
 Government control the price when the price is extremely lower and extremely higher
 Two ways that government can protect the producers and consumers:
 Minimum price (price floor)
 Imposed by the government when the price of the certain goods and services are extremely lower.
 Imposed on:
i.
The agricultural products
- Where the price control is to protect the farmers from getting lower prices in a free market.
- Eg: price of paddy. When the harvest season, the supply curve will become higher and increase the supply
curve. The supply curve will shift to the right from S0 to S1 and equilibrium price and quantity also
changed from E0 to E1 and from P0 to P1, Q 0 to Q1. But the price changes are too low. Therefore, the
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MARKET EQUILIBRIUM & GOVERNMENT INTERVENTION
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government have to intervene to set the control price at a minimum price which at P 2. At the new price
P2, the supply exceeds demand and create a problem surplus (excess stock) which at (A – B). the
government will buy that surplus and by this way the price are not allowed to turn down only at P2 but
cannot lower than P2.
ii.
Minimum wage rate
- The minimum wage rate is the lowest wage paid by employers to workers to protect them from
exploitations.
- Has the potential to reduce the poverty by increasing wages paid to low skilled labor.
- Eg: labor for rubber industry
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Advantages
- The incomes of producers are protected as the government buys up all the surplus goods and services.
- The government will store this surplus for the future use.
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Disadvantages
- Prices are higher than the equilibrium price under the price floor.
- Consumers have to pay more
- Surplus will occur and the government need to purchases of all the surpluses.
- Wastage of resources
- Unemployment occurs since the wage paid rates are higher since the employers are going to supply the
workers who are willing to be paid for the low income rates.
 Maximum price (price ceiling)
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i.
Imposed by the government when the price is extremely high i.e imposed during eid seasons, inflation, and
war.
Example:
Eid season
- During eid seasons, the prices of essential commodities such as rice, sugar, cooking oil etc are most likely to
increase due to the increment of demand. When the demand increase, the demand curve shift to the right
from D0 to D1 and the prices also increase from P0 to P1. However, the increment of the prices are too
higher and that is why the government should intervene imposes a ceiling price on these. The government
just can reduce the price only at P2. Thus, the producers are not allowed to increase over the P2. At a new
price P2, demand is greater than supply and it creates shortage where people are encouraged to pay more.
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ii.
Monthly housing rental
- The control of housing rental is referred to as rent control.
- Rent control is exercised in the major cities in Malaysia in order to help people in the lower income groups
own houses. The government controls the price of low costs houses. Current market price for low cost
houses is now at between RM 42001 to RM 60000.
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Advantages
- Consumers can buy at lower prices
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Disadvantages
- Creates shortages that will lead to black marketeering.
- Due to the shortages, customers willing to pay higher prices to get that goods.
- The reduction productions from the producers since the prices are being reduced.
- Producers tend to receive illegal payments like bribery from consumers.
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