Chapter 5: Market Equilibrium

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.

Solution coming soon.

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 = VMP_L

Where,

W = Wage rate

VMP_L = Value of Marginal Product of Labour

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.

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.