Market equilibrium refers to that point which has come to be established under a given condition of demand and supply and has a tendency to stick to that level, i.e. where Demand = Supply.
If due to some disturbance we divert from our position the economic forces will work in such a manner that it could be driven back to its original position, i.e., where Demand = Supply. In short it is the position of rest.
It can be explained with the help of following schedule and diagram:

(a) • In the below schedule market equilibrium is determined at Price 3 where Market demand is equal to Market Supply.

• At price 1 and 2, there is excess demand, which leads to rise in price, resulting tendency is expansion in supply.

• Similarly, at price 4 and 5, there is excess supply, which leads to fall in price, resulting tendency is Contraction in supply.

(b) • In the given diagram, price is measured on vertical axis, whereas quantity demanded and supply is measured on horizontal axis.

• Suppose that initially the price in the market is P1. At this price, the consumer demand P1B and the producer supply P1A, i.e. consumers want more than what the producer are willing to supply. There is excess demand equal to AB. So, price cannot stay on P1 as excess demand will create competition among the buyers and push the price up till we reach equilibrium. Due to rise in price from P1 to P, there is upward movement along the supply curve (expansion in supply) from A to E and upward movement along the demand curve (contraction in demand) from B to E.

• Similarly, at price P2, the quantity demanded P2K is less than the quantity supplied P2L. There is excess supply, equal to KL, which will create competition among the sellers and lower the price. The price will keep falling as long as there is an excess supply.

Due to fall in price from P2 to P there is downward movement along the supply curve (contraction in supply) from L to E and downward movement along the demand curve (expansion in demand) from K to E.

• The situation of zero excess demand and zero excess supply defines market equilibrium (E). Alternatively, it is defined by the equality between quantity demanded and quantity supplied. The price P is called equilibrium price and quantity Q is called equilibrium quantity.

Question - 3 : - When do we say there is excess demand for a commodity in the market?

Answer - 3 : - When Market price is below the equilibrium price, then at that given price, demand is greater than supply, which leads to excess demand.

Question - 4 : - When do you say there is excess supply for a commodity in the market?

Answer - 4 : - When Market price is above the equilibrium price, then at that given price, demand is lesser than supply, which leads to excess supply.

Question - 5 : -
How are equilibrium price and quantity affected when income of the consumers

Increase?
Decrease?

Answer - 5 : -

1. Increase in Income: When income increases, demand curve will shift to rightward in case of Normal good as shown below:

(a) As, we know normal goods are those whose quantity demanded varies positively with the change in income. As income of a consumer rises and goods consumed is normal goods equilibrium price and equilibrium quantity both rise. It can be shown with the help of the given figure.

(b) In the given figure, price of normal goods is measured on vertical axis and quantity demanded and supplied are measured on horizontal axis. Initially, the equilibrium price is OP and equilibrium quantity is OQ.

(c) But as given in the examination problem when income of a consumer rises the demand of normal goods increases shifting the demand curve to the right from DD to D1D1.

(d) With new demand curve DJDJ, there is excess demand at initial price OP because at price OP demand is PB and supply is PA; so there is excess demand of AB at price OP.

(e) Due to this excess demand, competition among the consumer will raise the price. With the rise in price there is upward movement along the demand curve (contraction in demand) from B to C and similarly, there is upward movement along the supply curve (expansion in supply) from A to C . So, finally, equilibrium price rises from OP to OPi; and equilibrium quantity also rises from OQ to OQr

Conclusion

Due to increase in income of a buyer

for normal goods,

(a) Equilibrium price rises from OP to OP1.

(b) Equilibrium quantity also rises from OQ to OQ1.

2. Decrease in income: When income decreases, demand curve will shift to leftward in case of Normal good as shown below:

(a) As we know that normal goods are those whose quantity demanded varies positively with the change in income. As given in the examination problem if income of a consumer falls and goods consumed is normal goods, then both equilibrium price and the equilibrium quantity fall. It can be shown with the help of the given figure.

(b) In the given figure price of normal goods is measured on vertical axis and quantity demanded and supplied is measured on horizontal axis. Initially, the equilibrium price is OP and equilibrium quantity is OQ.

(c) But as given in the examination problem when income of a consumer falls the demand of normal goods also falls shifting the demand curve to the left from

DD to D1D1.

(d) With new demand curve D1D1 there is excess supply at initial price OP because at price OP demand is PB and supply is PA; so there is excess supply of AB at price OP.

(e) Due to this excess supply competition among the producer will fall the price. Due to fall in price there is downward movement along the demand curve (Expansion in demand) from B to C and similarly, there is downward movement along the supply curve (Contraction in supply) from A to C. So, finally, the equilibrium price falls from OP to OP1 and equilibrium quantity also falls from OQ to OQ1

Conclusion

Due to decrease in income of a buyer for normal goods,

Equilibrium price falls from OP to OP1.
Equilibrium quantity also falls from OQ to OQ1.

Question - 6 : - Using supply and demand curves, show how an increase in the price of shoes affects the price of a pair of socks and the number of pairs of socks bought and sold.

Answer - 6 : -

As we know, shoes and pair of socks are complementary good to each other. As, price of complementary goods are inversely related with the demand of given commodity. So, rise in price of shoes (complementary good) decreases the demand for given commodity (pair of socks), and demand curve shifts leftward as shown in given figure:

In the given diagram, price is on vertical axis and quantity demanded and supplied is on horizontal axis. Initially, the equilibrium price is OP and equilibrium quantity is OQ.
But due to rise in price of complementary good the demand curve of given commodity shifts leftward from DD to D1D1.
With new demand curve D1D1 there is excess supply at initial price OP because at price OP demand is PB and supply is PA; so, there is excess supply of AB at price OP.
Due to this excess supply, competition among the producer will fall the price. Due to fall in price, there is downward movement along the demand curve (Expansion in demand) from B to C and similarly there is downward movement along the supply curve (Contraction in supply) from A to C. So, finally, the equilibrium price falls from OP to OP1 and equilibrium quantity also falls from OQ to OQ1 So, due to rise in price of complementary goods,

(a) Equilibrium price falls from OP to OP1 and

(b) Equilibrium quantity also falls from OQ to OQ1

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Chapter 12 Market Equilibrium with Simple Applications Solutions

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