NCERT Class 12 Economics Market Equilibrium

This chapter will be built on the foundation laid down in Chapters 2 and 4 where we studied the consumer and firm behaviour when they are price takers. In Chapter 2, we have seen that an individual’s demand curve for a commodity tells us what quantity a consumer is willing to buy at different prices when he takes price as given. The market demand curve in turn tells us how much of the commodity all the consumers taken together are willing to purchase at different prices when everyone takes price as given. In Chapter 4, we have seen that an individual firm’s supply curve tells us the quantity of the commodity that a profit-maximising firm would wish to sell at different prices when it takes price as given and the market supply curve tells us how much of the commodity all the firms taken together would wish to supply at different prices when each firm takes price as given.
In this chapter, we combine both consumers’ and firms’ behaviour to study market equilibrium through demand-supply analysis and determine at what price equilibrium will be attained. We also examine the effects of demand and supply shifts on equilibrium. At the end of the chapter, we will look at some of the applications of demand-supply analysis.

EQUILIBRIUM, EXCESS DEMAND, EXCESS SUPPLY

A perfectly competitive market consists of buyers and sellers who are driven by their self-interested objectives. Recall from Chapters 2 and 4 that objectives of the consumers are to maximise their respective preference and that of the firms are to maximise their respective profits. Both the consumers’ and firms’ objectives are compatible in the equilibrium.  An equilibrium is defined as a situation where the plans of all consumers and firms in the market match and the market clears. In equilibrium, the aggregate quantity that all firms wish to sell equals the quantity that all the consumers in the market wish to buy; in other words, market supply equals market demand. The price at which equilibrium is reached is called equilibrium price and the quantity bought and sold at this price is called equilibrium quantity. Therefore, (p*, q*) is an equilibrium if

qD(p∗) = qS(p∗)

where p∗ denotes the equilibrium price and qD(p∗) and qS(p∗) denote the market demand and market supply of the commodity respectively at price p∗. If at a price, market supply is greater than market demand, we say that there is an excess supply in the market at that price and if market demand exceeds market supply at a price, it is said that excess demand exists in the market at that price. Therefore, equilibrium in a perfectly competitive market can be defined alternatively as zero excess demand-zero excess supply situation. Whenever market supply is not equal to market demand, and hence the market is not in equilibrium, there will be a tendency for the price to change. In the next two sections, we will try to understand what drives this change.

Excercise

1. Explain market equilibrium.
2. When do we say there is excess demand for a commodity in the market?
3. When do we say there is excess supply for a commodity in the market?
4. What will happen if the price prevailing in the market is
(i) above the equilibrium price?
(ii) below the equilibrium price?
5. Explain how price is determined in a perfectly competitive market with fixed number of firms.
6. Suppose the price at which equilibrium is attained in exercise 5 is above the minimum average cost of the firms constituting the market. Now if we allow for free entry and exit of firms, how will the market price adjust to it?
7. At what level of price do the firms in a perfectly competitive market supply when free entry and exit is allowed in the market? How is equilibrium quantity determined in such a market?
8. How is the equilibrium number of firms determined in a market where entry and exit is permitted?
9. How are equilibrium price and quantity affected when income of the consumers

(a) increase? (b) decrease?
10. 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.

Please refer to attached file for NCERT Class 12 Economics Market Equilibrium