Class 12 Economics Notes Chapter 5 (Market equilibrium) – Introduction MicroEconomics Book

Detailed Notes with MCQs of Chapter 5: Market Equilibrium from your Microeconomics textbook. This is a crucial chapter, forming the basis of how prices and quantities are determined in a market economy, and it frequently appears in government exams. Pay close attention to the concepts and their implications.

Market Equilibrium: Detailed Notes

1. What is a Market?

• A market is a system or arrangement where buyers (consumers) and sellers (producers) of a commodity interact to determine its price and quantity exchanged.
• It doesn't necessarily refer to a physical place but the mechanism of interaction.

2. Equilibrium: The Balancing Point

• Definition: Equilibrium, in the context of a market, refers to a state of balance where the quantity demanded (Qd) of a commodity equals the quantity supplied (Qs) of that commodity.
• At this point, there is no tendency for the price or quantity to change, assuming other factors remain constant (ceteris paribus).
• Condition: Market Equilibrium occurs when Qd = Qs.

3. Equilibrium Price and Quantity

• Equilibrium Price (Pe): The price at which quantity demanded equals quantity supplied. It's the price that clears the market.
• Equilibrium Quantity (Qe): The quantity of the commodity bought and sold at the equilibrium price.

4. How Equilibrium is Reached: The Market Mechanism

• The market reaches equilibrium through the interaction of demand and supply forces, often referred to as the 'invisible hand'.
• Disequilibrium Situations:
  • Excess Demand (Shortage):
    • Condition: Occurs when the market price (P) is below the equilibrium price (P < Pe).
    • Result: Quantity demanded (Qd) exceeds quantity supplied (Qs) (Qd > Qs).
    • Market Response: Buyers compete to purchase the limited goods, putting upward pressure on the price. As the price rises, Qd falls (law of demand) and Qs rises (law of supply). This continues until Qd = Qs at Pe.
    • Formula: Excess Demand = Qd - Qs (at P < Pe)
  • Excess Supply (Surplus):
    • Condition: Occurs when the market price (P) is above the equilibrium price (P > Pe).
    • Result: Quantity supplied (Qs) exceeds quantity demanded (Qd) (Qs > Qd).
    • Market Response: Sellers compete to sell their excess stock, putting downward pressure on the price. As the price falls, Qd rises and Qs falls. This continues until Qd = Qs at Pe.
    • Formula: Excess Supply = Qs - Qd (at P > Pe)

5. Effects of Shifts in Demand and Supply on Equilibrium

• Changes in factors other than the price of the commodity cause shifts in the demand or supply curves, leading to a new equilibrium.

  • Shift in Demand (Supply Constant):

    • Increase in Demand (Rightward Shift): Leads to a rise in both Equilibrium Price (Pe ↑) and Equilibrium Quantity (Qe ↑). (Reason: At the old price, there's excess demand).
    • Decrease in Demand (Leftward Shift): Leads to a fall in both Equilibrium Price (Pe ↓) and Equilibrium Quantity (Qe ↓). (Reason: At the old price, there's excess supply).

  • Shift in Supply (Demand Constant):

    • Increase in Supply (Rightward Shift): Leads to a fall in Equilibrium Price (Pe ↓) and a rise in Equilibrium Quantity (Qe ↑). (Reason: At the old price, there's excess supply).
    • Decrease in Supply (Leftward Shift): Leads to a rise in Equilibrium Price (Pe ↑) and a fall in Equilibrium Quantity (Qe ↓). (Reason: At the old price, there's excess demand).

  • Simultaneous Shifts in Demand and Supply: The final impact on Pe and Qe depends on the magnitude of the shifts.

    • Both Demand and Supply Increase: Qe definitely increases (Qe ↑). Pe may increase, decrease, or remain unchanged (Pe is indeterminate).
    • Both Demand and Supply Decrease: Qe definitely decreases (Qe ↓). Pe may increase, decrease, or remain unchanged (Pe is indeterminate).
    • Demand Increases, Supply Decreases: Pe definitely increases (Pe ↑). Qe may increase, decrease, or remain unchanged (Qe is indeterminate).
    • Demand Decreases, Supply Increases: Pe definitely decreases (Pe ↓). Qe may increase, decrease, or remain unchanged (Qe is indeterminate).
      (For exams, remember the definite changes and that one variable is often indeterminate in simultaneous shifts unless specific magnitudes are given).

6. Market Equilibrium under Perfect Competition

• The standard model of market equilibrium assumes perfect competition:
  • Large number of buyers and sellers.
  • Homogeneous product.
  • Free entry and exit of firms.
  • Perfect knowledge among buyers and sellers.
  • No government intervention (initially).
• In this market, individual buyers or sellers cannot influence the price; they are price-takers.

7. Applications: Price Controls (Government Intervention)

• Sometimes governments intervene when they feel the equilibrium price is either too high for consumers or too low for producers.

  • Price Ceiling (Maximum Price):

    • Definition: A legal maximum price that sellers can charge for a good or service.
    • Purpose: To protect consumers, usually imposed on essential commodities (e.g., wheat, sugar, rent control).
    • Condition: To be effective, the price ceiling must be set below the equilibrium price (Pceiling < Pe).
    • Consequences:
      • Shortages (Persistent Excess Demand): As the price is artificially low, Qd > Qs.
      • Rationing: Government may need to ration the limited supply.
      • Black Markets: Goods may be sold illegally at prices higher than the ceiling price.
      • Lower quality of goods/services.

  • Price Floor (Minimum Price):

    • Definition: A legal minimum price that buyers must pay for a good or service.
    • Purpose: To protect producers, ensuring they get a minimum income (e.g., Minimum Support Price (MSP) for agricultural crops, minimum wage laws).
    • Condition: To be effective, the price floor must be set above the equilibrium price (Pfloor > Pe).
    • Consequences:
      • Surpluses (Persistent Excess Supply): As the price is artificially high, Qs > Qd.
      • Government Purchase: The government often has to buy the surplus stock (creating buffer stocks) to maintain the floor price, which involves costs.
      • Inefficiency and misallocation of resources.
      • Potential for illegal sales below the floor price.

Multiple Choice Questions (MCQs)

1. Market equilibrium is achieved when:
   a) Quantity demanded is greater than quantity supplied.
   b) Quantity supplied is greater than quantity demanded.
   c) Quantity demanded equals quantity supplied.
   d) Demand equals supply.

2. If the market price is below the equilibrium price, there will be:
   a) Excess supply
   b) Surplus
   c) Shortage
   d) Equilibrium

3. An increase in the demand for a commodity, keeping supply constant, will lead to:
   a) A decrease in equilibrium price and quantity.
   b) An increase in equilibrium price and quantity.
   c) An increase in equilibrium price and a decrease in equilibrium quantity.
   d) A decrease in equilibrium price and an increase in equilibrium quantity.

4. A decrease in the supply of a commodity, keeping demand constant, will lead to:
   a) A decrease in equilibrium price and quantity.
   b) An increase in equilibrium price and quantity.
   c) An increase in equilibrium price and a decrease in equilibrium quantity.
   d) A decrease in equilibrium price and an increase in equilibrium quantity.

5. A price ceiling set below the equilibrium price typically results in:
   a) A surplus of the commodity.
   b) A shortage of the commodity.
   c) An increase in the quality of the commodity.
   d) The market clearing price being established.

6. A price floor set above the equilibrium price typically results in:
   a) A shortage of the commodity.
   b) A surplus of the commodity.
   c) Increased demand for the commodity.
   d) Black marketing.

7. If both demand and supply for a good increase simultaneously, what is the definite impact on the equilibrium?
   a) Equilibrium price will increase.
   b) Equilibrium price will decrease.
   c) Equilibrium quantity will increase.
   d) Equilibrium quantity will decrease.

8. The price at which quantity demanded equals quantity supplied is known as:
   a) Floor Price
   b) Ceiling Price
   c) Equilibrium Price
   d) Market Price

9. What is the primary purpose of imposing a Minimum Support Price (MSP) on agricultural products?
   a) To ensure consumers get goods at low prices.
   b) To create shortages in the market.
   c) To protect farmers from sharp falls in income.
   d) To encourage exports.

10. When excess demand exists in the market, the price tends to:
    a) Fall
    b) Rise
    c) Remain constant
    d) Fluctuate randomly

Answers to MCQs:

1. c) Quantity demanded equals quantity supplied.
2. c) Shortage
3. b) An increase in equilibrium price and quantity.
4. c) An increase in equilibrium price and a decrease in equilibrium quantity.
5. b) A shortage of the commodity.
6. b) A surplus of the commodity.
7. c) Equilibrium quantity will increase.
8. c) Equilibrium Price
9. c) To protect farmers from sharp falls in income.
10. b) Rise

Make sure you understand the reasoning behind each point and the consequences of shifts and price controls. This chapter is fundamental for understanding how markets operate. Revise these notes thoroughly for your exam preparation.