<h5 id="51-equllibrium-excess-demand-excess-supply">5.1 Equllibrium, Excess Demand, Excess Supply</h5> <ul> <li>A perfectly competitive market is in equilibrium when the plans of all consumers and firms match and the market clears.</li> <li>Equilibrium price and quantity are denoted by $p^{<em>}$ and $q^{</em>}$ respectively, where market supply equals market demand: $ q^{D}\left(p^{<em>}\right)=q^{S}\left(p^{</em>}\right) $.</li> <li>Excess supply occurs when market supply is greater than market demand at a given price, and excess demand exists if market demand exceeds market supply at a given price.</li> <li>Equilibrium in a perfectly competitive market can be defined as a zero excess demand-zero excess supply situation.</li> <li>The ‘Invisible Hand’ in a perfectly competitive market adjusts prices in response to excess demand or excess supply, driving the market toward equilibrium.</li> </ul> <p>======</p> <h5 id="511-market-equilibrium-fixed-number-of-firms">5.1.1 Market Equilibrium: Fixed Number of Firms</h5> <ul> <li>The equilibrium price and quantity are determined by the intersection of demand and supply curves.</li> <li>A rightward shift in both demand and supply curves leads to an increase in equilibrium quantity and no change in equilibrium price.</li> <li>A rightward shift in supply curve and a leftward shift in demand curve result in the same equilibrium quantity but a lower equilibrium price.</li> <li>The shifts in the curves are represented in Figure 5.4(a) and Figure 5.4(b).</li> <li>The concepts of simultaneous shifts in demand and supply are illustrated, with the rest left as exercises for the readers.</li> </ul> <p>======</p> <h5 id="512-market-equilibrium-free-entry-and-exit">5.1.2 Market Equilibrium: Free Entry and Exit</h5> <ul> <li>The market equilibrium with free entry and exit of firms implies that the market price will always be equal to the minimum average cost of the firms.</li> <li>With free entry and exit, if the price is greater than the minimum average cost, new firms will enter the market, and at prices below minimum average cost, existing firms will start exiting.</li> <li>At the price level equal to the minimum average cost of the firms, each firm will earn normal profit so that no new firm will be attracted to enter the market, and the existing firms will not leave the market.</li> <li>The equilibrium quantity is determined at the intersection of the market demand curve with the price line p=min AC.</li> <li>With shifts in demand, under free entry and exit, the market will always supply the desired quantity at the same price, i.e., the minimum average cost of the existing firms.</li> </ul> <p>======</p> <h5 id="52-applications">5.2 Applications</h5> <ul> <li>The text discusses the application of supply-demand analysis, focusing on government intervention through price control.</li> <li>Price control regulations are implemented when the prices of certain goods and services are not at desired levels.</li> <li>The text uses perfect competition as a framework to analyze the impact of these regulations.</li> <li>Two examples of government intervention are discussed.</li> <li>The analysis is centered on understanding the effects of these interventions on the market for the regulated goods.</li> </ul> <p>======</p> <h5 id="521-price-ceiling">5.2.1 Price Ceiling</h5> <ul> <li>Price ceiling is the maximum price set by the government for certain goods or services, usually necessary items.</li> <li>Imposing a price ceiling below the market-determined price results in an excess demand in the market.</li> <li>When the government sets a price ceiling (p_c) for wheat, there is an excess demand for wheat at that price, as consumers demand q_c kilograms and firms supply q_c’.</li> <li>To distribute the quantity of wheat among consumers, rationing can be implemented through the issuance of ration coupons and selling the stipulated amount of wheat in ration shops or fair price shops.</li> <li>Adverse consequences of price ceiling accompanied by rationing may include long queues for consumers and the creation of black markets due to consumers willing to pay higher prices for the goods.</li> </ul> <p>======</p> <h5 id="522-price-floor">5.2.2 Price Floor</h5> <ul> <li>Price floor is the minimum price set by the government for certain goods and services.</li> <li>It is implemented in agricultural price support programs and minimum wage legislation.</li> <li>The imposition of a price floor higher than the equilibrium price leads to excess supply.</li> <li>At the price floor, the quantity demanded by consumers is less than the quantity supplied by producers.</li> <li>In agricultural support, the government buys the surplus at the predetermined price to prevent the price from falling.</li> </ul> <p>======</p>