The document discusses market equilibrium and how it is achieved through the interaction of supply and demand. It defines market equilibrium as the point where supply and demand curves intersect, with no tendency for prices or quantities to change. Disequilibrium can result in surpluses or shortages. The market makes adjustments through shifts in supply and demand. Government can interfere through price ceilings, floors, taxes, and subsidies, which shift supply curves and potentially create black markets.

1. Unit 5
Market and Market Equilibrium
Objectives:
After going through this unit, you will be able to explain:
Interaction of demand and supply curves.
Concept of market and market equilibrium.
What causes disequilibrium in the market?
Various market adjustments.
Concept of surplus and shortage in the market.
What happens in the market when government intervenes?
Structure:
1.1 Introduction
1.2 Market Equilibrium
1.3 Adjustments in the market
1.4 Government interference with market equilibrium
1.5 Summary
1.6 Key words
1.7 Self-assessment questions
1.1 Introduction
Market has assumed substantial in modern market and global economies. Understanding
the concept of market becomes absolutely imperative. Infact, understanding markets is
the first step in analyzing it. In economics, a market is primarily understood as a
mechanism which allows people to trade, normally governed by the theory of supply and
demand, allocating resources through a price mechanism and matching, so that those
willing to pay a price for something meet those willing to sell for it. It is network which

2. because of advancements in modern technology can be real or virtual, by way of which
buyers and sellers interact to exchange goods and services for money. Markets perform
the vital economic function of bringing buyers and sellers together through the price
mechanism.
1.2 Market Equilibrium
Equilibrium is understood as a situation in which competing forces balance with each
other. In the market buyers and sellers may have competing objectives where buyers aim
to maximize value for their money and sellers maximize profits. Economics helps us
understand how they arrive at equilibrium. It defines market equilibrium as follows,
The point at which the demand and the supply curve intersect and the buyers and
sellers expectations match for trade to take place.
Market equilibrium is, hence, state of equilibrium that exists when the disparate market
forces of demand and supply exactly counterbalance each other and there is no innate
tendency for change. Consider the following figure,
In a price or market system, supply and demand together will determine the prices at
which transaction or exchanges will take place. Once achieved, market equilibrium
persists unless or until an outside force disrupts it. Market equilibrium is indicated by

3. equilibrium price and equilibrium quantity. When the equilibrium is disturbed there can
be two situations:
a) Shortage - A situation where quantity demanded is in excess of quantity supplied.
b) Surplus – A situation where quantity supplied is in excess of quantity demanded.
The following figure shows surplus and shortage situations in the market.
Quantit
y Supply
Demand
Surplus
Equilibrium
Shortage
Quantity
0
The above figure shows, the surplus situation when supply exceeds demand, and shortage
situation when demand exceeds supply. Either of these situations is a movement away
from equilibrium and is called a disequilibrium situation in the market.
1.3 Adjustments in the Market
We have already analyzed in detail various factors that cause demand and supply to
change in the market. The economic analysis of the changes in market equilibrium is
caused by changes in the demand determinants and supply determinants.

4. The demand curve and the supply curve are the two curves that comprise the market,
each of which can increase or decrease causing adjustments in the market. These
adjustments come in eight varieties. Four involve a shift of either the demand curve or the
supply curve. The other four involve a shift of both the demand curve and the supply
curve. Consider the following table which show shifts in demand and supply and
consequent adjustments and impact on the market equilibrium.
Diagram Change in Change in Impact on market equilibrium
number Demand Supply
1 Increase No change Price increases; Quantity increases
2 Decrease No change Price decreases; Quantity decreases
3. No change Increase Price decreases; Quantity increases
4 No change Decrease Price increases; Quantity decreases
5 Increase Increase Price decreases; Quantity increases
6 Increase Decrease Price increases; Quantity increases
7 Decrease Increase Price decreases; Quantity decreases
8. Decrease Decrease Price increases; Quantity decreases
This table is further exhibited through the following diagrams:

5. 1 2
4
3
5
6
7 8

6. 1.4 Government interference with market equilibrium
Governments the world over interfere with the market mechanism in some or the other
way. Such interference can be subtle or indirect on one hand, or outright or direct on the
other hand. The underlying objectives could be socio-economic in nature, such as,
a) To keep a low price in the market in favor of the consumer
b) To maintain certain income levels for the sellers
c) Price stability
Some direct forms of interference which are discussed below may greatly affect the
equilibrium price and quantity in the market. Consider some cases:
a) Price ceilings: Government sometimes, imposes a price ceiling - a price is fixed
at a level lower than the equilibrium price. The objective could be to enable
product affordability to the masses. Sometimes prices of some products are kept
artificially low through a ceiling because if the prices were allowed to rise it
would lead to cascading effect in the economy.
Price
D S
P e
P1
Q1 Q Q2 Quantity
In the above diagram, at equilibrium ‘e’, market price is P and quantity bought
and sold is Q. A price ceiling at price P1 lower than the equilibrium price creates
market demand Q2 in excess of market supply Q1.

7. b) Price Floors: Sometimes in order to protect the seller and assure him of some
minimum income, government fixes a price floor, which is a price higher than the
equilibrium price. The price in the market is not allowed to fall below the floor
price. This strategy is popular particularly for agricultural prices which have a
tendency to fall after a bumper harvest. The situation is explained through the
following diagram:
Price
D S
P1
P
e
Q1 Q Q2 Quantity
In the above figure, at equilibrium ‘e’, market price is P and quantity bought and
sold is Q. A price floor at price P1 higher than the equilibrium price creates
market supply Q2 in excess of market demand Q1.
c) Taxes and subsidies: Taxes and subsidies imposed by government also influence
the equilibrium in the market. We have already discussed that taxes increase the
cost of production and shift the supply curve leftwards while subsidies acting as a
negative tax shift the supply curve leftwards. This is shown in the following set of
diagrams. Consider first the effect of the tax:

8. Price
S1
D S
P1 e’
P
e
Q1 Q Quantity
In the above figure, D is the demand curve and S is the supply curve which intersect
at equilibrium ‘e’, market price is P and quantity bought and sold is Q. After the tax
the supply curve shifts leftwards to S1. The new equilibrium point is e’, the
equilibrium price is higher at P1 and quantity bought and sold is lesser at Q1.
Consider the following diagram that shows the effect of subsidies:

9. Price
S
D
S1
P
e
P1 e
Q Q1 Quantity
In the above figure, D is the demand curve and S is the supply curve which
intersect at equilibrium ‘e’, market price is P and quantity bought and sold is Q.
After the subsidy the supply curve shifts rightwards to S1. The new equilibrium
point is e’, the equilibrium price is lower at P1 and quantity bought and sold is
higher at Q1.
d) Existence of Black Markets: Whenever there is government intervention to fix
prices that are too high or too low, it means that there is another price at which the
buyers and sellers are willing to trade. Such a situation has the tendency to create
“black markets”, where people begin to make illegal arrangements to circumvent
the fixed prices.
1.5 Summary
In this unit we have learnt that markets arrive at equilibrium as a result of the forces of
demand and supply. Changes in demand and supply, forces adjustments in the market.
The result could also be creation of shortages or surplus in the market. Government
interference with equilibrium prices is likely to influence the movements of the supply
curve and in some situations create a parallel market.

10. 1.6 Key words
a) Equilibrium: A situation in which competing forces balance with each other.
b) Market equilibrium: The point at which the demand and the supply curve
intersect and the buyers and sellers expectations match for trade to take place.
c) Shortage: A situation where quantity demanded is in excess of quantity supplied.
d) Surplus : A situation where quantity supplied is in excess of quantity demanded.
e) Price ceiling: A price is fixed at a level lower than the equilibrium price.
f) Price floor: A price which is higher than the equilibrium price.
g) Black market: A parallel, illegal market where buyers and sellers are willing to
trade for a price which is higher or lower than the price fixed by the government.
1.7 Self-assessment questions
1. Explain the term market equilibrium.
2. Show through neatly labeled, well indexed diagrams what happens in the market
when:
a) Supply increases
b) Demand decreases
c) Supply decreases
d) Demand increases
3. Explain the following diagram and highlight the following:
a) Equilibrium point
b) Shortages and surplus

11. 4. Write a short note on government interference in the market.
5. In economics, a market is primarily understood as a mechanism which allows
people to
a) Trade
b) Talk
c) Watch
d) None of the above
6. Markets perform the vital economic function of bringing buyers and sellers
together through the,
a) Price mechanism
b) Quantity mechanism
c) Share mechanism
d) None of the above
7. In economics, a market is primarily understood as a mechanism which allows
people to trade
a) True
b) False
c) Can’t say
d) None of the above
8. Governments the world over interfere with the market mechanism in some or the
other way in order to
a) Keep a low price in the market in favor of the consumer
b) Maintain certain income levels for the sellers
c) Maintain price stability
d) None of the above
9. Fill in the blanks:
a) Markets perform the vital economic function of bringing
____________and____________ together..
b) Equilibrium is understood as a situation in which competing forces
____________with each other.

12. c) When the equilibrium is disturbed there can be two situations:
____________and ____________
d) The ____________curve and the____________ curve are the two curves
that comprise the market.
e) Government sometimes, imposes a ____________- a price is fixed at a
level lower than the equilibrium price.
f) Sometimes in order to protect the seller and assure him of some minimum
income, government fixes a____________, which is a price higher than
the equilibrium price.
g) Taxes increase the cost of production and shift the supply
curve____________ while subsidies acting as a negative tax shift the
supply curve ____________.
h) In a “black markets”, people begin to make ____________arrangements to
circumvent the fixed____________.