Market Equilibrium and Simple Applications

About this unit

This unit brings demand and supply together. It shows how the market price and quantity are set, what happens when the market is not in equilibrium, and how shifts in demand or supply change the outcome. It also covers what happens when firms can enter and exit freely, and uses the same tools to study government controls on prices, such as price ceilings and price floors.

Key ideas

• Equilibrium where market demand equals market supply.
• Excess demand raises price; excess supply lowers price.
• Effects of shifts in demand and supply, singly and together.
• With free entry and exit, long-run price equals minimum average cost.
• Price ceiling (maximum price) and its results: shortage, rationing, black markets.
• Price floor (minimum price) and its results: surplus, government purchase.

How to prepare

Practise solving linear demand and supply equations for equilibrium price and quantity. Draw the shift diagrams for each case and learn which results are definite and which are indeterminate when both curves shift. Link price ceilings to fair price shops and price floors to minimum support prices.