Class | Subject | Book | Chapter | Session | Questions covered |
|---|---|---|---|---|---|
XII | Economics | Microeconomics (NCERT) | 5 – Market Equilibrium | 2026-27 | 25 of 25 |
Chapter at a glance
Concept | Key point |
|---|---|
Equilibrium | Market demand = market supply; no excess demand or supply |
Excess demand / supply | At price below / above equilibrium; price rises / falls (invisible hand) |
Fixed number of firms | Equilibrium where market demand meets market supply; shifts of D and S change both price and quantity |
Free entry and exit | Long-run price = minimum AC; demand shifts change quantity and number of firms, not price |
Simultaneous shifts | Same direction: quantity certain, price ambiguous; opposite directions: price certain, quantity ambiguous |
Labour market | Demand by firms ( for competitive firms); supply by households; wage where they are equal  |
Price ceiling | Maximum price below equilibrium → excess demand, rationing, black market |
Price floor | Minimum price above equilibrium (MSP, minimum wage) → excess supply |
Exercises
Explain market equilibrium.
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Market equilibrium is the situation in which the plans of all consumers and firms in the market match – market demand equals market supply. The price at which this happens is the equilibrium price () and the quantity is the equilibrium quantity ():
At this price there is no excess demand or excess supply, so there is no tendency for the price to change.
Market equilibrium is where market demand equals market supply; the price and quantity at that point are the equilibrium price and quantity, with no tendency to change.
When do we say there is excess demand for a commodity in the market?
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There is excess demand when, at the prevailing price, market demand is greater than market supply – i.e. when the price is below the equilibrium price: .
When market demand exceeds market supply at the prevailing price (price below equilibrium).
When do we say there is excess supply for a commodity in the market?
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There is excess supply when, at the prevailing price, market supply is greater than market demand – i.e. when the price is above the equilibrium price: .
When market supply exceeds market demand at the prevailing price (price above equilibrium).
What will happen if the price prevailing in the market is (i) above the equilibrium price? (ii) below the equilibrium price?
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(i) Above equilibrium – there is excess supply. Firms cannot sell all they want, so competition among sellers pushes the price down. As price falls, demand rises and supply falls until equilibrium is restored.
(ii) Below equilibrium – there is excess demand. Some consumers cannot get the good, so competition among buyers pushes the price up. As price rises, demand falls and supply rises until equilibrium is restored.
This adjustment is called the working of the “invisible hand”.
- Excess supply makes the price fall until equilibrium; (ii) excess demand makes the price rise until equilibrium.
Explain how price is determined in a perfectly competitive market with fixed number of firms.
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With a fixed number of firms, the market supply curve is the horizontal sum of the supply curves of the firms (upward sloping), and the market demand curve is the horizontal sum of consumers’ demand (downward sloping). The equilibrium price is determined where the two curves intersect: .
- If the price is above , excess supply pushes it down.
- If the price is below , excess demand pushes it up.
E.g. with and : , .
The price is determined where the downward-sloping market demand curve meets the upward-sloping market supply curve (sum of the fixed firms’ supplies); excess supply or demand moves the price to this level.
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?
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If the price is above the minimum AC, existing firms earn supernormal (positive) profits. With free entry, new firms enter the market, attracted by the profits. Market supply increases (the supply curve shifts right), and the price falls. Entry continues until the price falls to the minimum average cost, where firms earn only normal profit (zero economic profit).
Firms earn supernormal profits, so new firms enter; market supply rises and price falls until it equals minimum average cost (normal profit only).
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?
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With free entry and exit, firms supply at a price equal to the minimum average cost (). At any higher price, firms enter; at any lower price, firms exit.
The equilibrium quantity is determined by the market demand at that price: . The supply curve is effectively horizontal at .
Firms supply at price = minimum average cost; the equilibrium quantity is the quantity demanded at that price.
How is the equilibrium number of firms determined in a market where entry and exit is permitted?
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At the equilibrium price , each firm supplies the output at which its MC = (the output at minimum AC). The market quantity is . The equilibrium number of firms is
Number of firms = market demand at the price equal to minimum AC ÷ output of each firm at that price.
How are equilibrium price and quantity affected when income of the consumers (a) increase? (b) decrease?
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(a) Income increases
- Normal good: demand rises, so the demand curve shifts right → equilibrium price and quantity both rise.
- Inferior good: demand falls → price and quantity both fall.
(b) Income decreases
- Normal good: demand falls (the curve shifts left) → price and quantity both fall.
- Inferior good: demand rises → price and quantity both rise.
(With a fixed number of firms. With free entry and exit, price stays at minimum AC and only quantity changes.)
For a normal good, a rise in income raises both equilibrium price and quantity and a fall lowers both; for an inferior good the effects are reversed.
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.
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Shoes and socks are complements. A rise in the price of shoes reduces the demand for shoes, and hence the demand for socks falls. The demand curve for socks shifts left from D to D′. With supply unchanged, the equilibrium moves from E to E′: the price of socks falls and the quantity bought and sold falls.
Since shoes and socks are complements, demand for socks falls (D shifts left), so both the price of socks and the number of pairs bought and sold fall.
How will a change in price of coffee affect the equilibrium price of tea? Explain the effect on equilibrium quantity also through a diagram.
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Tea and coffee are substitutes. If the price of coffee rises, consumers switch to tea, so the demand for tea rises – the demand curve shifts right from D to D′. With supply unchanged, both the equilibrium price and quantity of tea rise (E to E′). If the price of coffee falls, the opposite happens.
A rise in the price of coffee (a substitute) raises demand for tea, so both the equilibrium price and quantity of tea rise (a fall in coffee’s price lowers both).
How do the equilibrium price and quantity of a commodity change when price of input used in its production changes?
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- Input price rises → cost of production rises → supply decreases (the supply curve shifts left) → equilibrium price rises and quantity falls.
- Input price falls → supply increases (the curve shifts right) → equilibrium price falls and quantity rises.
A rise in input price shifts supply left, raising price and lowering quantity; a fall in input price does the opposite.
If the price of a substitute (Y) of good X increases, what impact does it have on the equilibrium price and quantity of good X?
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When the price of substitute Y rises, consumers shift to X, so demand for X increases – the demand curve shifts right. With supply unchanged, the equilibrium price and quantity of X both increase.
Demand for X rises, so both its equilibrium price and quantity increase.
Compare the effect of shift in demand curve on the equilibrium when the number of firms in the market is fixed with the situation when entry-exit is permitted.
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Basis | Fixed number of firms | Free entry and exit |
|---|---|---|
Supply curve | Upward sloping | Horizontal at minimum AC |
Effect of rise in demand on price | Price rises | Price unchanged (= minimum AC) |
Effect on quantity | Quantity rises (less) | Quantity rises (more) |
Number of firms | Unchanged | Increases |
Effect of fall in demand | Price and quantity fall | Price unchanged; quantity and number of firms fall |
So a demand shift affects price and quantity with a fixed number of firms, but only quantity and the number of firms (by a larger amount) under free entry and exit.
With fixed firms, a demand shift changes both price and quantity; with free entry and exit, price stays at minimum AC and the shift changes only quantity (by a larger amount) and the number of firms.
Explain through a diagram the effect of a rightward shift of both the demand and supply curves on equilibrium price and quantity.
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When both demand and supply increase (shift right), the equilibrium quantity definitely increases. The effect on price depends on the relative size of the shifts:
- shift in demand = shift in supply → price unchanged (shown in the figure, E to E′);
- shift in demand > shift in supply → price rises;
- shift in demand < shift in supply → price falls.
Equilibrium quantity rises for sure; price rises, falls or stays the same depending on whether demand shifts more than, less than or equal to supply.
How are the equilibrium price and quantity affected when (a) both demand and supply curves shift in the same direction? (b) demand and supply curves shift in opposite directions?
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(a) Same direction
- Both increase → quantity rises; price may rise, fall or stay unchanged.
- Both decrease → quantity falls; price indeterminate.
In both cases the effect on quantity is definite; the effect on price depends on the magnitude of the shifts.
(b) Opposite directions
- Demand increases, supply decreases → price rises; quantity may rise, fall or stay unchanged.
- Demand decreases, supply increases → price falls; quantity indeterminate.
In both cases the effect on price is definite; the effect on quantity depends on the magnitude of the shifts.
- Same direction: quantity changes in that direction while price is ambiguous; (b) opposite directions: price moves in the direction of the demand shift while quantity is ambiguous.
In what respect do the supply and demand curves in the labour market differ from those in the goods market?
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Basis | Goods market | Labour market |
|---|---|---|
Demand comes from | Households (consumers) | Firms (derived demand – labour is demanded to produce goods) |
Supply comes from | Firms | Households (who supply labour) |
Basis of demand | Utility from goods | Value of marginal product of labour ()  |
Basis of supply | Cost of production | Labour–leisure choice (households weigh wage against leisure) |
So the roles of households and firms are reversed in the labour market.
In the labour market, demand comes from firms (derived from the output labour produces) and supply from households (labour–leisure choice) – the reverse of the goods market.
How is the optimal amount of labour determined in a perfectly competitive market?
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A profit-maximising firm hires labour up to the point where the extra revenue from the last worker equals the extra cost (the wage). In a perfectly competitive market, the extra revenue is the value of marginal product: (= marginal revenue product, since MR = p).
- If , hiring one more worker adds to profit → hire more.
- If , the last worker costs more than he adds → hire fewer.
Since diminishes, is downward sloping; it is the firm’s demand curve for labour.
The firm hires labour until the wage equals the value of the marginal product of labour (w = p × MP_L).
How is the wage rate determined in a perfectly competitive labour market?
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The wage rate is determined by the intersection of the market demand curve for labour (sum of firms’ curves – downward sloping) and the market supply curve of labour (sum of households’ labour supply – upward sloping). At the equilibrium wage , the quantity of labour demanded equals the quantity supplied. If the wage is above , there is excess supply of labour (wage falls); if below, excess demand (wage rises).
The wage rate is set where the market demand for labour (based on VMP_L) equals the market supply of labour.
Can you think of any commodity on which price ceiling is imposed in India? What may be the consequence of price-ceiling?
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Examples: wheat, rice, sugar and kerosene sold through the Public Distribution System (ration shops); LPG cylinders (earlier); essential medicines under price control (DPCO); rent control in some cities.
Consequences of a price ceiling (below equilibrium price):
- Excess demand (shortage) – quantity demanded exceeds quantity supplied.
- Rationing – the government issues ration cards; each household gets a fixed quantity.
- Long queues and waiting.
- Black market – some sellers sell at higher prices illegally.
- Poor quality – sellers may reduce quality.
- Supply may fall as producers have less incentive.
Price ceilings apply to PDS items (wheat, rice, sugar, kerosene) and controlled medicines; they cause excess demand, rationing, queues, black markets and possibly poorer quality or lower supply.
A shift in demand curve has a larger effect on price and smaller effect on quantity when the number of firms is fixed compared to the situation when free entry and exit is permitted. Explain.
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- Fixed number of firms: the market supply curve is upward sloping. When demand increases, part of the extra demand is met by a rise in price (which raises output of existing firms) and only part by more output. So price rises and quantity rises less.
- Free entry and exit: the supply curve is horizontal at minimum AC. When demand increases, new firms enter and supply expands until price returns to minimum AC. So price does not change, and the whole increase in demand is met by a larger increase in quantity.
Hence the price effect is larger and the quantity effect smaller with a fixed number of firms.
With fixed firms, supply is upward sloping, so a demand shift is absorbed partly by price; with free entry the supply curve is horizontal at minimum AC, so price stays unchanged and quantity changes by the full amount.
Suppose the demand and supply curve of commodity X in a perfectly competitive market are given by: ; for , for . Assume that the market consists of identical firms. Identify the reason behind the market supply of commodity X being zero at any price less than ₹ 15. What will be the equilibrium price for this commodity? At equilibrium, what quantity of X will be produced?
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Reason for zero supply below ₹ 15: ₹ 15 is the minimum average variable cost (shut-down price) of the identical firms. Below it, firms cannot cover their variable costs, so they produce nothing.
Equilibrium: (≥ 15, valid).
Quantity: units.
Supply is zero below ₹ 15 because that is the firms’ minimum AVC (shut-down point); equilibrium price = ₹ 50 and quantity = 650 units.
Considering the same demand curve as in exercise 22, now let us allow for free entry and exit of the firms producing commodity X. Also assume the market consists of identical firms producing commodity X. Let the supply curve of a single firm be explained as for , for . (a) What is the significance of p = 20? (b) At what price will the market for X be in equilibrium? State the reason for your answer. (c) Calculate the equilibrium quantity and number of firms.
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(a) ₹ 20 is the minimum average cost of each firm (the long-run shut-down point). Below it the firm makes losses and supplies nothing.
(b) With free entry and exit, the equilibrium price equals minimum average cost = ₹ 20. If the price were higher, firms would earn supernormal profits and new firms would enter; if lower, firms would exit.
(c) Market quantity: units. Each firm’s output at : . Number of firms .
- ₹ 20 is the firms’ minimum average cost; (b) equilibrium price = ₹ 20, since free entry and exit drive price to minimum AC; (c) equilibrium quantity = 680 units, produced by 10 firms of 68 units each.
Suppose the demand and supply curves of salt are given by: , . (a) Find the equilibrium price and quantity. (b) Now suppose that the price of an input used to produce salt has increased so that the new supply curve is . How does the equilibrium price and quantity change? Does the change conform to your expectation? (c) Suppose the government has imposed a tax of ₹ 3 per unit of sale of salt. How does it affect the equilibrium price and quantity?
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(a) ; .
(b) ; . Price rises and quantity falls – this conforms to expectation, since a rise in input price reduces supply (the curve shifts left).
(c) With a tax of ₹ 3 per unit (on the original supply curve), sellers receive , so supply becomes . ; . Consumers pay ₹ 102 (₹ 2 more) and producers receive ₹ 99 (₹ 1 less); quantity falls by 2 units. (If the tax is applied to the supply curve of part (b): , .)
- p* = ₹ 100, q* = 900; (b) p* = ₹ 200, q* = 800 – price rises and quantity falls, as expected; (c) the tax raises the price to ₹ 102 and lowers quantity to 898.
Suppose the market determined rent for apartments is too high for common people to afford. If the government comes forward to help those seeking apartments on rent by imposing control on rent, what impact will it have on the market for apartments?
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Rent control is a price ceiling – a maximum rent fixed below the equilibrium rent. Its effects:
- Excess demand (shortage) of apartments – more people want to rent at the lower rent, but fewer apartments are offered.
- Reduced supply – landlords find renting less profitable; fewer new apartments are built; some convert to other uses.
- Poor maintenance – landlords spend less on repairs, so quality deteriorates.
- Black market / side payments – tenants may pay “pagdi” or key money illegally.
- Discrimination and long waiting – landlords choose tenants arbitrarily.
- Tenants who already have apartments benefit; newcomers find it hard to get one.
So while rent control aims to help common people, it creates a shortage and other distortions.
Rent control is a price ceiling below the equilibrium rent; it creates excess demand (shortage), reduces supply and maintenance, and encourages black-market payments and discrimination, even though existing tenants pay less.
Topic checklist
- ☒ Equilibrium, excess demand and supply (Q 1–5)
- ☒ Free entry and exit, number of firms (Q 6–8, 14, 21, 23)
- ☒ Shifts in demand and supply (Q 9–13, 15, 16, 24)
- ☒ Labour market (Q 17–19)
- ☒ Price ceiling and price floor (Q 20, 25)
- ☒ Numerical equilibrium problems (Q 22–24)