NCERT Solutions for class 12th Economics Part A Chapter 5 Market Equilibrium

NCERT Textbook Question Solved

Question 1. Explain market equilibrium.

Ans. Market Equilibrium is achieved at a point where quantity demanded is equal to quantity supplied. This is called market equilibrium. There is neither excess nor shortage of demand and supply in the market. If at a price the market demand is not equal to market supply there will be either excess demand or excess supply and the price will have tendency to change until it settles once again at a point where market demand equals market supply. A demand and supply schedule and curve will show the determination of equilibrium price.

In the table, demand and supply of the commodity at different prices are shown. The equilibrium price is fixed at rs. 8 where the quantity demanded and the quantity supplied are equal, i.e., equal to 30 units. The following figure shows the market equilibrium.

Question 2. When do we say there is excess demand for a commodity in the market?

Ans. When the quantity demanded is more than the quantity supplied, it is called excess demand. It is shown with the help of the following schedule and diagram

At 1st and 2nd unit, there is excess demand as the quantity demanded is more than the quantity supplied. It happens when the market price is less than I equilibrium price. It is shown below:

Question 3. When do we say there is excess supply for a commodity in the market?

Ans. When the quantity supplied is more than the quantity demanded, it is called excess supply. It is shown with the help of the following schedule and diagram.

At 3rd and 4th units, there is excess supply as the quantity supplied is more than the quantity demanded. It happens when the market price is less than I equilibrium price.

Question 4. What will happen if the price prevailing in the market is
(i) Above the equilibrium price?
(ii) Below the equilibrium price?

Ans. (i) Above the equilibrium price: When market price is above the equilibrium price there is excess supply.

  1. Due to excess supply there is surplus in the market. It leads to increased competition amongst sellers.
  2. In this increased competition, they get ready to sell at a lower price.
  3. When price is lowered supply contracts and demand expands.
  4. Equilibrium is regained

(ii) Below the equilibrium price: When market price is above the equilibrium price there is excess supply.

  1. Due to excess demand there is shortage in the market. It leads t increased competition amongst buyers.
  2. In this increased competition, they get ready to buy at a higher price.
  3. When price is increased supply expands and demand contracts.
  4. Equilibrium is regained

Question 5. Explain how price is determined in a perfectly competitive market with fixed number of firms.

Ans. Equilibrium for a perfectly competitive market with a fixed number of firms is attained with the intersection of demand and supply curve. SS denotes the market supply curve and DD denotes the market demand curve for a commodity. The market supply curve SS shows how much of the commodity firms would wish to supply at different prices, and the demand curve DD tells us how much of the commodity, the consumers would be willing to purchase at different prices.

Graphically, an equilibrium is a point where the market supply curve intersects the market demand curve because this is where the market demand equals market supply. At any other point, either there is excess supply or excess demand. It is shown in the figure given below:

Question 6. 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?

Ans. If we allow for free entry and exit of firms, there will be an increase in supply and the supply curve will shift rightwards. With the increase in supply, the equilibrium price will fall and the equilibrium quantity will increase. It will happen until the industry reaches at normal profits. It is shown with the help of the following diagram:

Question 7. Suppose the price at which equilibrium is attained in exercise 6 is above the average variable cost of firms constituting the market. Now if we allow for free entry and exit for firms, how will the market price adjust to it?

Ans. If the market price is above the average cost of the firms, it means they are earning supernormal profits. It will attract new forms to enter the market. Entry of new firms will reduce the market price and the price will fall until it becomes equal to a minimum of AC. Before it was as follows:

With the entry of new firms supply increased and the equilibrium price fell with fall in price all firms reached at a level of normal profits only as shown below:

Question 8. 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?

Ans. The assumption of fixed number of firms implies that in equilibrium no firm earns supernormal profit or incurs loss by remaining in production; in other words, the equilibrium price will be equal to the minimum average cost of the firms To see why it is so, suppose, at the prevailing market price, each firm is earning supernormal profit. The possibility of earning supernormal profit will attract some new firms which will lead to a reduction in the supernormal profit and eventually supernormal profit will be wiped out when there is a sufficient number of firms. At this point, with all firms in the market earning normal profit, no more firms will have incentive to enter.

Similarly, if the firms are earning less than normal profit at the prevailing price, some firms will exit which will lead to an increase in profit, and with sufficient number of firms, the profits of each firm will increase to the level of normal profit. At this point, no more firms will want to leave since they will be earning normal profit here. Thus, with free entry and exit, each firm will always earn normal profit at the prevailing market price. Therefore, free entry and exit of the firms imply that the market price will always be equal to the minimum average cost, that is p = min AC

Question 9. How is the equilibrium number of firms determined where free entry and exit is allowed?

Ans. If free entry and exit is allowed then the equilibrium number of firms is determined by using the following formula.
X/Xf
Where X is market equilibrium quantity Xf is the equilibrium quantity of each firm.

Question 10. How are equilibrium price and quantity affected when income of the consumers
(a) Increase? (b) Decrease?

Ans. Normal Goods: When there is an increase in income, demand also increases in the case of normal goods. With the increase in demand, the equilibrium price and the equilibrium quantity will also increase. It is shown in Figure 1. In case of a decrease in income, there will be a decrease in demand. With the decrease in demand, there will be a decrease in equilibrium price and equilibrium quantity as shown in Figure 2.

(ii) Inferior Goods: When there is an increase in income, demand decreases in the case of inferior goods. With the decrease in demand, the equilibrium price and equilibrium quantity will also decrease. It is shown in Figure 1. In case of an increase in income, there will be an increase in demand. With the increase in demand, there will be an increase in equilibrium price and equilibrium quantity as shown in Figure 2.

Question 11. 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.

Ans. Shoes and socks are complementary goods and there is an inverse relation between price and demand of complementary goods. Therefore, if there is an increase in the price of shoes, demand for socks will decrease and its demand curve will shift leftward. Accordingly, its equilibrium price and equilibrium quantity will decrease.

Question 12. How will a change in the price of coffee affect the equilibrium price of tea? Explain the effect on equilibrium quantity also through a diagram.

Ans. Tea and coffee are substitute goods. With the increase in the price of coffee, demand for tea will increase and therefore demand curve will shift rightward. Accordingly, the equilibrium price and equilibrium quantity will increase as shown below:

On the other hand, if price of coffee falls, demand for tea decreases and accordingly demand curve shifts leftward and equilibrium price and equilibrium quantity also fall as shown below:

Question 13. How do the equilibrium price and quantity of a commodity change when price of input used in its production changes?

Ans. Case I: When Price of Input Increases: With the increase in the price of input, the cost of production increases. With the increase in cost of production, supply decreases and there is excess demand or shortage. It increases competition among buyers. They get ready to pay a higher price. At higher prices, demand contracts and supply expands and equilibrium is regained at higher prices and lower quantities as shown in the figure given below:

Case II: When Price of Input Decreases: With the decrease in the price of input, cost of production decreases. With the decrease in cost of production, supply increases and there is excess supply. It increases competition among sellers. They get ready to sell at a lower price. At lower price, demand expands and supply contracts and equilibrium is regained at lower price and higher quantity as shown in the figure given below:

Question 14. 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?

Ans. With the increase in price of y, demand for X will increase and therefore demand curve will shift rightward. Accordingly, the equilibrium price and the equilibrium quantity will increase as shown below:

On the other hand, if the price of Y falls, demand for X decreases and accordingly demand curve shifts leftward and the equilibrium price and equilibrium quantity also fall as shown below:

Question 15. Compare the effect of the shift in the demand curve on the equilibrium when the number of firms in the market is fixed with the situation when entry-exit is permitted.

Ans. Equilibrium for a perfectly competitive market with a fixed number of firms is attained with the intersection of demand and supply curve. SS denotes the market supply curve and DD denotes the market demand curve for a commodity. The market supply curve SS shows how much of the commodity firms would wish to supply at different prices, and the demand curve DD tells us how much of the commodity, the consumers would be willing to purchase at different prices.

Graphically, an equilibrium is a point where the market supply curve intersects the market demand curve because this is where the market demand equals market supply. At any other point, either there is excess supply or excess demand.

The assumption of fixed number of firms implies that in equilibrium no firm earns super normal profit or incurs loss by remaining in production; in other words, the equilibrium price will be equal to the minimum average cost of the firms To see why it is so, suppose, at the prevailing market price, each firm is earning supernormal profit. The possibility of earning supernormal profit will attract some new firms which will lead to a reduction in the supernormal profit and eventually supernormal profit will be wiped out when there is a sufficient number of firms. At this point, with all firms in the market earning normal profit, no more firms will have incentive to enter.

Similarly, if the firms are earning less than normal profit at the prevailing price, some firms will exit which will lead to an increase in profit, and with sufficient number of firms, the profits of each firm will increase to the level of normal profit. At this point, no more firms will want to leave since they will be earning normal profit ere. Thus, with free entry and exit, each firm will always earn normal profit at the prevailing market price. Therefore, free entry and exit of the firms imply that the market price will always be equal to the minimum average cost, that is
p = min AC

Question 16. Explain through a diagram the effect of a rightward shift of both the demand and supply curves on equilibrium price and quantity.

Ans. (i) Increase in both demand and supply:
(a) If both demand and supply increase equally, there will be no change in equilibrium price but equilibrium quantity will increase as shown in the figure given below. It is so because the effect of an increase in demand and an increase in supply is in opposite directions and it balances each other. Equilibrium quantity will increase.

(b) If the increase in demand is greater than the increase in supply, the equilibrium price will increase and the equilibrium quantity will also increase as shown by the figure given below. It is so because when an increase in demand is greater than the increase in supply, the effect of an increase in demand dominates.

(c) If the increase in supply is more than an increase in demand, the equilibrium price will decrease and the equilibrium quantity will increase as shown by the figure given below. It is so because when an increase in supply is greater than an increase in demand, the effect of an increase in supply dominates.

Question 17. 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?

Ans. (ii) Both demand and supply curves shift in the same direction
(a) If both demand and supply decrease equally, there will be no change in equilibrium price but equilibrium quantity will decrease as shown in the figure given below. It is so because both affect equilibrium prices in opposite directions and hence their effect gets neutral.

(b) If the decrease in demand is more than a decrease in supply, equilibrium price will decrease and equilibrium quantity will also decrease as shown in figure given below. It is so because if decrease in demand is more than decrease in supply, the effect of decrease in demand dominates.

(c) If decrease in supply is more than decrease in demand, equilibrium price will increase and equilibrium quantity will decrease as shown in figure given below. It is so because if decrease in supply is more than decrease in demand, the effect of decrease in supply dominates.

(iii) Demand and supply curves shift in opposite directions.
Demand Decreases and Supply Increases:

(a) When decrease in demand is equal to increase in supply, equilibrium quantity remains the same but equilibrium price falls as shown in the figure.

(b) When decrease in demand is more than increase in supply, then both equilibrium quantity and price as shown in the figure.

(c) When decrease in demand is less than increase in supply, equilibrium quantity rises but equilibrium price falls as shown in the figure.

Demand Increases and Supply Decreases:

(a) When increase in demand is equal to decrease in supply, equilibrium quantity remains the same at OQ, but equilibrium price rises as shown in the figure.

(b) When increase in demand is more than decrease in supply, both equilibrium quantity and price rises as shown in the figure.

(c) When increase in demand is less than decrease in supply, both equilibrium quantity falls and price rises as shown in the figure.

Question 18. In what respect do the supply and demand curves in the labour market differ from those in the goods market?

Question 19. How is the optimal amount of labour determined in a perfectly competitive market?
Note:
No answers required as Q. Nos. 18 & 19 are not in course now.

Question 20. How is the wage rate determined in a perfectly competitive labour market?

Ans. The equilibrium wage rate in the industry is set by the meeting point of the industry supply and industry demand curves.

  • In a competitive market firms are wage takers because if they set lower wages workers would not accept the wage.
  • Therefore they have to set the equilibrium wage We.
  • Because firms are wages takers the supply curve of labour is perfectly elastic therefore AC = MC
  • The firm will maximize profits by employing at Q1 where MRP of Labour = MC of Labour

Question 21. Can you think of any commodity on which price ceiling is imposed in India? What may be the consequence of price ceiling?

Ans. In India, there are many goods on which government has imposed price ceiling, in order to keep them available within the reach of the BPL (below poverty lime) people. These goods are kerosene, sugar, wheat, rice, etc.

The following are the consequences of price ceiling:

(1) Excess demand−Due to artificially imposed price, cutting lower than the equilibrium price leads to the emergence of the problem of excess demand.
(2) Fixed Quota − Each consumer gets a fixed quantity of good (as per the quota). The quantity often falls short of meeting the individual’s requirements. This further leads to the problem of shortage and the consumer remains unsatisfied.
(3) Inferior goods−Often it has been found that the goods that are rationed are usually inferior goods and are adulterated.
(4) Black marketing−The needs of a consumer remains unfulfilled as per the quota laid by the government. Consequently, some of the unsatisfied consumers get ready to pay higher price for the additional quantity. This leads to black-marketing and artificial shortage in the market.

Question 22. 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.

Ans. Figure given below depicts both the cases when the number of firms is fixed (in short run) and when the number of firms is not fixed (in long run). P = min AC represents the long run price line; D1D1 and D2D2 represents the demand in the short run and the long run respectively. The point E1 represents the initial equilibrium, where the demand and the supply intersect each other.

Let us suppose that the demand curve shifts, assuming that the number of firms is fixed. Now, the new equilibrium will be at ES (as it is short run equilibrium),where the supply curve and the demand curve D2D2 intersect each other. The equilibrium price is Ps and equilibrium quantity is qs.

On the other hand, under the assumption of free entry and exit, an increase in demand will shift the demand curve rightwards to D2D2. The new equilibrium will be at E2(as it is a long run equilibrium) with the equilibrium price P = min AC and equilibrium quantity ql.Therefore, on comparing both the cases, we find that when the firms are given the freedom of entry and exit, the equilibrium price remains the same. The price is lower than that of the short run equilibrium price (Ps ); whereas, the long run equilibrium quantity (ql) is more than that of the short run equilibrium quantity (qs).

Similarly, for the leftward demand shift, it can be found that the short run equilibrium price (P s ) is lower than the long run equilibrium price and the short run equilibrium quantity (qs) in less than the long run equilibrium quantity (ql).

Question 23. Suppose the demand and supply curve of commodity
X in a perfectly competitive market are given by: qD = 700 – p
qS = 500 + 3p for p ≥ 15 = 0 for 0 ≤ p < 15
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 rs.15. What will be the equilibrium price for this commodity? At equilibrium, what quantity of X will be produced?

Ans. At any price less than 15, its marginal cost also is not getting covered and therefore, he will shut down at a price less than rs.15. Therefore, at a price less than this, supply is equal to zero.
To be in equilibrium,
Qd = Qs
qD = 700 – p
qS = 500 + 3p
700 – p = 500 + 3p
4p = 200
P = 50 rupees
Equilibrium quantity can be obtained by placing the value of equilibrium rice in Qd or Qs Equilibrium quantity = 700 – 50 = 650 units.

Question 24. 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 qS f = 8 + 3p for p ≥ 20 = 0 for 0 ≤ p < 20

(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.

Ans. (a) P = 20 is the minimum of average cost below which price will not be accepted by the firms.

(b) Firm will be in equilibrium when price is equal to rs. 20 because there is free entry and exit of firms. In case there are losses, some firms will exit the market and price will rise to such level that it becomes equal to rs. 20 i.e. minimum of AC. On the other hand, if there are super normal profits, more firms will be attracted leading to increase in supply. It will cause prices to fall and therefore once again price will be equal to ` 20 i.e. minimum of AC.

(c) Equilibrium Quantity = 8 + 3 (20)
8 + 60 = 68
Qd = 700-p
700 – 20
680
Therefore, equilibrium number of firms =

Question 25. Suppose the demand and supply curves of salt are given by: qD = 1,000 – p
qS = 700 + 2p

(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 qS= 400 + 2p How does the equilibrium price and quantity change? Does the change conform to your expectation?
(c) Suppose the government has imposed a tax of Rs 3 per unit of sale of salt.How does it affect the equilibrium price and quantity?

Ans. (a) To be in equilibrium,
Qd = Qs
qD = 1000 – p
qS = 700 + 2p
1000 – p = 700 +2p
3p = 300
P = 100 rupees
Equilibrium quantity can be obtained by placing the value of equilibrium rice in Qd or Qs
Equilibrium quantity = 1000-100 = 900 units.

(b) To be in equilibrium, new supply should be equal to demand, therefore,
1000 – p = 400 +2p
3p = 600
P = 200 rupees
Equilibrium quantity can be obtained by placing the value of equilibrium price in Qd or Qs.
Equilibrium quantity = 1000 – 200 = 800 units.

(c) If the government has imposed a tax of Rs, it will decrease the demand and equilibrium price will increase as shown below:

Question 26. 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 apartment?

Ans. There will be excess demand for apartments and it will create a shortage and black marketing i.e. charging a rent higher than what has been fixed by the government. It is shown with the help of the diagram given below in which DD is the demand curve and SS is the supply curve. These curves intersect each other at rs.3000 but the government has fixed a price of ` 2000 therefore demand for apartments is 40 while supply is only 20 leading to a shortage of 20 apartments.

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