📌 Snapshot
- How demand and supply fix price and quantity, and what shifts, entry and exit or price controls do to them.
- Why a market drifts to equilibrium from either side, solved with schedules and equations you can redo in the exam.
- Shifts of demand and supply, alone and together, and why free entry and exit pins the price at minimum average cost.
- Price ceiling and price floor with worked numbers, plus the labour market and the traps NTA sets on all of it.
📖 Detailed Notes
Written and reviewed by Devendra Dubey, Mathematics & Commerce faculty at UniDrill (M.Sc. Mathematics, Osmania University · 10 years teaching). Based on NCERT Economics Class XII (Introductory Microeconomics), Chapter 5.
Who sets the price of a kilogram of wheat?
Nobody, and everybody. No farmer decides it and no shopper decides it. Yet on any given day the wheat in your town sells at roughly one price, and that price changes when the monsoon fails or when incomes rise. This chapter explains that quiet process. Chapter 2 gave us how buyers behave (the demand curve) and Chapter 4 gave us how sellers behave (the supply curve). Here we put the two on the same page and ask where they agree.
Equilibrium, excess demand and excess supply
In a perfectly competitive market every buyer is trying to get the most satisfaction and every firm is trying to make the most profit. An equilibrium is a situation where the plans of all buyers and firms match, so the market clears: the quantity firms wish to sell equals the quantity buyers wish to buy.
$$q_D(p^{\ast}) = q_S(p^{\ast})$$
The price at which this happens is the equilibrium price $p^{\ast}$ and the quantity traded is the equilibrium quantity $q^{\ast}$. If at some price supply is greater than demand there is excess supply; if demand is greater than supply there is excess demand. Equilibrium is the price with zero excess demand and zero excess supply.
Why the market moves there. From the time of Adam Smith it has been argued that an "Invisible Hand" changes the price whenever there is an imbalance: it raises the price when there is excess demand and lowers it when there is excess supply. Think of a half empty mandi in the evening. Sellers with unsold stock cut their price rather than carry it home, which also tempts more buyers. Think of a crowded queue for scarce sugar: some buyers will pay a little more to get served, which pushes the price up.
| Market price | Quantity demanded vs supplied | What happens next |
|---|---|---|
| Below the equilibrium price | Demand exceeds supply: excess demand | Unserved buyers offer more; price rises; quantity demanded falls and quantity supplied rises |
| At the equilibrium price | Demand equals supply | No pressure to change: the market clears |
| Above the equilibrium price | Supply exceeds demand: excess supply | Unsold sellers cut price; price falls; quantity demanded rises and quantity supplied falls |
On a graph with price on the vertical axis and quantity on the horizontal axis, the demand curve DD slopes downward and the supply curve SS slopes upward. Equilibrium is the single point where they cross. At a price below that point, the supply curve lies to the left of the demand curve, and the gap between them is excess demand. Above that point the supply curve lies to the right, and the gap is excess supply.
Worked example: equilibrium from equations. The market for wheat has demand $q_D = 120 - 2p$ and supply $q_S = 30 + p$, with quantity in kg and price in ₹ per kg. Find the equilibrium and the excess demand at ₹20.
| Step | What we do | Result |
|---|---|---|
| 1 | Equilibrium means $q_D = q_S$ | $120 - 2p = 30 + p$ |
| 2 | Collect the $p$ terms | $90 = 3p$ |
| 3 | Solve for the price | $p^{\ast} = 30$ |
| 4 | Put the price in either curve | $q^{\ast} = 120 - 60 = 60$ kg (check: $30 + 30 = 60$) |
| 5 | Excess demand at ₹20 | $q_D = 80$, $q_S = 50$, so excess demand is 30 kg |
Excess demand in general: $ED(p) = q_D - q_S = (120 - 2p) - (30 + p) = 90 - 3p$. It is positive for any price below ₹30 and negative (that is, excess supply of $3p - 90$) for any price above ₹30.
| Price (₹ per kg) | Quantity demanded (kg) | Quantity supplied (kg) | Position |
|---|---|---|---|
| 10 | 100 | 40 | Excess demand 60 |
| 20 | 80 | 50 | Excess demand 30 |
| 30 | 60 | 60 | Equilibrium |
| 40 | 40 | 70 | Excess supply 30 |
| 50 | 20 | 80 | Excess supply 60 |
Common wrong step. Stopping at $p^{\ast} = 30$ and writing 30 as the answer to "equilibrium quantity", or setting the two curves equal and then substituting into only one of them with an arithmetic slip. Always substitute into both curves; they must give the same quantity.
Pause and predict: wheat is selling at ₹40 in the table above. Who is unhappy, and which way does the price move?
Check your answer: Sellers. They want to sell 70 kg but buyers will take only 40 kg, so 30 kg is unsold. Sellers will lower their price, and the price keeps falling until it reaches ₹30, where both sides want 60 kg.
Beyond the textbook. For the exam: the market reaches equilibrium because the Invisible Hand moves the price in the right direction. In reality: adjustment takes time. When tomatoes arrive in a glut, the wholesale price falls within days. But farmers only respond with smaller sowings the next season, and by then the shortage may have pushed the price up. Prices in real markets overshoot and swing around equilibrium rather than landing on it instantly.
The labour market in brief
The same demand and supply logic fixes the wage rate, but the roles are reversed: households supply labour (in hours of work) and firms demand it.
Demand for labour. A profit-maximising competitive firm keeps hiring labour until the cost of one more unit equals what it brings in. The extra cost is the wage $w$. The extra revenue is the marginal revenue product of labour: the extra output from one more worker (MPL) times the marginal revenue from selling it (MR).
$$w = \text{MRPL}, \qquad \text{MRPL} = \text{MR} \times \text{MPL}$$
A competitive firm has MR equal to the price, so here MRPL equals the value of marginal product of labour, $\text{VMPL} = p \times \text{MPL}$. While VMPL exceeds the wage, one more unit of labour adds more to revenue than to cost, so the firm hires it. When VMPL falls below the wage, it cuts labour.
Why labour demand slopes down. Because of diminishing marginal product, MPL falls as more labour is hired. The firm hires until $w = \text{VMPL}$. If the wage rises, VMPL must rise to match it, which needs a higher MPL, and that is only possible with less labour. So a higher wage means fewer labour hours demanded.
Quick check with numbers. The output sells at ₹10 per unit and the marginal product of successive hours of labour is 12, 9, 7, 5 and 3 units.
| Hour of labour | MPL (units) | VMPL (₹) |
|---|---|---|
| 1 | 12 | 120 |
| 2 | 9 | 90 |
| 3 | 7 | 70 |
| 4 | 5 | 50 |
| 5 | 3 | 30 |
At a wage of ₹70 the firm hires 3 hours (the third hour just pays for itself). At ₹50 it hires 4 hours and at ₹90 only 2. A lower wage means more hours demanded: the labour demand curve slopes downward.
Supply of labour. An individual chooses between income and leisure. When the wage rises, two effects pull in opposite directions. Leisure becomes costlier (every hour off means more money forgone), so she works longer. But she also becomes richer, so she can afford more leisure and may work less. At low wages the first effect dominates and her labour supply rises with the wage. At high wages the second dominates and her supply falls. The individual labour supply curve is therefore backward bending. The market supply curve of labour, however, is upward sloping, because even if some people cut hours at high wages, many more are drawn into work.
The wage rate is where the downward sloping labour demand curve meets the upward sloping market labour supply curve.
| Goods market | Labour market | |
|---|---|---|
| Who supplies | Firms | Households |
| Who demands | Households | Firms |
| What is traded | A good (kg, units) | Hours of work |
| Price | Price of the good | Wage rate |
Shifts in demand and supply (fixed number of firms)
Everything so far kept tastes, incomes, input prices and technology fixed. When one of those changes, a whole curve shifts, and the equilibrium moves.
A demand shift. Say the demand curve shifts right (more is demanded at every price). At the old price there is now excess demand, so the price rises, and the new equilibrium has a higher price and a higher quantity. A leftward shift lowers both. So price and quantity move in the same direction when demand shifts.
A supply shift. Say the supply curve shifts right. At the old price there is now excess supply, so the price falls; the new equilibrium has a lower price and a higher quantity. A leftward shift raises the price and lowers the quantity. So price and quantity move in opposite directions when supply shifts.
| What changes | Curve that shifts | Direction | Equilibrium price | Equilibrium quantity |
|---|---|---|---|---|
| Income rises (normal good such as clothes) | Demand | Right | Rises | Rises |
| Income rises (inferior good) | Demand | Left | Falls | Falls |
| Number of consumers increases | Demand | Right | Rises | Rises |
| Price of an input rises | Supply | Left | Rises | Falls |
| Number of firms increases | Supply | Right | Falls | Rises |
Income and the number of buyers have no effect on supply, and input prices and the number of firms have no effect on demand. Each cause moves only one curve.
Worked example: four single shifts. Start from the wheat market ($q_D = 120 - 2p$, $q_S = 30 + p$; equilibrium ₹30 and 60 kg). Find the new equilibrium for each change.
| Change | New curves | Working | New price (₹) | New quantity (kg) |
|---|---|---|---|---|
| Demand rises by 30 at every price | $q_D = 150 - 2p$ | $150 - 2p = 30 + p$ gives $3p = 120$ | 40 | 70 |
| Demand falls by 30 at every price | $q_D = 90 - 2p$ | $90 - 2p = 30 + p$ gives $3p = 60$ | 20 | 50 |
| Supply falls by 30 at every price (dearer inputs) | $q_S = p$ | $120 - 2p = p$ gives $3p = 120$ | 40 | 40 |
| Supply rises by 30 at every price (more firms) | $q_S = 60 + p$ | $120 - 2p = 60 + p$ gives $3p = 60$ | 20 | 80 |
Thinking: a shift changes the intercept of one equation, so redo the equating. A demand shift moves price and quantity the same way (both 40 and 70 are up, both 20 and 50 are down). A supply shift moves them opposite ways (price 40 with quantity 40; price 20 with quantity 80).
Common wrong step. Treating a leftward supply shift as if it lowers the price because "the curve moved left". With less supplied at every price, buyers compete for scarcer goods and the price rises.
When both curves shift
If demand and supply shift together, the answer depends on the sizes of the shifts.
| Shift in demand | Shift in supply | Equilibrium quantity | Equilibrium price |
|---|---|---|---|
| Leftward | Leftward | Decreases | May increase, decrease or stay the same |
| Rightward | Rightward | Increases | May increase, decrease or stay the same |
| Leftward | Rightward | May increase, decrease or stay the same | Decreases |
| Rightward | Leftward | May increase, decrease or stay the same | Increases |
The rule behind the table: when the shifts point the same way, both push quantity the same way, so quantity is certain, but they push price in opposite directions, so price depends on which is bigger. When the shifts point opposite ways, both push price the same way, so price is certain, and quantity is uncertain.
Worked example: same direction shifts. Demand rises by 30 at every price ($q_D = 150 - 2p$). Supply also rises, by different amounts. Starting point: ₹30 and 60 kg.
| Supply rises by | Supply curve | Working | New price (₹) | New quantity (kg) | Price compared with ₹30 |
|---|---|---|---|---|---|
| 0 | $q_S = 30 + p$ | $150 - 2p = 30 + p$ | 40 | 70 | Rises |
| 30 | $q_S = 60 + p$ | $150 - 2p = 60 + p$ | 30 | 90 | Unchanged |
| 60 | $q_S = 90 + p$ | $150 - 2p = 90 + p$ | 20 | 110 | Falls |
Quantity rises every time (70, 90, 110), but price rises, stays put or falls depending on whether supply grew by less than, the same as, or more than demand.
Worked example: opposite direction shifts. Demand rises by 30 ($q_D = 150 - 2p$) and supply falls.
| Supply falls by | Supply curve | Working | New price (₹) | New quantity (kg) |
|---|---|---|---|---|
| 9 | $q_S = 21 + p$ | $150 - 2p = 21 + p$ gives $3p = 129$ | 43 | 64 |
| 30 | $q_S = p$ | $150 - 2p = p$ gives $3p = 150$ | 50 | 50 |
Price rises in both cases. Quantity rose from 60 to 64 in the first and fell to 50 in the second, so the effect on quantity is ambiguous.
Common wrong step. Answering "price will rise" for a demand rise and a supply rise, without comparing the sizes. With same-direction shifts the price can go either way (or nowhere); only the quantity is certain.
Pause and predict: a new fertiliser plant lowers input costs for wheat farmers at the same time as incomes (and demand) fall. What happens to price and quantity?
Check your answer: Supply shifts right and demand shifts left. Both push price down, so price falls for sure. Quantity depends on which shift is bigger, so it may rise, fall or stay the same.
Free entry and exit: the price is pinned down
So far the number of firms was fixed. Now let firms enter and leave freely, and assume all firms are identical.
Why the price settles at minimum average cost. Suppose firms are earning super-normal profit at the going price. This attracts new firms, which shifts the market supply curve right. With demand unchanged, the price falls, and the extra profit melts away. Entry stops only when each firm earns just normal profit. In the opposite case, if firms earn less than normal profit, some leave, supply shifts left, the price rises, and exit stops once firms are back to normal profit. A firm earns normal profit exactly when the price equals the minimum of its average cost. So with free entry and exit:
$$p = \min \text{AC}$$
The quantity is then read off the demand curve at that price, and each firm supplies its own output at that price.
$$n_0 = \dfrac{q_0}{q_{0f}}$$
On a graph, the "supply curve" in this case is a horizontal line at the minimum average cost, and equilibrium is where the demand curve meets it.
Worked example: price, quantity and number of firms. Market demand is $q_D = 350 - 5p$. Each identical firm supplies $q_f = 3p - 10$ when $p \ge 20$ and nothing below ₹20. Find the equilibrium with free entry and exit, then the effect of demand rising to $q_D = 450 - 5p$.
| Step | What we do | Result |
|---|---|---|
| 1 | Firms supply only from ₹20, so minimum average cost is ₹20 | $p_0 = 20$ |
| 2 | Quantity from demand at that price | $q_0 = 350 - 100 = 250$ |
| 3 | Each firm's output at ₹20 | $q_{0f} = 60 - 10 = 50$ |
| 4 | Number of firms | $n_0 = 250 \div 50 = 5$ |
| 5 | After demand rises: price stays at min AC | $p_1 = 20$ |
| 6 | New quantity from new demand | $q_1 = 450 - 100 = 350$ |
| 7 | New number of firms | $n_1 = 350 \div 50 = 7$ |
Compare with the case where the number of firms stays fixed at 5. Market supply is then $5(3p - 10) = 15p - 50$, so $450 - 5p = 15p - 50$ gives $p = 25$ and $q = 325$.
| Fixed 5 firms | Free entry and exit | |
|---|---|---|
| New price | ₹25 (up by ₹5) | ₹20 (unchanged) |
| New quantity | 325 (up by 75) | 350 (up by 100) |
| Number of firms | 5 | 7 |
| Profit of each firm | Super-normal (price above ₹20) | Normal |
A demand shift under free entry and exit changes quantity and the number of firms in the same direction as the shift, leaves the price unchanged, and changes the quantity by more than when the number of firms is fixed.
Common wrong step. Reading the price from the intersection of demand with a rising supply curve. With free entry and exit the price is already fixed by minimum average cost; only the quantity comes from demand. And "no profit" is the wrong summary: firms earn normal profit, which is inside average cost.
Price ceiling: a maximum price
A price ceiling is an upper limit on the price of a good or service, set by the government. It is usually placed on necessities such as wheat, rice, kerosene or sugar, and is set below the market price because at the market price some people cannot afford the good.
Suppose the ceiling is set below the equilibrium price. At that price buyers want more than sellers will supply, so there is excess demand: a shortage. Quantity actually traded is the smaller number, the quantity supplied. The government may then use rationing through fair price shops, with coupons limiting how much one buyer may take. The usual side effects are long queues, and since many buyers are not satisfied with their ration, some will pay extra, which creates a black market.
Worked example: a price ceiling. In the wheat market (equilibrium ₹30, 60 kg) the government fixes a ceiling.
| Ceiling | Binding? | Quantity demanded (kg) | Quantity supplied (kg) | Outcome |
|---|---|---|---|---|
| ₹20 | Yes, below ₹30 | $120 - 40 = 80$ | $30 + 20 = 50$ | Shortage of 30 kg; only 50 kg is sold |
| ₹35 | No, above ₹30 | 60 at the market price | 60 at the market price | Market stays at ₹30 and 60 kg |
Thinking: a ceiling does nothing unless the legal price is below what the market would have charged. At ₹20, sellers will bring only 50 kg to the market even though buyers want 80 kg.
Common wrong step. Saying that 80 kg is sold at ₹20 because that is what consumers demand. Trade needs a willing seller as well as a willing buyer, so the quantity traded is the smaller of demand and supply, 50 kg.
Pause and predict: the government imposes a ceiling of ₹35 on the wheat market. What changes?
Check your answer: Nothing. The market price of ₹30 is already below the ceiling, so the ceiling does not bind.
Beyond the textbook. For the exam: a ceiling below the equilibrium price causes excess demand, handled by rationing. In reality: India's public distribution system sells grain such as rice and wheat through fair price shops at government fixed prices, using ration cards to limit how much each household can buy. The grain for these shops is bought by the government from farmers at support prices, so the same grain market has a floor on the farmer's side and a controlled price on the consumer's side.
Price floor: a minimum price
A price floor is a lower limit on the price, set by the government, for a good or service whose price it does not want to see fall too low. The best known cases are agricultural price support and minimum wages. The floor is set above the equilibrium price.
At a floor above the equilibrium price, sellers want to supply more than buyers want to buy: there is excess supply. In agricultural support the government must buy the surplus at the announced price so the price does not fall. With a minimum wage the same logic holds: a minimum above the equilibrium wage means more labour is offered than firms want to hire.
Worked example: a price floor. In the wheat market (equilibrium ₹30, 60 kg) the government sets a support price.
| Floor | Binding? | Quantity demanded (kg) | Quantity supplied (kg) | Outcome |
|---|---|---|---|---|
| ₹40 | Yes, above ₹30 | $120 - 80 = 40$ | $30 + 40 = 70$ | Surplus of 30 kg |
| ₹25 | No, below ₹30 | 60 at the market price | 60 at the market price | Market stays at ₹30 and 60 kg |
If the government promises to buy all the surplus at ₹40, it must buy 30 kg, spending 30 × ₹40 = ₹1,200.
Common wrong step. Believing that producers get to sell the full 70 kg at ₹40 on their own. Private buyers want only 40 kg at that price. The extra 30 kg sells only because the government steps in as buyer.
| Price ceiling | Price floor | |
|---|---|---|
| What it is | Maximum legal price | Minimum legal price |
| Where it binds | Set below the equilibrium price | Set above the equilibrium price |
| Result | Excess demand (shortage) | Excess supply (surplus) |
| Quantity traded without help | Quantity supplied (smaller) | Quantity demanded (smaller) |
| Familiar examples | Rationed wheat, rice, kerosene, sugar | Agricultural support prices, minimum wage |
| Usual side effects | Queues, black market | Government stock buying, unsold output |
Beyond the textbook. For the exam: a minimum wage set above the equilibrium wage creates excess supply of labour. In reality: economists do not all agree on how large the employment effect of minimum wages is in practice. Studies of actual labour markets have found effects ranging from small to noticeable, partly because real firms have some wage setting power that the competitive model assumes away. The model is a clear first step for reasoning, not the last word.
Exam traps
| The trap | Why it's tempting | The truth |
|---|---|---|
| Reporting the equilibrium price when asked for the quantity | Solving for $p$ is the last algebra step | Substitute $p$ back into a curve to get the quantity |
| "A rightward supply shift raises both price and quantity." | Demand shifts move price and quantity together | Supply shifts move them in opposite directions |
| "Excess demand makes the price fall." | Goods look plentiful when a price drops | Excess demand pushes the price up; excess supply pushes it down |
| "A ceiling always creates a shortage." | It is a famous result | Only a ceiling set below the equilibrium price binds |
| "A floor always creates a surplus." | Same reason | Only a floor set above the equilibrium price binds |
| "Same direction shifts: price must rise." | Demand growth is the headline | Quantity is certain; price depends on which shift is bigger |
| "With free entry and exit firms earn nothing." | Super-normal profit is zero | Firms earn normal profit, which is part of cost |
| "Both the individual and market labour supply curves bend backward." | Both are called labour supply | The individual curve bends back; the market curve slopes upward |
Formula sheet
| Quantity | Formula | Unit | When to use |
|---|---|---|---|
| Equilibrium | $q_D(p^{\ast}) = q_S(p^{\ast})$ | kg or units | Solve the two equations for price, then substitute for quantity |
| Excess demand | $ED(p) = q_D - q_S$ | kg or units | Positive when price is below equilibrium |
| Excess supply | $ES(p) = q_S - q_D$ | kg or units | Positive when price is above equilibrium |
| Hiring rule | $w = \text{MRPL}$ | ₹ per hour | Labour demand of a firm |
| Marginal revenue product | $\text{MRPL} = \text{MR} \times \text{MPL}$ | ₹ per hour | Any firm |
| Value of marginal product | $\text{VMPL} = p \times \text{MPL}$ | ₹ per hour | Competitive firm, where MR equals price |
| Free entry and exit price | $p = \min \text{AC}$ | ₹ per unit | Long run, identical firms |
| Number of firms | $n_0 = \dfrac{q_0}{q_{0f}}$ | firms | Free entry and exit |
| Ceiling binds | $p_c < p^{\ast}$ | ₹ per unit | Gives excess demand |
| Floor binds | $p_f > p^{\ast}$ | ₹ per unit | Gives excess supply |
60-second revision
| Topic | Lock this in |
|---|---|
| Equilibrium | Plans match, market clears, $q_D = q_S$ at $p^{\ast}$ |
| Out of equilibrium | Excess demand pushes price up · excess supply pushes it down |
| Demand shift | Right: price up, quantity up · left: both down (same direction) |
| Supply shift | Right: price down, quantity up · left: price up, quantity down (opposite) |
| Both shift, same direction | Quantity certain, price ambiguous |
| Both shift, opposite directions | Price certain, quantity ambiguous |
| Labour market | Firms demand, households supply · hire until $w = \text{VMPL}$ · individual supply bends back, market supply slopes up |
| Free entry and exit | $p = \min \text{AC}$ · demand shift changes quantity and firms, not price |
| Price ceiling | Maximum price below $p^{\ast}$ · excess demand · rationing, queues, black market |
| Price floor | Minimum price above $p^{\ast}$ · excess supply · government buys the surplus |
Where this chapter connects
- Previous: The Theory of the Firm under Perfect Competition gives the firm and market supply curves, and the minimum average cost used here.
- Demand side: Theory of Consumer Behaviour explains where the downward sloping demand curve and its shifts come from.
- Costs behind supply: Production and Costs explains MPL, diminishing returns and the cost curves that drive the labour demand and the average cost used above.
🎯 Practice MCQs
First 3 questions free · create a free account to unlock the rest — answers & explanations included, no payment needed
Q1. A market is said to be in equilibrium when:
▸ Show answer & explanation
Answer: B
Equilibrium means the quantity firms wish to sell equals the quantity consumers wish to buy, so the market clears. Option A describes excess supply, option C a price ceiling, and option D has nothing to do with the definition.
Q2. In a market, demand is $q_D = 240 - 3p$ and supply is $q_S = 40 + 2p$. The equilibrium price and quantity are:
▸ Show answer & explanation
Answer: A
Setting $240 - 3p = 40 + 2p$ gives $5p = 200$, so $p = 40$. Then $q_D = 240 - 120 = 120$ and $q_S = 40 + 80 = 120$. Option C wrongly uses a different equation, and option D is a price where demand and supply are not equal.
Q3. For the same market ($q_D = 240 - 3p$, $q_S = 40 + 2p$), at a price of ₹30 there is:
▸ Show answer & explanation
Answer: B
At ₹30, $q_D = 240 - 90 = 150$ and $q_S = 40 + 60 = 100$. Demand exceeds supply by 50 units, so there is excess demand and the price will rise toward ₹40.
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Q4. In a perfectly competitive market the price is above the equilibrium price. Which of the following correctly describes what follows?
▸ Show answer & explanation
Answer: B
Above the equilibrium price supply exceeds demand. Unsold sellers lower their price, which raises the quantity demanded and lowers the quantity supplied until the two are equal. Options A and D mix up the direction of imbalance, and option C gives the wrong direction for price.
Q5. With a fixed number of firms, the price of an input used in producing a good rises. At the new equilibrium:
▸ Show answer & explanation
Answer: A
Dearer inputs raise marginal cost, so the supply curve shifts left while demand is unchanged. At the old price there is excess demand, so the price rises and the quantity falls. Price and quantity move in opposite directions after a supply shift.
Q6. Match List I with List II. List I: (i) Demand and supply both shift rightward (ii) Demand and supply both shift leftward (iii) Demand shifts rightward, supply shifts leftward (iv) Demand shifts leftward, supply shifts rightward. List II: (p) Quantity increases, price may rise, fall or stay the same (q) Quantity decreases, price may rise, fall or stay the same (r) Price increases, quantity may rise, fall or stay the same (s) Price decreases, quantity may rise, fall or stay the same
▸ Show answer & explanation
Answer: A
Same direction shifts fix the quantity and leave the price open. Opposite shifts fix the price: rightward demand with leftward supply pushes both toward a higher price, and leftward demand with rightward supply pushes both toward a lower price.
Q7. The demand and supply of a good are $q_D = 200 - p$ and $q_S = 120 + p$, so the equilibrium is at ₹40 and 160 units. Demand rises to $q_D = 240 - p$ and supply rises to $q_S = 160 + p$. The new equilibrium is:
▸ Show answer & explanation
Answer: A
Setting $240 - p = 160 + p$ gives $2p = 80$, so $p = 40$, and $q = 240 - 40 = 200$. Both curves shifted right by 40, so quantity rises and price stays unchanged because the shifts are equal. Option D forgets that quantity must rise.
Q8. Market demand is $q_D = 600 - 8p$. Identical firms each supply $q_f = 2p - 30$ when $p \ge 25$ and nothing below ₹25. With free entry and exit, the equilibrium price, quantity and number of firms are:
▸ Show answer & explanation
Answer: A
Firms supply only from ₹25, so the price is ₹25. Quantity from demand is $600 - 200 = 400$. Each firm supplies $2 \times 25 - 30 = 20$, so the number of firms is $400 \div 20 = 20$. Option B divides by the wrong output, and options C and D use prices other than the minimum average cost.
Q9. Under free entry and exit of identical firms, demand shifts rightward. Which of the following statements are correct? I: The price returns to the minimum average cost. II: The equilibrium quantity and the number of firms both increase. III: The effect on quantity is smaller than when the number of firms is fixed. IV: Each firm still earns only normal profit.
▸ Show answer & explanation
Answer: B
Entry keeps pushing the price back to the minimum average cost, so quantity and the number of firms rise while each firm earns normal profit. Statement III is wrong: the quantity effect is larger with free entry, because the price does not rise to choke off demand.
Q10. Consider the statements about a price ceiling. I: It is an upper limit on price set by the government. II: It affects the market only when set below the equilibrium price. III: A binding ceiling creates excess supply. IV: Rationing through fair price shops may be used to share the limited supply. Which are correct?
▸ Show answer & explanation
Answer: B
A ceiling is a maximum price and binds only if it is below the equilibrium price, where it creates excess demand, which rationing then shares out. Statement III is wrong because a binding ceiling creates excess demand, not excess supply.
Q11. Assertion (A): A price floor set below the equilibrium price has no effect on the market outcome. Reason (R): The equilibrium price is already above the floor, so buyers and sellers keep trading at the equilibrium price.
▸ Show answer & explanation
Answer: A
A floor only stops the price from falling below a set level. If the equilibrium price is already above that level, trade continues at the equilibrium price and nothing changes, so the floor does not bind. R gives exactly this reason.
Q12. A competitive firm sells its output at ₹8 per unit. The fourth hour of labour has a marginal product of 6 units and the wage is ₹40 per hour. The firm should:
▸ Show answer & explanation
Answer: A
For a competitive firm VMPL equals price times marginal product, which is 8 × 6 = ₹48. This is more than the wage of ₹40, so the fourth hour adds more to revenue than to cost and should be hired. Option B compares unlike things, and option C reverses the hiring rule.
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