Market Equilibrium

2.1 Core concepts

• A perfectly competitive market consists of buyers and sellers driven by self-interest — consumers maximise preferences, firms maximise profits — and these objectives are compatible at equilibrium (NCERT §5.1, p. 71–72).
• Equilibrium is a situation where the plans of all consumers and firms match and the market clears, i.e. market supply equals market demand at the equilibrium price p* and equilibrium quantity q*: qD(p*) = qS(p*) (NCERT §5.1, p. 72).
• If market supply exceeds demand at a price there is excess supply; if market demand exceeds market supply at a price there is excess demand. Equilibrium can equivalently be defined as a zero excess demand-zero excess supply situation (NCERT §5.1, p. 72).
• The Adam Smith "Invisible Hand" raises price when there is excess demand and lowers price when there is excess supply, driving the market towards equilibrium (NCERT §5.1 box "Out-of-equilibrium Behaviour", p. 72).
• With a fixed number of firms, equilibrium is the intersection of market demand DD and market supply SS. At p1 < p*, excess demand forces price up; at p2 > p*, excess supply forces price down (NCERT §5.1.1, Fig. 5.1, p. 72–73).
• In the worked example with qD = 200 − p and qS = 120 + p, equating gives p* = 40 and q* = 160 kg of wheat; algebraic excess demand = 80 − 2p; excess supply = 2p − 80 (NCERT §5.1.1, Example 5.1, p. 73–74).
• Labour market: households supply labour, firms demand it. A profit-maximising firm hires labour up to w = MRPL where MRPL = MR × MPL; for a perfectly competitive firm MR equals price, so MRPL equals the Value of Marginal Product of Labour (VMPL) (NCERT §5.1.1 box "Wage Determination", p. 74–75).
• Demand for labour slopes downward because of the law of diminishing marginal product: at a higher wage, MPL must rise to maintain w = VMPL, which means less labour is employed (NCERT §5.1.1 box "Wage Determination", p. 75).
• An individual's labour supply curve is backward-bending — at low wages the substitution effect (leisure becomes costlier) dominates so labour rises with wage; at high wages the income effect dominates so labour falls with wage. The market labour supply curve, however, is upward sloping (NCERT §5.1.1 box, p. 76).
• Demand shift with fixed firms: rightward shift in DD raises both equilibrium price and quantity; leftward shift lowers both. The direction of change in p and q is the same (NCERT §5.1.1 "Demand Shift", Fig. 5.2, p. 76–77).
• Supply shift with fixed firms: rightward shift in SS lowers price and raises quantity; leftward shift raises price and lowers quantity. The directions of change in p and q are opposite (NCERT §5.1.1 "Supply Shift", Fig. 5.3, p. 78–79).
• Simultaneous shifts (Table 5.1): if both DD and SS shift rightward (leftward), quantity increases (decreases) unambiguously but price may rise, fall or remain unchanged depending on magnitudes; if DD and SS shift in opposite directions, price changes unambiguously but quantity is ambiguous (NCERT §5.1.1, Table 5.1, p. 80).
• With free entry and exit of identical firms, the equilibrium price is always equal to the minimum average cost of the firms (p = min AC) because supernormal profits attract entry and losses cause exit until each firm earns only normal profit (NCERT §5.1.2, p. 81).
• Under free entry-exit, equilibrium quantity equals market demand at p = min AC, and equilibrium number of firms n0 = q0/q0f where q0f is each firm's output (NCERT §5.1.2, p. 81–82).
• In Example 5.2 with qD = 200 − p and qfs = 10 + p (p ≥ 20), equilibrium p0 = 20 (= min AC), q0 = 180, each firm supplies 30, so n0 = 180/30 = 6 firms (NCERT §5.1.2, Example 5.2, p. 82).
• Under free entry-exit, a shift in demand changes equilibrium quantity and number of firms in the same direction as the shift, but leaves the equilibrium price unchanged at min AC (NCERT §5.1.2 "Shifts in Demand", Fig. 5.6, p. 82–83).
• Compared with a fixed number of firms, demand shifts have a larger effect on quantity and no effect on price when entry-exit is free (NCERT §5.1.2, p. 83).
• Price ceiling is a government-imposed upper limit on the price of a good; when set below the equilibrium price it creates excess demand (shortage), often handled via rationing through fair price shops, with possible side-effects of long queues and black markets (NCERT §5.2.1, Fig. 5.7, p. 84–85).
• Price floor is a government-imposed lower limit on the price of a good; when set above the equilibrium price it creates excess supply. Familiar examples are agricultural price-support programmes and minimum-wage legislation (NCERT §5.2.2, Fig. 5.8, p. 85).

2.2 Definitions to memorise

2.3 Diagrams / processes to remember

• Figure 5.1: Market equilibrium with fixed number of firms — intersection of SS and DD at (p*, q*); illustrates excess supply above p* and excess demand below p* (p. 72).
• Figure 5.2: Shifts in demand with fixed firms — rightward shift moves equilibrium to G (higher p, higher q); leftward shift moves to F (lower p, lower q) (p. 77).
• Figure 5.3: Shifts in supply with fixed firms — leftward shift raises p and lowers q; rightward shift lowers p and raises q (p. 78).
• Labour market diagram: upward-sloping market labour supply meets downward-sloping labour demand at equilibrium wage w* (p. 75).
• Figure 5.4: Simultaneous shifts — rightward shifts of both curves; opposite shifts (rightward SS, leftward DD) (p. 80).
• Figure 5.5: Free entry-exit — equilibrium at intersection of DD with horizontal price line p0 = min AC (p. 81).
• Figure 5.6: Demand shifts under free entry-exit — quantity changes but price stays fixed at min AC (p. 83).
• Figure 5.7: Price ceiling pc below p* creates excess demand qc − qc' in the wheat market (p. 84).
• Figure 5.8: Price floor pf above p* creates excess supply qf' − qf (p. 85).

2.5 Key formulas

2.4 Common confusions / NTA trap points

• Students confuse equilibrium price (a per-unit money figure) with equilibrium quantity (units bought/sold); always check what the question asks.
• The MRPL = MR × MPL formula: under perfect competition (only), MR = price, so MRPL = VMPL. Don't apply this to monopoly markets.
• Direction of change in supply shifts: rightward SS shift lowers price but raises quantity — students often mistakenly assume both move together as in demand shifts.
• Free entry-exit eliminates supernormal profit but firms still earn normal profit; "no profit" is wrong — normal profit is built into costs.
• Price ceiling must be set below the equilibrium price to bite; if set above, it is non-binding. Similarly a price floor must be above p*. NTA distractors flip these.
• The individual labour supply is backward-bending but the market labour supply curve is upward-sloping — easy to confuse.