Market Equilibrium Class 12 Notes

Q: Q6 Explain the effect of a price floor with an example. Why does the government have to buy the surplus?

A price floor set above equilibrium creates excess supply. Floor: a legal minimum price above the market price. Result: firms want to sell more than buyers want to buy. Surplus: unsold stock would push price below the floor. Purchase: to keep the floor, the government buys the surplus. Example: minimum support price for wheat. With demand 500 − 4p, supply 100 + 6p and a minimum price of ₹50, farmers offer 400 units but buyers want only 300, leaving a surplus of 100 that the government buys at the floor price.

Key takeaways

Equilibrium is where q^D = q^S; below p* there is excess demand and above it excess supply.
A demand shift moves price and quantity in the same direction; a supply shift moves them in opposite directions.
With free entry and exit, p = min AC, and a demand change alters quantity and the number of firms, not price.
The wage is set where labour demand (VMP_L) meets labour supply.
A price ceiling below equilibrium creates a shortage; a price floor above it creates a surplus.

This page is part of the Introductory Microeconomics chapter list for Class 12 Economics. It combines the demand side of Chapter 2 with the supply side of Chapter 4.

5.1Equilibrium, Excess Demand, Excess Supply

Market equilibrium is a situation where the plans of all consumers and firms match and the market clears: the quantity demanded equals the quantity supplied at the equilibrium price. At a higher price there is excess supply; at a lower price there is excess demand. In either case the price tends to move back towards equilibrium.

In a perfectly competitive market, consumers maximise satisfaction and firms maximise profit, and both act as price takers. An equilibrium is a pair (p*, q*) at which q^D(p*) = q^S(p*), so what firms want to sell equals what buyers want to buy. If supply exceeds demand at some price there is excess supply; if demand exceeds supply there is excess demand. Equilibrium is therefore the situation of zero excess demand and zero excess supply.

Economists since Adam Smith have said that an “invisible hand” moves price up under excess demand and down under excess supply. We assume that it does so and that the market reaches equilibrium.

5.1.1 Market equilibrium: fixed number of firms

With the number of firms fixed, equilibrium is where the market demand curve meets the market supply curve. If the price is below p*, buyers want more than is supplied and some will offer more, so price rises. Quantity demanded falls and quantity supplied rises until they match. If the price is above p*, some firms cannot sell what they want and cut their price, which raises demand and cuts supply until they match.

Figure 5.1: Equilibrium, a ceiling below it and a floor above itDemand q^D = 500 − 4p and supply q^S = 100 + 6p give the equilibrium E. The bands show the gap between demand and supply at ₹30 (shortage) and ₹50 (surplus).

Wage determination in a labour market

The labour market works like any other market with the roles reversed: households supply labour and firms demand it. Here “labour” means hours of work, not the number of workers.

Demand for labour. A competitive firm hires labour up to the point where the wage equals the extra revenue a worker brings: w = MRP_L = MR × MP_L. Since MR = p for a competitive firm, this is the value of marginal product, VMP_L = p × MP_L. Because MP_L diminishes, a higher wage means fewer workers are hired, so the demand curve slopes downward.
Supply of labour. Each person chooses between income and leisure. A higher wage makes leisure costlier, which tempts her to work more, but it also raises her purchasing power, which tempts her to enjoy more leisure. At low wages the first effect dominates; at high wages the second can, giving a backward-bending individual supply curve. The market supply curve still slopes upward, since higher wages draw more people into work.

Figure 5.2: Wage determinationThe equilibrium wage is where firms' demand for labour equals households' supply of labour.

Shifts in demand and supply

Equilibrium is drawn for given tastes, incomes, related prices, technology and input prices. If any of them changes, a curve shifts, and a new equilibrium is reached.

Effect of a single shift on equilibrium (fixed number of firms)
Shift	Equilibrium price	Equilibrium quantity	Example
Demand shifts right	Rises	Rises	Higher incomes raise demand for clothes
Demand shifts left	Falls	Falls	A health scare lowers demand for a drink
Supply shifts right	Falls	Rises	More firms enter the market
Supply shifts left	Rises	Falls	Higher input prices raise costs

A demand shift moves price and quantity in the same direction; a supply shift moves them in opposite directions.

Simultaneous shifts

Both curves shift at once
Demand	Supply	Quantity	Price
Right	Right	Rises	May rise, fall or stay the same
Left	Left	Falls	May rise, fall or stay the same
Right	Left	May rise, fall or stay the same	Rises
Left	Right	May rise, fall or stay the same	Falls

When both curves move the same way, the effect on quantity is certain and on price depends on the sizes of the shifts. When they move in opposite directions, the effect on price is certain and on quantity depends on the sizes.

5.1.2 Market equilibrium: free entry and exit

Now let identical firms enter and leave freely. If firms earn super-normal profit, new firms enter, output expands, price falls, and profit shrinks. If firms earn less than normal profit, some exit, price rises. Entry and exit stop only when every firm earns exactly normal profit, which means the equilibrium price equals the minimum average cost: p = min AC.

The equilibrium quantity is then read from the demand curve at that price, and each firm supplies the amount q^f it chooses at that price, so the equilibrium number of firms is n = q* ÷ q^f.

Figure 5.3: A demand shift under free entry and exitA rise in demand raises quantity, and so the number of firms, but not the price (from 400 units at E₀ to 500 at E₁). The effect on quantity is larger than when the number of firms is fixed.

5.2Applications: Price Ceiling and Price Floor

Governments sometimes fix prices that are too high or too low. A price ceiling is a maximum price set below the equilibrium price, which creates excess demand, usually met by rationing. A price floor is a minimum price set above equilibrium, which creates excess supply that the government may have to buy.

Price ceiling

A price ceiling is a legal upper limit on the price of a good, usually set on necessities such as wheat, rice, sugar and kerosene because the market price is unaffordable for some. To bind, it must be set below the equilibrium price. At the ceiling, buyers want more than firms supply, so there is a shortage. To share the limited supply, governments issue ration cards and sell through fair price shops. Rationing has costs: long queues, and since some buyers remain unsatisfied and will pay more, a black market may arise.

Price floor

A price floor is a legal lower limit on the price. Two familiar cases are agricultural price support and minimum wage laws. To bind, it must be set above the equilibrium price. At the floor, firms want to supply more than buyers want to buy, so there is excess supply. Under agricultural support, the government buys the surplus at the fixed price. Under a minimum wage above the equilibrium wage, more people offer to work than firms want to hire.

Ceiling and floor compared
Basis	Price ceiling	Price floor
Meaning	Legal maximum price	Legal minimum price
Set relative to equilibrium	Below	Above
Market result	Excess demand (shortage)	Excess supply (surplus)
Typical response	Rationing, fair price shops	Government purchase of the surplus
Examples	Ration shop prices, controlled drug prices	Minimum support price, minimum wage

Worked Examples

Example 1: Equilibrium, ceiling and floor

Given: q^D = 500 − 4p and q^S = 100 + 6p.
Formula: Equilibrium: q^D = q^S; excess demand ED = q^D − q^S
Steps: 500 − 4p = 100 + 6p gives p* = 40 and q* = 500 − 160 = 340. ED(p) = 400 − 10p. At a ceiling of ₹30: q^D = 380, q^S = 280, shortage = 100. At a floor of ₹50: q^D = 300, q^S = 400, surplus = 100.
Answer: p* = ₹40; q* = 340. A ceiling of ₹30 causes a shortage of 100; a floor of ₹50 causes a surplus of 100.

Example 2: Free entry and exit

Given: Minimum average cost = ₹25. Each firm supplies 20 units at that price. Market demand is q^D = 500 − 4p, then rises to q^D = 600 − 4p.
Formula: p = min AC; q* from demand; n = q* ÷ q^f
Steps: Initially q* = 500 − 100 = 400, so n = 400 ÷ 20 = 20 firms. After the shift q* = 600 − 100 = 500, so n = 25 firms, with price still ₹25.
Answer: Price stays ₹25; quantity rises from 400 to 500; the number of firms rises from 20 to 25.

Example 3: How many workers to hire

Given: Output sells at ₹20 per unit. The marginal product of the 1st to 5th worker is 10, 8, 6, 4 and 2 units. The daily wage is ₹120.
Formula: Hire while VMP_L = p × MP_L ≥ w
Steps: VMP: 200, 160, 120, 80, 40. The first three workers earn at least ₹120. The fourth adds only ₹80. If the wage rises to ₹160, only the first two are worth hiring.
Answer: At a wage of ₹120 the firm hires 3 workers; at ₹160 it hires 2.

Common Mistakes

Setting a price ceiling above the equilibrium price. It has no effect unless it is below equilibrium.
Saying a demand shift moves price and quantity in opposite directions. That is true of supply shifts.
Claiming price rises with free entry and exit when demand rises. In the long run price returns to minimum average cost.
Writing excess demand as q^S − q^D. Excess demand is q^D − q^S.
Counting workers instead of hours when describing labour supply.

10 Important Questions for Class 12 Board and School Examinations

Questions are written in original words. Marks are shown beside each question.

Q1At a price below the equilibrium price, there is: (A) excess supply (B) excess demand (C) equilibrium (D) no change in quantity demanded 1 mark · MCQ

(B) Excess demand.

At a lower price buyers want more than firms supply, so price tends to rise.

Q2Assertion (A): With free entry and exit, the equilibrium price equals the minimum average cost. Reason (R): Entry and exit stop only when every firm earns normal profit. Choose: (a) both true, R explains A; (b) both true, R does not explain A; (c) A true, R false; (d) A false, R true. 1 mark · Assertion-reason

(a) Both are true and R correctly explains A.

Normal profit means price equals average cost at its minimum point.

Q3Define equilibrium price, excess demand and excess supply. 3 marks

Equilibrium price is the price at which quantity demanded equals quantity supplied.

Excess demand: quantity demanded exceeds quantity supplied at a price.
Excess supply: quantity supplied exceeds quantity demanded at a price.
At equilibrium both are zero.

Example: if q^D = 380 and q^S = 280 at ₹30, there is excess demand of 100.

Excess demand pushes price up and excess supply pushes it down.

Q4What happens to equilibrium price and quantity when demand shifts to the right and supply is unchanged? 3 marks

Both the equilibrium price and the equilibrium quantity rise.

At the old price there is excess demand.
Buyers who cannot get the good offer more, so price rises.
Firms supply more along the supply curve, so quantity rises.

Example: higher incomes increase demand for clothes.

For example, if demand rises from 500 − 4p to 560 − 4p, equilibrium rises above ₹40 as buyers compete for the limited supply.

Q5What is a price ceiling? State two problems it can create. 3 marks

A price ceiling is a government-imposed maximum price set below the equilibrium price.

It creates excess demand, a shortage of the good.
Rationing leads to queues.
Unsatisfied buyers may pay more, creating a black market.

Example: wheat sold at fair price shops.

It lowers the price paid by buyers who can get the good, but fewer units are supplied. Governments therefore use ration cards and fair price shops to share the available supply, though this adds to administrative cost.

Q6Explain the effect of a price floor with an example. Why does the government have to buy the surplus? 4 marks

A price floor set above equilibrium creates excess supply.

Floor: a legal minimum price above the market price.
Result: firms want to sell more than buyers want to buy.
Surplus: unsold stock would push price below the floor.
Purchase: to keep the floor, the government buys the surplus.

Example: minimum support price for wheat.

With demand 500 − 4p, supply 100 + 6p and a minimum price of ₹50, farmers offer 400 units but buyers want only 300, leaving a surplus of 100 that the government buys at the floor price.

Q7Explain what happens to equilibrium price and quantity when both demand and supply shift rightward. 4 marks

Equilibrium quantity certainly rises, but the effect on price depends on the relative size of the shifts.

Higher demand tends to raise price.
Higher supply tends to lower price.
If the demand shift is larger, price rises; if the supply shift is larger, price falls.
If they are equal, price is unchanged.

Example: both curves shifting equally leave price at p* but raise quantity.

If both curves shift right by 60 units at every price, price stays the same and quantity rises by 60. The effect on one variable is ambiguous and on the other certain.

Q8Explain how equilibrium is determined when firms can freely enter and exit. What happens when demand increases? 6 marks

With free entry and exit, the equilibrium price equals minimum average cost, and demand then fixes quantity and the number of firms.

Super-normal profit attracts new firms, which lowers price.
Below-normal profit makes firms leave, which raises price.
Equilibrium is reached when profit is normal: p = min AC.
Quantity comes from market demand at that price; n = q* ÷ q^f.
A rise in demand raises quantity and the number of firms.
Price does not change.

Thus a demand shift has a bigger effect on quantity than with a fixed number of firms.

A numerical example: with minimum AC of ₹25 and each firm supplying 20 units, a demand of 500 − 4p gives q* = 400 and 20 firms. If demand rises to 600 − 4p, q* is 500 and 25 firms are needed, so five new firms enter at the same price.

Q9Explain how the wage rate is determined in a perfectly competitive labour market. 6 marks

The wage is set where the demand for labour from firms equals the supply of labour from households.

A firm hires labour until w = VMP_L = p × MP_L.
Diminishing MP_L makes labour demand slope downward.
Households trade off income and leisure.
Individual supply may bend backward at high wages.
The market supply of labour still slopes upward.
The curves intersect at the equilibrium wage.

Hence wage and employment are determined together.

A firm’s labour demand curve is its VMP curve, and labour is measured in hours of work. Wage and employment are determined together: a minimum wage above equilibrium leaves more people seeking work than firms want to hire. If demand shifts right, both wage and employment rise.

Q10The demand and supply for a good are q^D = 300 − 2p and q^S = 60 + 4p. Find the equilibrium price and quantity, and the excess demand at a price of ₹30. 4 marks · Numerical

The equilibrium price is ₹40, the equilibrium quantity is 220, and the excess demand at ₹30 is 60.

Given: q^D = 300 − 2p; q^S = 60 + 4p.

Formula: q^D = q^S; ED = q^D − q^S.

Steps: 300 − 2p = 60 + 4p gives 6p = 240, p* = 40; q* = 300 − 80 = 220. At p = 30: q^D = 240, q^S = 180, so ED = 60.

Final answer: p* = ₹40; q* = 220; excess demand = 60 units.

10 Points for State PSC and UPSC Aspirants

The Minimum Support Price is a price floor announced by the Centre for 22 mandated crops, based on CACP recommendations.Why it matters: the standard Indian example of a price floor.Source: CACP; Department of Agriculture
The Food Corporation of India (set up 1965) buys foodgrains at MSP and stores buffer stock for the public distribution system.Why it matters: the agency that buys the surplus created by the floor.Source: Food Corporation of India
The National Food Security Act, 2013 covers up to 75% of the rural and 50% of the urban population under the targeted PDS, at ₹3, ₹2 and ₹1 per kg for rice, wheat and coarse cereals.Why it matters: an Indian price-ceiling-plus-rationing system.Source: National Food Security Act portal
Since 1 January 2023 the Centre has supplied NFSA foodgrains free to beneficiary households; check the current position before quoting.Why it matters: shows how policy keeps changing after a textbook example.Source: Department of Food and Public Distribution; PIB
The Essential Commodities Act, 1955 lets governments control production, supply and price, and impose stock limits; a 2020 amendment deregulated cereals, pulses, oilseeds, onion and potato except in extraordinary circumstances.Why it matters: a legal basis for ceilings and stock limits.Source: India Code
The Drugs (Prices Control) Order, 2013 lets the NPPA fix ceiling prices of scheduled medicines on the National List of Essential Medicines.Why it matters: a price ceiling in practice.Source: National Pharmaceutical Pricing Authority
The Code on Wages, 2019 consolidates the Minimum Wages Act, 1948 and other wage laws and provides for a national floor wage.Why it matters: India's minimum wage price floor.Source: Ministry of Labour and Employment
The Model Tenancy Act, 2021 was circulated to states to replace older rent control laws that held rents below market levels.Why it matters: rent control is the textbook price ceiling.Source: Ministry of Housing and Urban Affairs; PIB
One Nation One Ration Card, launched in 2019, lets beneficiaries draw their ration anywhere in the country.Why it matters: an administrative response to the problems of rationing.Source: Department of Food and Public Distribution
The Periodic Labour Force Survey (PLFS) reports earnings and employment, the data side of the labour market.Why it matters: the official source for wages and employment.Source: MoSPI, PLFS

These are revision notes, not official predictions of exam content.

Quick Revision

Equilibrium: q^D = q^S at p*.
p < p*: excess demand; p > p*: excess supply.
Demand shift: price and quantity move together.
Supply shift: price and quantity move in opposite directions.
Both shift: one of price or quantity is ambiguous.
Free entry and exit: p = min AC; n = q* ÷ q^f.
Labour: w = VMP_L = p × MP_L.
Ceiling below p*: shortage; floor above p*: surplus.

Glossary:

Equilibrium price Price ceiling Price floor Perfect competition Excess demand

Related chapters: Theory of Consumer Behaviour, the source of the demand curve; The Theory of the Firm under Perfect Competition, the source of the supply curve; Non-Competitive Markets, where price is not set by equilibrium alone. From Class 11: Rural Development, Poverty.

Sources

NCERT textbooks: Introductory Microeconomics, Class 12, National Council of Educational Research and Training. Syllabus reference. Accessed 23 October 2026.
National Food Security Act portal, Government of India. Accessed 23 October 2026.
Commission for Agricultural Costs and Prices, Government of India. MSP policy reports. Accessed 23 October 2026.
Ministry of Labour and Employment, Government of India. Code on Wages. Accessed 23 October 2026.
India Code: Central Acts, Legislative Department, Government of India. Accessed 23 October 2026.

About this page

Drafted with AI assistance from the NCERT chapter structure, in original words. Content is checked and approved by Dr. Anamika Shrivastava, PhD Economics, before publication. Read how this site works or send a correction.

Syllabus year 2026-27 · Last updated 23 October 2026