1. What this chapter is about

• This chapter explains how market prices and quantities are determined by the interaction of demand and supply, what happens when they do not match (excess demand or excess supply), and how markets adjust — both in the short run and in the long run.
• It covers stability, welfare (consumer & producer surplus), and typical policy interventions such as price ceilings and price floors, plus implications for efficiency and equity.
• Focus is on clear definitions, diagrams you must draw in exams, and typical numerical + conceptual questions in CBSE pattern.

2. Key definitions (quick)

• Demand (D): relationship showing quantities buyers wish to purchase at various prices, ceteris paribus.
• Supply (S): relationship showing quantities sellers are willing to sell at various prices.
• Equilibrium (P*, Q*): the price–quantity pair where demand equals supply: D(P*) = S(P*).
• Excess demand (shortage): when price is below equilibrium (P < P*), quantity demanded > quantity supplied.
• Excess supply (surplus): when price is above equilibrium (P > P*), quantity supplied > quantity demanded.

3. How equilibrium forms — intuition

• If price > P*: sellers have unsold stock → pressure to reduce price → quantity demanded rises, quantity supplied falls, moving toward P*.
• If price < P*: buyers compete and bid up price → quantity demanded falls, quantity supplied rises, moving toward P*.
• Thus market forces push price toward the market-clearing level when price is free to adjust.
• Draw the standard diagram: downward-sloping D, upward-sloping S — intersection is (P*, Q*). Shade consumer and producer surplus for welfare analysis.

4. Excess demand and excess supply — dynamics & consequences

• Excess demand (shortage): queues, rationing, non-price allocation (first-come, coupons), or black markets if controls exist. Tends to push price upwards if allowed.
• Excess supply (surplus): unsold inventories, price-cutting, increased promotions, production cuts — tends to push price downwards.
• Speed of adjustment depends on market institutions: auctions adjust quickly; labour markets and regulated markets can adjust slowly because of contracts, wages, regulations.

5. Short-run market equilibrium (fixed number of firms)

• Short run: number of firms is fixed; firms change output but cannot enter/exit.
• Industry supply is the horizontal sum of individual firm supplies. Given demand D(P), solve for P* from D(P)=S(P).
• At the short-run P*, firms may earn positive profits, zero profit (normal profit), or losses depending on position of P* relative to short-run ATC.

6. Long-run equilibrium — free entry and exit

• In the long run firms can enter or exit. Entry occurs if existing firms earn positive economic profit → supply shifts right; exit if firms incur losses → supply shifts left.
• Long-run competitive equilibrium occurs where price equals minimum long-run average cost (LRAC), so firms earn zero economic profit (normal profit).
• Industry long-run supply depends on input price responses:
1. Constant-cost industry: LR supply is horizontal at P = min LRAC.
2. Increasing-cost industry: LR supply slopes upward (expansion raises input prices).
3. Decreasing-cost industry: LR supply slopes downward (expansion reduces input costs due to scale or learning).

7. Stability of equilibrium

• Equilibrium is stable if small deviations trigger forces that restore the equilibrium (e.g., excess demand → price rise → moves back to equilibrium).
• Walrasian tâtonnement: price adjustments based on excess demand. Not all real markets follow this ideal process; quantity adjustments, rationing, and institutional delays can create lasting disequilibrium.

8. Welfare at equilibrium

• Consumer surplus (CS): area under demand above price up to Q* — net benefit to buyers.
• Producer surplus (PS): area above supply (MC) below price up to Q* — net benefit to sellers.
• Total surplus = CS + PS. Competitive equilibrium (P*=MC for marginal unit) maximizes total surplus under standard assumptions (no externalities, public goods or market power).
• Deadweight loss occurs when quantity traded deviates from Q* because of taxes, price controls, or other distortions.

9. Policy interventions — Price ceiling and price floor (applications)

• Price ceiling (maximum price P_max): if P_max ≥ P* → non-binding. If P_max < P* → binding → shortage (Qd(P_max) > Qs(P_max)).
• Consequences: rationing, queues, black markets, quality deterioration, misallocation. Consumer surplus may increase for those allocated the good but total surplus usually falls (deadweight loss).
• Price floor (minimum price P_min): if P_min ≤ P* → non-binding. If P_min > P* → binding → surplus (Qs > Qd).
• Consequences: unsold inventories, government purchase programs, wasted resources, higher prices for consumers, deadweight loss. Minimum wage is a common example with potential unemployment effects if binding.

10. Taxes, subsidies and incidence

• A per-unit tax (t) on sellers shifts the supply curve vertically up by the amount t (or shifts left in schedule form). A tax on buyers shifts demand down by t. Result: quantity traded falls.
• Tax incidence: who bears the burden depends on relative price elasticities. The side (demand or supply) that is less elastic bears more of the tax.
• Tax revenue = t × Q_tax. Deadweight loss arises because trade reduces below efficient level.
• Subsidy is the mirror image: supply shifts down (or demand up), quantity increases, and subsidy cost is typically borne by government — again incidence depends on elasticities.

11. Non-price rationing & real-world frictions

• When price controls bind, allocation often occurs via non-price methods: ration coupons, first-come-first-served, connections, or black markets — typically inefficient and inequitable.
• Sticky prices (menu costs, contracts) mean adjustments occur through quantities (inventory changes, layoffs) rather than prices, which affects unemployment and shortages in real markets.

12. Heterogeneous firms and industry supply

• Firms differ in cost functions. Industry supply is the horizontal sum of individual supplies: low-cost firms supply more at low prices; high-cost firms supply only at higher prices.
• In the long run, entry/exit selects efficient firms — inefficient firms exit, average costs and industry composition adjust.

13. Comparative statics — how changes affect equilibrium

• Demand increase: D → D’ (right): SR → higher P and Q. If permanent, LR entry may raise supply and bring P down toward LRAC, increasing Q further.
• Supply increase: S → S’ (right): lower P, higher Q.
• When both shift, compare magnitude to determine net effects on P and Q.

14. Efficiency, equity and policy trade-offs

• Competitive markets are efficient benchmarks, but efficiency may conflict with equity (distribution). Governments may intervene to redistribute (taxes/transfers) or correct market failures (externalities, public goods).
• Policy design should minimize distortions — targeted transfers are usually less distortionary than blanket price controls.

15. Diagrams & practice you must do

• Draw and label: demand and supply intersection (equilibrium), consumer & producer surplus; a binding price ceiling and its shortage; a binding price floor and its surplus; tax wedge showing prices paid and received and tax revenue rectangle.
• Practice algebra: solving linear demand & supply equations, computing equilibrium P and Q, shortage/surplus, tax revenue, and change in consumer/producer surplus.

16. Useful formulas & quick reference

17. Short CBSE-style sample questions (with answers)

18. Longer practice question (CBSE style — 8 marks) with model answer

19. How to answer CBSE questions (exam strategy)

1. Use diagrams: Always draw clean, labeled diagrams for equilibrium, tax, ceiling/floor questions. Label axes, curves, equilibrium points, and shaded areas.
2. State conditions clearly: e.g., binding vs non-binding, shutdown conditions (if relevant), who pays tax (incidence).
3. Short & precise: For 2–3 mark questions, give definitions and 1–2 short implications. For 6–8 mark questions, structure: definition, diagram, effects, reasons/examples, conclusion.
4. Practice algebra: Be fluent solving linear supply/demand equations; examiners often use simple linear forms in numerical questions.