Prelims High-Yield Explanations & Traps

• the market
• role
• the demand for and supply of wheat (in kg) respectively
• to point out that by labour, we mean the hours of work provided
• the equilibrium number of firms by n
• that with free entry and exit, shift in demand has a
• a situation where the plans of all consumers and firms in the market match and the market clears

Essential Definitions & Formulas

An equilibrium

a situation where the plans of all consumers and firms in the market match and the market clears.

The price at which equilibrium is reached is called equilibrium price and the quantity bought and sold at this price

called equilibrium quantity.

Whenever market supply

not equal to market demand, and hence the market is not in equilibrium, there will be a tendency for the price to change.

In this section with the help of these two curves we will look at how supply and demand forces work together to determine where the market will be in equilibrium when the number of firms

fixed.

The equilibrium quantity

q* and the equilibrium price is p*.

Market Equilibrium there

excess demand.

The market moves towards the point where the quantity that the firms want to sell

equal to the quantity that the consumers want to buy.

This happens when price

p * , the supply decisions of the firms only match with the demand decisions of the consumers.

S which implies that there

excess demand at this price.

The basic difference between a labour market and a market for goods

with respect to the source of supply and demand.

The wage rate

determined at the intersection of the demand and supply curves of labour where the demand for and supply of labour balance.

The firm being a profit maximiser will always employ labour upto the point where the extra cost she incurs for employing the last unit of labour

equal to the additional benefit she earns from that unit.

The extra cost of hiring one more unit of labour

the wage rate (w).

The extra output produced by one more unit of labour

its marginal product (MP L ) and by selling each extra unit of output, the additional earning of the firm is the marginal revenue (MR) she gets from that unit.

As long as the VMP L

greater than the wage rate, the firm will earn more profit by hiring one more unit of labour, and if at any level of labour employment VMP L is less than the wage rate, the firm can increase her profit by reducing a unit of labour employed.

VMP L implies that the demand curve for labour

downward sloping.

To explain why it

so, let us assume at some wage rate w 1 , demand for labour is l 1 .

Wage

determined at the point where the labour demand and supply curves intersect.

Since the firm under consideration

perfectly competitive, it believes it cannot influence the price of the commodity.

Their supply decision

essentially a choice between income and leisure.

Related PYQs (2)