Price Determination (Copy)

2.5.1 Market Equilibrium

• Equilibrium: The point where demand equals supply, i.e. where there is no tendency for price to change.
• Equilibrium price (Pₑ): The price at which the quantity demanded (Qd) equals the quantity supplied (Qs).
• Equilibrium quantity (Qₑ): The quantity bought and sold at equilibrium price.
• Both buyers and sellers are satisfied at this point → no surplus, no shortage.

Demand and Supply Schedules Example

• At price 30: Qd = 60, Qs = 60 → equilibrium.

ASCII Diagram: Market Equilibrium

Price
 |
 | 
 |     D (Demand)
 |   
 |         
 |         
 |       
 |-------X---------- S (Supply)
 |       | Qₑ
 |       |
 +------------------ Quantity
         Qₑ

• The intersection point (X) shows equilibrium price (Pₑ) and quantity (Qₑ).

2.5.2 Market Disequilibrium

• Disequilibrium: Any situation where demand ≠ supply, i.e. the market price is not at equilibrium.
• Two main types:
  1. Shortage (Excess Demand): Price is below equilibrium.
     • Demand > Supply.
     • Buyers compete → price rises.
  2. Surplus (Excess Supply): Price is above equilibrium.
     • Supply > Demand.
     • Sellers lower prices to clear stock.

ASCII Diagram: Shortage (Excess Demand)

Price
 |
 |         D
 |       
 |         
 |---------- S
 |    /
 |   /  
 |  /     
 | /      
 |/        
 +------------------ Quantity
       Qd > Qs   → Shortage

• At this low price:
  • Quantity demanded > Quantity supplied.
  • Creates shortage → upward pressure on price.

ASCII Diagram: Surplus (Excess Supply)

Price
 |
 |          D
 |        
 |        
 |---------- S
 |         
 |         
 |         
 |         
 +------------------ Quantity
       Qs > Qd   → Surplus

• At this high price:
  • Quantity supplied > Quantity demanded.
  • Creates surplus → downward pressure on price.

Market Forces Returning to Equilibrium

• In both surplus and shortage situations, market forces (demand and supply) push the price back to equilibrium.
• Mechanism:
  • If shortage → buyers bid up prices → supply extends, demand contracts → equilibrium restored.
  • If surplus → sellers lower prices → demand extends, supply contracts → equilibrium restored.
• This is the price mechanism at work.

Key Takeaways

• Equilibrium: where demand = supply.
• Disequilibrium: shortage (excess demand) or surplus (excess supply).
• Market forces naturally adjust prices toward equilibrium.
• Diagrams and schedules are essential for understanding the adjustment process.