1.3 Market equilibrium & role of price mechanisms

market equilibrium definition

point at which quantity demand = quantity supplied, resulting in a stable market with no shortages or surplus

The market remains in equilibrium when

an outside disturbance - a change in any of the non-price determinants of demand or supply

Price mechanism definition

The process through which prices adjust in response to shortage or surplus (changes in demand and supply often caused by non-price factors). meaning the market naturally adjusts itself through the price mechanism (without needing external control - gov intervention unless necessary)

Price mechanisms

1. self regulating in theory (free market, perfectly competitive)

2. guide producers and consumers to restore market equilibrium

3. no central authority “corrects itself “

Change in price signals

1. to producers to produce more or less

2. to consumers to consumer more or less

3. where resources should be moved to match consumer preferences and resource scracity

Surplus definition

occurs when the quantity supplied exceeds the quantity demanded at a given price.

(too much of the good is available)

Shortage definition

occurs when the quantity demanded exceeds the quantity supplied at a given price.

(too many people want the good but not enough available)

Causes of surplus

1. when the market price is set above equilibrium price (producers want to supply more, consumers want to buy less)

2. government intervention:

   • minimum prices set above the equilibrium can cause surpluses

   • subsides - may lead to overproduction if they artificially boost supply beyond demand

3. Sudden increase in supply

   • due to technological improvements

   • lower production costs

   • good weather

Consequences of Surplus

1. Downward pressure on price - producers may lower prices to sell of excess stock

2. waste for storage costs - increases costs of firms

3. inefficiency - resources could have been used better, so that society could get most benefit from its limited resource

4. Government action (if caused by policy) - government may buy up the surplus

Causes of shortages

1. price set below equilibrium price - consumers want to buy more, producers are willing to supply less

2. government intervention

• price ceiling

3. supply side issues - natural disasters, wars may reduce supply while demand stays the same or increases

4. sudden increase in demand:

• panic buying (COVID) or trends can lead to temporary shortage

Consequences of a shortage

1. Upward pressure on price

• buyers compete for limited goods

• seller may raise prices, market moves back towards equilibrium

2. rationing of black markets

• black markets can emerge where goods are sold illegally at higher prices above ceiling

• gov may ration goods

3. consumer dissatisfaction

• long lines, waiting lists, unmet needs

4. inefficiency & misallocation - the good may go to those who not value them

increase in demand

caused: non-price determinants in demand

effect:

• demand curve shifts right

• prices increase

• quantity increases

Decrease in demand

caused: non-price determinants in demand (fall in them)

effect:

• demand curve shifts left

• price decreases

• quantity deceases

Increase in supply

caused: non-price determinants of supply (rise)

effects:

• supply curve shifts right

• price decreases

• quantity increases

decrease in supply

caused; non-price determinants of supply

effects:

• supply curve shifts left

• price increases

• quantity decreases

Process of regulation in shortage

1. upward pressure due to shortage price will rise, producers increase supply, consumers demand less

   = the market goes back to equilibrium

2. market eliminates shortage by slow rise in price

process of regulation in a surplus

1. downward pressure due to surplus, prices will fall due to unsold goods, causing prices to fall, producers reduce supply, noshers buy more

= the market goes back to equilibrium