4.1.3.5 - Determination of Market Equilibrium Prices

Market Equilibrium

When planned demand equals planned supply, so no excess demand or supply. (point where demand curve crosses supply curve)

Market Disequilibrium

Exists at any price other than equilibrium price.

- Either excess demand or supply exists in the market

If price is set below equilibrium...

then quantity demanded will be greater than quantity supplied (excess demand)

If price is set above equilibrium...

then quantity demanded will be less than quantity supplied (excess supply)

What happens to price and quantity if: "An increase in the raw material costs"

1) An increase in raw material costs will cause an increase in costs of production.

2) As a result, producers become less willing and able to supply at any given price over a given period of time. This is shown in a shift of the supply curve to the left (S1 to S2).

3) As a result, at P1, there is less quantity of supply than demand and thus a disequilibrium exists.

4) In order to maximise profits, firms will increase the price (P1 to P2)

5) This causes an extension of supply and a contraction of demand, which means equilibrium is regained at E2.

6) The overall consequence is that the equilibrium price increases from P1 to P2, and the equilibrium quantity decreases from Q1 to Q2.

What happens to price and quantity if: "A product becomes more fashionable"

1) A product becoming more fashionable means consumers have more desire for the product.

2) This causes consumers to be more willing and able to buy at any given price over a given period of time. This is shown by a shift of the demand curve to the right (D1 to D2.)

3) As a result, at P1, there is more demand than supply for the product, therefore a disequilibrium exists.

4) In order to maximise profits, the firm will increase the price from P1 to P2

5) This causes an extension of the supply curve and a contraction of the demand curve, causing an equilibrium to be regained at E2.

6) The overall consequence is that equilibrium price increases from P1 to P2, and equilibrium quantity increases from Q1 to Q2.