2.3 Competitive Market equilibrium

market equilibrium

when demand equals supply and the market clearing price and output are established

disequilibrium

if the price of a good is not at the equilibrium level there a natural market pressure to push it to the equilibrium price

explain the rationing function of price

price increase - reduces Qd - only consumers willing and able to pay more remain in the market

this is a contraction along the demand curve

when does a surplus occur

when the current market price is set above the equilibrium price meaning quantity supplied is greater than quantity demanded, causing producers to supply more than consumers are willing to buy

when does a shortage occur

when the current market price is set below the equilibrium price meaning quantity demanded is greater than quantity supplied, causing consumers to demand more than producers are willing to supply

how does a market leave disequilibrium when there’s a shortage

- buyers can't buy products, producers dont make enough profit

-producers gradually increase prices

- some buyers no longer desire the good or service

-producers are incentivised by the higher prices to produce more

-Qd falls and Qs rises

-market returns back to equilibrim

how does a market leave disequilibrium when there’s a surplus

• quantity demanded for a good or service falls

• suppliers have accumulated unsold inventory

• producers are incentivised to lower prices

• consumers are willing and able to buy more at the lower price

• Qd increases and Qs falls

• market returns to equilibrium

what causes the establishment of a new market equilibrium

shifts in either supply or demand

what is the price mechanism

the system in a free market economy where interaction between buyers and sellers determines prices, which in turn allocates scarce resourcesin a free market

what two functions does the price mechanism fulfil?

resource allocation

rationing

what are the two types of resource allocation

signalling

incentive

signalling function of price

a change in price sends a signal to producers and consumers that market conditions are changing and the price provides them with information to make decisions on how they might act in response to the price change

mechanism for the signalling function of price

e.g. demand shifts right

excess demand at the existing market price

for the market to clear, the market price needs to rise

the rise in price signals to consumers and producers that market conditions are changing providing them with information to make informed buying and selling decisions

incentive

-when prices for a good/service rise, incentivises producers to reallocate resources from a less profitable market to this market in order to maximise their profits

-falling prices incentivise the reallocation of resources to new markets

what is the price mechanism when prices rise caused by a leftwards shift in demand or a rightwards shift in supply?

1. signal excess demand and need for an increased quantity of resources

2. incentivise firms to increase output due to profit maximisation - extension along supply curve

3. ration resources by lowering consumption - contraction along demand curve

4. allocate resources efficiently at new equilibrium

what is the price mechanism when prices fall caused by a rightwards shift in demand or a leftwards shift in supply?

1. signal excess supply and need for fewer quantity of resources

2. incentivise firms to decrease output to increase profit - contraction along supply curve

3. ration scarce resources by increasing consumption - extension along demand curve

4. allocate resource efficiently at equilibrium

what is consumer surplus

difference between the amount consumer is willing to pay for a product and the price they have actually paid

what is producer surplus

the difference between the amount that the producer is willing to sell a product for and the price they actually do

how to calculate community surplus

consumer surplus + producer surplus

allocative efficiency

occurs when resources in the market are allocated such that community surplus is maximised

when demand equals supply or MB equals MC

marginal benefits

the additional utility a consumer gains from consuming one extra unit of a good or service

marginal costs

the additional cost incurred from producing an extra unit of a good or service

what is the difference between allocative efficiency and productive efficiency

Productive efficiency occurs when goods are produced at the lowest possible average cost, meaning that scarce resources are used without waste. It happens at any point on the PPC or at the minimum point of the average cost curve.Allocative efficiency occurs when resources are distributed in a way that maximizes societal welfare, where price equals marginal cost (P = MC). This ensures the most desired combination of goods and services is produced, reflecting consumer preferences.