3.5 the determination of eqiulibrium market prices

unfinished

assumptions of the supply and demand model

firms are price takers

many buyers and sellers

perfect information

homogenous product

market clearing price

equilibrium price → quantity supplied = quantity demanded

disequilibrium

where supply and demand are not equal and there is excess demand or supply

surplus

excess supply

shortage

excess demand

why does excess demand lead to changes in prices

too much money chasing too few goods

sellers notice the excess demand (goods selling out)

and respond by increasing prices to maximize profit

consumers ration their demand and more sellers are incentivised to join the market

leading to a new equilibrium

why does excess supply lead to changes in price

sellers are stuck with more goods than buyers are willing to purchase

to attract buyers, sellers lower their prices

lower price attracts more buyers and removes incentives for some suppliers

functions of the price mechanism

signalling function

incentive function

rationing function

allocative function