1.2.3 Markets & Equilibrium

The interaction of supply and demand

In markets with no product differentiation, the price is determined by market forces of supply and demand. The equilibrium price is the price where the demand and supply are equal, resulting in the market clearing price. The market can experience a surplus or shortage when supply exceeds demand or demand exceeds supply, respectively. In such cases, the market should return to the equilibrium price.

The drawing and interpretation of supply and demand diagrams to show the causes and consequences of price changes

The market is said to be in disequilibrium when demand and supply are not equal. Surplus is an excess of supply over demand, and a shortage is an excess of demand over supply. To regain equilibrium when prices are higher than the equilibrium price, there would be a surplus of products, and manufacturers would reduce the price to clear the surplus supply. This results in an extension of demand and a new equilibrium price of P2 and new equilibrium quantity of Q2. If prices are lower than the equilibrium price, there would be a shortage of the product. Manufacturers would increase the price to maximize profits, resulting in a contraction of demand. Eventually, the market forces would lead to the equilibrium position being reached, with a new equilibrium price of P2 and new equilibrium quantity of Q2.

To answer an exam question on this topic, it is essential to use the correct terminology and logic. If prices are set too high, the market experiences a surplus, resulting in a reduction in price and a contraction of supply and an extension of demand. If prices are set too low, the market experiences a shortage, resulting in an increase in price and a contraction of demand. To answer such questions, it is crucial to draw the appropriate diagrams and apply the concepts correctly.

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