Identifying and Explaining Market Shortages and Surpluses

Conventions for Identifying and Graphing Market Shortages and Surpluses

• Graphing Best Practices:

  • Scale Selection: Choose an appropriate scale that ensures the graph occupies the majority of the provided grid space.

  • Axis Breaks: A break may be shown in the axis to allow for a scale that does not start at $0$.

  • Plotting Accuracy: Plotted points must be marked carefully to ensure high accuracy.

  • Curve Construction: Plot the points for one curve in its entirety and join them with ruled lines before beginning the second curve.

  • Essential Labels: Every graph must include:

    • A descriptive title (e.g., "Market for Cheese Scones per week").

    • Clearly labeled axes (typically Price [$P$] on the vertical axis and Quantity [$Q$] on the horizontal axis).

    • Labeled curves (Supply [$S$] and Demand [$D$]).

Identifying Market Imbalances Graphically

• The Horizontal Line Method: To identify a shortage or surplus, draw a dotted horizontal line across the graph at the specified price ($P_1$).

• Identifying Quantity Demanded ($Q_d$): Locate where the horizontal price line intersects the Demand curve ($D$). Draw a vertical line straight down to the horizontal axis and label it $Q_d$.

• Identifying Quantity Supplied ($Q_s$): Locate where the horizontal price line intersects the Supply curve ($S$). Draw a vertical line straight down to the horizontal axis and label it $Q_s$.

• Defining the Gap:

  • Shortage: Occurs when Q_d > Q_s. The shortage amount is the horizontal difference between the points on the quantity axis ($Q_d - Q_s$).

  • Surplus: Occurs when Q_d < Q_s. The surplus amount is the horizontal difference between the points on the quantity axis ($Q_s - Q_d$).

Illustrating Market Reactions and Equilibrium

• Market Adjustments: To show how a free market reacts to an imbalance, use arrows along the demand and supply curves indicating movement toward the equilibrium point ($P_e$, $Q_e$).

• Price and Quantity Shifts:

  • Indicate the change in price using an arrow on the vertical axis.

  • Identify the equilibrium price ($P_e$) and the equilibrium quantity ($Q_e$).

  • Show the quantity returning to equilibrium using arrows from $Q_s$ and $Q_d$ toward $Q_e$ on the horizontal axis.

Explaining the Free Market Reaction to a Shortage

• The Bidding Process: At a price below equilibrium, a shortage exists. For a shortage, explain that consumers will "bid up" the price of the good or service. They offer to pay more to ensure they do not miss out on the item.

• Implementation of Economic Laws:

  • The Law of Demand: As the price rises due to consumer bidding, the quantity demanded will fall. This occurs because fewer consumers are willing and able to purchase the good at the higher price.

  • The Law of Supply: As the price rises, the quantity supplied will rise. This occurs because the good becomes more profitable for producers to manufacture or sell.

• Restoration of Equilibrium: The price increase ceases when the price reaches $P_e$. At this point, quantity demanded equals quantity supplied ($Q_d = Q_s$), and there is no further incentive for prices to be bid higher.

Explaining the Free Market Reaction to a Surplus

• Clearing Excess Stock: At a price above equilibrium, a surplus exists. Producers will lower their prices to clear excess stock from their shelves, as they do not want unsold inventory left over.

• Implementation of Economic Laws:

  • The Law of Demand: As the price falls, the quantity demanded will rise. More consumers are willing and able to purchase the good at the lower price point.

  • The Law of Supply: As the price falls, the quantity supplied will fall. This occurs because the level of profitability for the good decreases, leading producers to supply less.

• Restoration of Equilibrium: The price decrease ceases when the price reaches $P_e$. At this point, quantity demanded equals quantity supplied ($Q_d = Q_s$), and there is no further need for producers to lower prices.

Case Study: New Zealand Market for Lord of the Rings Lego

The following data represents market trends per month:

• Analysis at Price $22$:

  • At $22$, market demand ($42$ range) exceeds supply ($18$ to $26$ range).

  • Market Reaction: Consumers in Timaru will bid up the price of cakes towards the equilibrium price of $30$.

• Analysis at Price $34$:

  • At $34$, supply ($35$ to $45$ range) exceeds demand ($22$ to $30$ range).

  • Market Reaction: Producers will lower the price to move surplus cakes off the shelves, returning the price toward the equilibrium of $30$.