Market equilibrium: where the quantity supplied equals the quantity demanded

• Excess supply: more is being supplied than demanded at P1, in order to eliminate the surplus, producer must lower the price

• Excess demand: more is being demanded than supplied at P2, in order to eliminate the surplus, producer must raise the price

A market consists of buyers and sellers who come together to exchange goods

• Equilibrium is when supply satisfies demand and is equal to it

• Qd = Qs

• Everything produced in the market will be sold

• Market won't change without external change

Eliminating excess supply (surplus):

• Market is in disequilibrium

• Producers will h2ave to supply at a lower rate

• Quantity demanded will increase until demand equals supply, resulting in equilibrium

• Surplus of Q1-Q2

• Decrease price to get rid of supply, demand increases

Eliminating excess demand (shortage):

• Disequilibrium due to excess demand

• Excess of Q2-Q1

• Q2 → demanded  Q1 → supplied = shortage

• To eliminate shortage, prices decrease

• Quantity will decrease

• Demand and supply will be equal resulting in equilibrium

Effect of changes in demand and supply on equilibrium:

• Initially → price at equilibrium

• Q1 → supplied   Q2 → demanded

• Prices need to increase for shortage to end

• Equilibrium restored at P2, new equilibrium quantity at P3

• A shift will cause demand/supply curve to adjust to a new equilibrium/market clearing price

Price mechanism moves the market into equilibrium, so that the scarce resources are reallocated.

• Opportunity cost: is the next best alternative forgone. When a choice is made, there is an opportunity cost.

• Price mechanism: forces of supply and demand:

  • Resources: allocated/re-allocated in response to changes in price

  • Price of a good increases, demand increases

  • Products hope to maximise profit, will produce more

  • Producers allocate more goods with higher demand (more profit)

    • Concept: factors of production produce desired goods and services

Market efficiency

Market efficiency refers to the degree to which market prices reflect all available, relevant information.

• Consumer surplus: the extra satisfaction a consumer gains from paying a price less than they were prepared to pay.

• Producer surplus: the excess of actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to accept for that output.

When a market is allocatively efficient, the social (community) surplus is maximised, this is made up of the consumer and producer surplus. This means that the marginal social benefit = the marginal social cost. Allocative efficiency happens when competitive market is in equilibrium, where resources are allocated in the most efficient way from society’s point of view.