Price determination Revision Notes

Market equilibrium occurs when the quantity of a good or service that consumers want to buy equals the quantity that producers want to sell at a particular price. This balance means there is no tendency for the price to change, as the market clears all goods supplied without surplus or shortage.

Understanding market equilibrium is fundamental to economics because it shows how prices are determined in a competitive market. It also helps explain how markets respond to changes in demand or supply conditions.

• Equilibrium is the point where demand equals supply.
• At equilibrium, the market 'clears' with no excess demand or supply.
• The equilibrium price is the price at which this balance occurs.
• The equilibrium quantity is the amount bought and sold at this price.

A demand schedule is a table that shows the quantity of a good consumers are willing and able to buy at different prices, holding other factors constant. Typically, as price falls, quantity demanded rises, reflecting the law of demand.

A supply schedule is a table showing the quantity producers are willing and able to sell at various prices. Usually, as price rises, quantity supplied increases, reflecting the law of supply.

By comparing demand and supply schedules, we can identify the price at which quantity demanded equals quantity supplied — the equilibrium price. The corresponding quantity is the equilibrium quantity.

• Demand schedule: price vs quantity demanded.
• Supply schedule: price vs quantity supplied.
• Equilibrium found where quantity demanded equals quantity supplied.
• Example: At $10, demand is 50 units and supply is 50 units — equilibrium.

Demand and supply schedules can be represented graphically as curves on a price-quantity graph. The demand curve slopes downward from left to right, showing that lower prices lead to higher quantity demanded.

The supply curve slopes upward from left to right, indicating that higher prices encourage producers to supply more.

The point where the demand and supply curves intersect is the market equilibrium. The price at this intersection is the equilibrium price, and the quantity is the equilibrium quantity.

• Demand curve slopes downwards due to inverse price-quantity relationship.
• Supply curve slopes upwards due to positive price-quantity relationship.
• Intersection point = market equilibrium.
• Graphical analysis helps visualise market balance.

To find the equilibrium price and quantity, examine the demand and supply schedules or curves to identify where quantity demanded equals quantity supplied.

For example, consider the following demand and supply schedule for a product:

| Price ($) | Quantity Demanded | Quantity Supplied | |---|---|---| | 5 | 100 | 20 | | 10 | 80 | 50 | | 15 | 60 | 80 | | 20 | 40 | 110 | | 25 | 20 | 140 | At a price of $15, quantity demanded (60 units) equals quantity supplied (80 units) — not equal, so no equilibrium. At $10, demand is 80 and supply is 50 — no equilibrium. At $20, demand is 40 and supply is 110 — no equilibrium. The equilibrium price lies between $10 and $15, closer to $15, where demand and supply quantities are approximately equal. More precise methods like interpolation or graphing can pinpoint the exact equilibrium.

• Equilibrium price is where quantity demanded equals quantity supplied.
• Use schedules or curves to identify this point.
• Example: At $15, demand and supply are close but not equal; equilibrium is near this price.
• Graphing helps find exact equilibrium visually.

If the price is above the equilibrium price, quantity supplied exceeds quantity demanded, creating a surplus. Producers may lower prices to sell excess stock, moving the market back to equilibrium.

If the price is below equilibrium, quantity demanded exceeds quantity supplied, causing a shortage. Consumers compete for limited goods, pushing prices up towards equilibrium.

Thus, the market mechanism tends to move prices toward equilibrium, balancing demand and supply over time.

• Price above equilibrium → surplus → downward pressure on price.
• Price below equilibrium → shortage → upward pressure on price.
• Market forces drive price toward equilibrium.
• Equilibrium is a stable point in a competitive market.

Market disequilibrium occurs when the quantity demanded by consumers does not equal the quantity supplied by producers at a given price. Unlike market equilibrium, where demand and supply balance perfectly, disequilibrium signals an imbalance that causes market forces to act in order to restore balance.

This imbalance can be identified by examining demand and supply schedules—tables showing quantities demanded and supplied at various prices—and their graphical representations, demand and supply curves. Recognising disequilibrium is essential for understanding how prices and quantities adjust in real markets.

• Market disequilibrium means quantity demanded ≠ quantity supplied at a specific price.
• Demand and supply schedules list quantities at different prices.
• Demand and supply curves graphically represent these relationships.

A demand schedule lists the quantity consumers want to buy at each price, typically showing that demand decreases as price rises. A supply schedule lists the quantity producers are willing to sell at each price, usually increasing with price.

Plotting these schedules produces demand and supply curves. The demand curve slopes downward, reflecting the inverse relationship between price and quantity demanded. The supply curve slopes upward, reflecting the direct relationship between price and quantity supplied.

By comparing quantities demanded and supplied at a particular price, we can identify whether the market is in equilibrium or disequilibrium.

• Demand schedule example: At $5, demand is 100 units; at $3, demand is 150 units.
• Supply schedule example: At $5, supply is 120 units; at $3, supply is 80 units.
• At $5, supply (120) > demand (100) → surplus.
• At $3, demand (150) > supply (80) → shortage.

A shortage occurs when the quantity demanded at a given price is greater than the quantity supplied. This means consumers want to buy more than producers are willing or able to sell at that price.

For example, if at a price of $2, consumers want 200 units but producers supply only 150 units, there is a shortage of 50 units.

Shortages create upward pressure on prices because consumers compete to obtain the limited goods. As prices rise, demand tends to fall and supply tends to increase, moving the market toward equilibrium.

• Shortage = Quantity demanded > Quantity supplied at a price.
• Example: Demand 200 units, supply 150 units at $2 → shortage of 50 units.
• Result: Prices tend to rise to reduce demand and increase supply.

A surplus occurs when the quantity supplied at a given price is greater than the quantity demanded. This means producers have more goods than consumers want to buy at that price.

For example, if at a price of $6, producers supply 180 units but consumers demand only 130 units, there is a surplus of 50 units.

Surpluses create downward pressure on prices because suppliers compete to sell their excess stock. As prices fall, demand tends to increase and supply tends to decrease, pushing the market back toward equilibrium.

• Surplus = Quantity supplied > Quantity demanded at a price.
• Example: Supply 180 units, demand 130 units at $6 → surplus of 50 units.
• Result: Prices tend to fall to increase demand and reduce supply.

When a market is in disequilibrium, the price acts as a signal to both consumers and producers. In the case of a shortage, rising prices discourage some consumers and encourage producers to supply more, reducing the shortage.

In the case of a surplus, falling prices encourage consumers to buy more and discourage producers from supplying as much, reducing the surplus.

This dynamic adjustment continues until the market reaches equilibrium, where quantity demanded equals quantity supplied, and there is no tendency for price to change.

• Price rises when shortage exists, reducing demand and increasing supply.
• Price falls when surplus exists, increasing demand and reducing supply.
• Equilibrium is restored when quantity demanded equals quantity supplied.