The market system Study Guide

Market equilibrium occurs when the quantity of a good or service that consumers are willing and able to purchase at a given price (demand) exactly matches the quantity that producers are willing and able to supply at that same price (supply). This point is known as the equilibrium price and equilibrium quantity. At this specific price, there is no tendency for the price to change because there are no pressures from excess supply (surplus) or excess demand (shortage). If the price is above the equilibrium, a surplus will emerge, leading producers to lower prices to clear stock. If the price is below the equilibrium, a shortage will occur, leading consumers to bid up prices. The forces of demand and supply thus naturally push the market towards this equilibrium. Changes in non-price determinants of demand or supply will shift the respective curves, leading to a new equilibrium price and quantity.

Price Elasticity of Demand (PED) measures the responsiveness of the quantity demanded of a good or service to a change in its price. It helps businesses and policymakers understand how consumers react to price adjustments. A high PED (elastic demand) indicates that consumers are very sensitive to price changes, meaning a small price increase can lead to a significant drop in quantity demanded. Conversely, a low PED (inelastic demand) suggests consumers are not very responsive to price changes, so a price increase would cause only a relatively small decrease in quantity demanded. The PED value is calculated as the percentage change in quantity demanded divided by the percentage change in price. The result is always negative, but economists typically use the absolute value for interpretation. Factors influencing PED include the availability of substitutes, the proportion of income spent on the good, and the necessity of the good.