In a market system, prices for goods/services are determined by the interaction of demand and supply.
○ A market is any place that brings buyers and sellers together.
○ Markets can be physical (e.g. McDonald's) or virtual (e.g. eBay).
Buyers and sellers meet to trade at an agreed price
○ Buyers agree the price by purchasing the good/service.
○ If they do not agree on the price then they do not purchase the good/service and are exercising their consumer sovereignty.
Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties
○ At the equilibrium price, sellers will be satisfied with the rate/quantity of sales.
○ At the equilibrium price, buyers are satisfied that the product provides benefits worth paying for.

Equilibrium in a market occurs when demand = supply.
At this point the price is called the market clearing price.
○ This is the price at which sellers are clearing (selling) their stock at an acceptable rate.

A graph showing a market in equilibrium with a market clearing price at P & quantity at Q

Any price above or below P creates disequilibrium in this market.
○ Disequilibrium occurs whenever there is excess demand or excess supply in a market.

Market Disequilibrium

Excess demand occurs when the demand is greater than the supply.
○ It can occur when prices are too low or when demand is so high that supply cannot keep up with it.

A graph that depicts the condition of excess demand in the market for electric scooters

At a price of P1, the quantity demanded of electric scooters (Qd) is greater than the quantity supplied (Qs).
There is a shortage in the market equivalent to QsQd.

This market is in disequilibrium.
○ Sellers are frustrated that products are selling so quickly at a price that is obviously too low.
○ Some buyers are frustrated as they will not be able to purchase the product.
Sellers realise they can increase prices and generate more revenue and profits.
Sellers gradually raise prices.
○ This causes a contraction in QD as some buyers no longer desire the good/service at a higher price.
○ This causes an extension in QS as other sellers are more incentivised to supply at higher prices.
In time, the market will have cleared the excess demand and arrive at a position of equilibrium (PeQe).
○ Different markets take different lengths of time to resolve disequilibrium. For example, retail clothing can do so in a few days. Whereas the housing market may take several months, or even years.

Disequilibrium: excess supply

Excess supply occurs when the supply is greater than the demand.
○ It can occur when prices are too high or when demand falls unexpectedly.
During the later stages of the pandemic the market for face masks was in disequilibrium.

A graph that depicts the condition of excess supply in the market for Covid-19 face masks during the later stages of the pandemic

2 comments

Comments (2)

Nov 10

What happens when there is a shift in the supply or demand curve, and how does it affect market equilibrium?
How do government interventions, such as price ceilings and price floors, impact market equilibrium?
What are the effects of market disequilibrium, such as surpluses and shortages, on the economy?
How do external factors, like changes in consumer preferences or production costs, influence market equilibrium?
What role do expectations about future prices play in determining current market equilibrium?

Nov 12

Replying to

As you can see, an increase in demand causes the equilibrium price to rise. On the other hand, a decrease in demand causes the equilibrium price to fall. An increase in supply causes the equilibrium price to fall, while a decrease in supply causes the equilibrium price to rise.
A price ceiling creates a shortage in the market as the quantity demanded exceeds the quantity supplied at the ceiling price. On the other hand, a price floor creates a surplus in the market as the quantity supplied exceeds the quantity demanded at the floor price.
Whenever markets experience imbalances—creating disequilibrium prices, surpluses, and shortages—market forces drive prices toward equilibrium. A surplus exists when the price is above equilibrium, which encourages sellers to lower their prices to eliminate the surplus.
There is a multitude of factors that affect a market and alter the equilibrium price. Demand factors that can change price range from changes in income or preferences, while supply factors can be taxes or production costs changes. Many firms have to restructure their finances after a minimum wage increase.
Such expectations have no effect on the current market supply and demand condition, but do affect agents' current inventory decision, the spot and expected future prices. It is such expectations that are referred to as the “expectations” in the model.

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