2.3 Market Equilibrium

• 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.
• Excess Demand: Sellers realize they can increase prices and generate more revenue and profits. They gradually raise prices, causing a contraction in quantity demanded (QD) as some buyers no longer desire the good/service at a higher price. This also causes an extension in quantity supplied (QS) as other sellers are more incentivized to supply at higher prices. In time, the market will have cleared the excess demand and arrive at a position of equilibrium.
• Excess supply occurs when the supply is greater than the demand. It can occur when prices are too high or when demand falls unexpectedly.
• Producer Surplus: Sellers will gradually lower prices in order to generate more revenue. This causes a contraction in quantity supplied (QS) as some sellers no longer desire to supply the product. At the same time, this causes an extension in quantity demanded (QD) as buyers are more willing to purchase at lower prices. In time, the market will have cleared the excess supply and arrive at a position of equilibrium.
• Shortages arise when the price is below equilibrium, while surpluses arise when the price is above equilibrium.
• • In a free market system, the price of a good fluctuates with the changes in supply and demand. Buyers and sellers trade at an agreed price. Based on the demand at each price point of a good/service, sellers will gradually adjust their prices until the market for those goods/services reach an equilibrium prine and quantity, which works for both parties. At equilibrium price, sellers will be satisfied with the quantity of sales, whereas the buyers are satisfied with the utility the product provides.
• Equilibrium in a market occurs when demand=supply, also called market-clearing price. Market-clearing price is when suppliers are selling their products at an acceptable rate.
• The price mechanism is the interaction of supply and demand in a free market. It determines the price of a good/service = efficient resource allocation. Adam Smith referred to this as the "invisible hand" of markets.
• Signalling: prices provide information to producers and consumers about where resources are wanted or not
• Incentives: when prices for a good/service rise, it encourages producers to allocate more resources to a profitable market in order to increase profits. Flaling prices enable producers to reallocate resources to a more profitable market.
• Rationing: Prices ration scarce resources. When a product becomes more scarce, the price rises more, and only the ones that can afford it get it. When there's a surplus, more people are able to affort the product due to a price fall.
• Whenever you are faced with questions on the functions of the price mechanism, remember that the functions are built on the principle of self-interest. This will help you to explain each function.
• Consumer surplus is the difference between the amount the consumer is willing to pay for a product and the amount they actually pay. Producer surplus is the difference between the amount that the producer is willing to sell at product for and the price they actually do.
• Consumer surpplus + Producer surplus = social surplus
• Producer/Consumer surplus = base x height / 2 (triangle formula)
• Productive efficiency - highest output using all resources available
• Allocative Efficiency - maximum possible benefit. Where no one can be made better off without making someone else worse off. Using scarce resources as efficiently as possible.
• Competitive market= a market where there are a large amount of buyers and sellers and no single buyer or seller can affect the market. Competitive markets have no barriers to entry.