1.2 - Price determination

Question 1

What is market equilibrium?

Answer 1

• occurs where
  demand = supply
  > this is market clearing price - place at which sellers are clearing their stock at an acceptable rate

Question 2

What happens if price is higher than clearing price?

Answer 2

• Excess supply
  > supply is greater than demand
  > occurs when prices are too high or when demand falls unexpectedly
  > market is in disequilibrium

Question 3

What happens if price is lower than clearing price

Answer 3

• Excess demand
  > demand is greater than supply
  > occurs when prices are too low
  > shortage in the market
  > market is in disequilibrium

Question 4

How do firms eliminate excess supply?

Answer 4

• Firms have unsold goods
• so this encourages them
  to put on sales/discounts to sell excess goods
• causes prices to fall and supply to contract
• as a result demand extends (to same point)
• market is now in equilibrium

Question 5

How do firms deal with excess demand/shortage in the market?

Answer 5

• Firms can charge higher prices and still sell their goods
• causes an extension in supply
• this higher price causes a contraction in demand
• prices are now in equilibrium