1.2.6 price determination

Question 1

what does the equlibrium point refer to?

Answer 1

This is where supply=demand, this is also known as the market clearing price since all the products supplied to the market are brought.

Question 2

what happens to price determination when there’s excess demand in the market?

Answer 2

Initially we state that the price is set below the equilibrium point where this will lead to excess demand.

• since prices are cheap the suppliers are willing to supply at QS but consumers want it at QD this the reason behind the excess demand.
• firms will therefore charge higher prices which will cause an extension in supply but a contraction in demand so that it can go back to the price equlibrium.

Question 3

how would you draw the curve for excess demand?

Answer 3

label x-axis as quantity

• label y-axis as price
• draw a normal supply and demand diagram
• then set the equilibrium price at pstar and qstar
• due to excess demand the price will be low where they are supplying at qs but consumers want qd this creates a small triangle under the equilibrium price to show excess demand before it gets rationed.

Question 4

what happens to excess supply?

Answer 4

when the price is set higher than the equilibrium price there will be excess supply

• at p2 the supplier are willing to supply at QS but consumers only want QD
• therefore the firm will have to reduce prices to get rid off excess goods which will cause prices to fall, this means that the point will go back to its equilibrium point at p1 and q1.

Question 5

How would the diagram look for excess supply diagram?

Answer 5

You draw a normal Demand and Supply diagram

• draw a dotted line across to represent the market equilibrium point between p1 and q1.
• then draw p2 to show how the prices have increased where consumers want QD but suppliers are willing to supply at qs this creates a small triangle above the price to show the excess supply.