1.2.6 Price determination Flashcards
What does equilibrium and equilibrium price mean?
Equilibrium means a state of equality or balance between market demand and supply. Equilibrium price
represents a trade-off for buyer and seller – higher prices are good for the producer (higher revenues and
profits) but they make the product more expensive for the buyer.
Show the equilibrium price on a S-D diagram
Show an inward shift in market supply
Show an outward shift in market demand
Explain how an outward shift of demand leads to a new equilibrium price
So, an outward shift of demand (depending upon supply conditions) initially leads to a shortage at the existing
market price (i.e. “excess demand”) – at the existing price, quantity demanded is greater than quantity supplied. There will be waiting lists and queues. This then leads to a short-term rise in price and a fall in available stocks. This acts as a signal to suppliers. The higher price is then an incentive for suppliers to raise their output (termed as an expansion of supply) causing a movement along the supply curve towards the new equilibrium point.
What is excess demand and how does it stimulate an expansion in supply?
- Excess demand is when quantity demanded exceeds available supply
- Excess demand happens when the current market price is set below the equilibrium price.
- This will result in queuing and an upward pressure on price
- Higher prices ration demand to those consumers with effective demand
- Higher prices – in theory – stimulate an expansion of supply as producers respond to higher profits
What is excess supply and how does it stimulate an extension in demand?
- Excess supply is a state of disequilibrium in a market
- When supply is greater than demand and there are unsold goods in the market, there is excess supply
(sometimes known as a ‘glut’) - Surpluses put downward pressure on the market price.
- As prices fall, there is an extension of demand which cuts the surplus and takes a market towards
equilibrium
