1.4 the determination of equilibrium price and output in a freely competitive market

Question 1

when is there an excess in demand

Answer 1

when the price is too low

Question 2

when is there an excess in supply

Answer 2

when the price is too high

Question 3

what is the equilibrium price also called?

Answer 3

the market clearing price

Question 4

why is the equilibrium price at equilibrium?

Answer 4

there is no pressure on price in either direction –> stable equilibrium

Question 5

what does an inwards shift of the demand curve result in?

Answer 5

• decrease in quantity sold
• fall in price

Question 6

what does an outwards shift of the demand curve result in?

Answer 6

• increase in quantity sold
• increase in price

Question 7

what does an inwards shift of the supply curve result in?

Answer 7

• decrease in quantity sold
• increase in price

Question 8

what does an outwards shift in the supply curve result in?

Answer 8

• increase in quantity sold
• decrease in price

Question 9

role of the price mechanism explanation (example: decrease in demand)

Answer 9

1. market begins at equilibrium at P1 and Q1
2. the demand curve shifts inwards
3. at the old price there is no temporary disequilibrium (qs>qd)
4. this is called an EXCESS IN SUPPLY which creates a DOWNWARD PRESSURE on the PRICE
5. price falls to P2
6. the new lower price acts as a signal and incentive (firms wish to supply less and consumers wish to consume more)
7. at the NEW PRICE, quantity demanded EXTENDS while quantity supplied CONTRACTS until qs = qd
8. new equilibrium formed at Q2
9. the new price has effectively RATIONED the good by brining the market back into equilibrium and ELIMINATING the surplus