Chapter 5: Competitive Market Equilibrium Flashcards
What is market equilibrium?
When a market is cleared of any shortage/surplus. Occurs at price where quantity demanded = quantity supplied. This establishes an equilibrium price and quantity traded.
What is equilibrium/market clearing price?
Established when demand matches supply of a product at a given point in time. There is neither excess qd or qs.
Change in non price determinants for both supply and demand will?
Cause a shift to the curve, thus causing a change to EQ price and quantity traded.
What is market disequilibrium?
When quantity supplied is not equal to the quantity demanded Disequilibrium is inefficient as there is a shortage (excess demand) or surplus of supply (excess supply) in the market.
What is excess supply?
Occurs when price is above market eq price, surplus exists because at higher price, supply exceeds quantity demanded. Incentive for firms to supply more at higher prices, but less of an incentive for customers to demand the product.
This can be represented as a shaded area.
Example of Excess supply (no need to remember)
If a baker sells bread at price of $3 per loaf, and is willing+able to supply 200 loaves per day, but consuemrs only demand 150 loaves. Excess supply is given as 50. (ES($3) = S($3) - D($3) = 200 - 150 = 50)
this is shown by horizontal distance
If a firm has a surplus of supply, what can be done to encourage expansion in quantity demanded?
Price can be reduced to encourage an expansion in quantity demanded (movement along demand curve) and a contraction in the supply of a product.
What is excess demand?
When price is set below equilibrium, there is a shortage in supply, as demand exceeds quantity supplied, consumers are more willing to buy more at lower prices, but less incentive for firms to supply product.
Excess demand = demand - supply, this is shown by horizontal distance
If market faces a shortage what can happen to encourage an expansion?
Increase in price (causing movement along supply curve) will cause an expansion in quantity supplied, and a contraction in quantity demanded for a product.
What is price mechanism?
Means by which forces of demand and supply determine the allocation scarce resources between competing uses, used to address the basic economic problem of scarce resources, needs and infinite wants. Relative prices and changes reflect forces of demand and supply, affecting what, how and for whom production should take place. Scarcity imposes production/consumption choices. Resulting in opportunity cost.
What are the two main functions of price mechanism?
Resource allocation (signalling1 and incentives2)
Aspects of price mechanism in allocating resources:
- 1) signalling. providing information to producers and consumers where resources are required in markets where prices increase and where they are not
- 2) incentives, price changes provide incentive for producers+consumers to change their behaviour in order to maximize their benefit.
Rationing (of scarce resources)
- deters some consumers from buying a product/resource owing to higher prices, therby rationing the proudct. Serves to ration resources when demnad exceeds supply.
What is resource allocation (signalling and incentives functions)?
Explain using price
Price has both a signalling function and incentive function. Signalling function occurs as market forces (s and d) signify where resources are required and where they are not.
rise in price, sends signal to manufacturers to enter industry. higher prices act as an incentive to raise output as well. If demand increases, demand curve shifts, eq price will also increase, signalling firms to raise supply as there is an incentive to do so. However consumers reduce demand/withdraw from market if prices are too high. Long term changes in price also inform producers about whether to enter/leave a market
What is an incentive?
Anything that motivates producers/consumers to follow a particular course of action/change their behaviour. Higher prices, supply more.
How do fluctuating market prices reflect relative scarcities and surpluses in different markets? (other examples of signalling and incentives functions oof the price mechanism include)
- if prices are rising due to an increase in demand, signals supplier to expand production in order to meet higher level of demand.
- If there is a surplus in the market, price mechanism eliminates the excess supply, by adjusting market price downwards.
- higher salaries, incentivises more people to enter the industry by acquiring the relevant qualifications, skills and experiences.
- during an recession when demand is lower, supply contracts as producers reduce their output.
What is the rationing function?
Serves to limit or preserve resources, higher the price of the product, the lower qd will tend to be, thereby helping to ration the good/service. This is important when demand outstrips supply (excess demand/shortage). Effect of such an increase helps conserve resources and to spread out their use over time. Greater the scarcity, the higher its price so more of the resource is rationed. If there is a shortage, eq price will be forced by price mechanism, reducing number of people willing+able to pay for product. e.gs are auctions.
