LS10 - Price Determination

Question 1

What is excess demand?

Answer 1

Excess demand is where the demand for a product or service exceeds its supply in the market. This occurs when the price of a good is lower than the equilibrium price

Question 2

What is excess supply?

Answer 2

Excess supply is a situation in the market where the quantity of a good or service supplied is more than the quantity demanded. This occurs when the price of a good is higher than the equilibrium price

Question 3

What is equilibrium and disequilibrium price?

Answer 3

Equilibrium price is the market price where quantity of goods supplied is equal to quantity of goods demanded. This is known as the allocative efficiency
Disequilibrium is where demand does not equal supply

Question 4

Where is excess demand found on the supply demand curve?

Answer 4

Excess demand is found below the equilibrium price. This is because the price is lower and when the line is drawn across, it meets the supply first, and then the demand.

Question 5

Where is excess supply found on the supply demand?

Answer 5

The excess supply is found above the equilibrium price. This is because the price is higher and when the line is drawn across, it meets demand first, and then the supply

Question 6

How does the market react to excess demand?

Answer 6

Firms react by increasing prices so:
- More resources are then produced
- Producers increase output to increase profit
- Rationing of scarce resources discourages consumption
- The market returns to allocative efficiency

Question 7

How does the market reaction to excess demand restore price equilibrium?

Answer 7

When producers increase output, it causes an expansion on the supply curve towards the equilibrium
When scarce resources are rationed, it discourages consumption leading to a contraction on the demand curve towards the equilibrium

Question 8

How does the market react to excess supply?

Answer 8

Firms react by decreasing prices so:
- Excess supply signifies a need for fewer resources
- This incentivises producers to decrease output
- The rationing of scarce resources encourages consumption
- The market returns to allocative efficiency

Question 9

How does the market reaction to excess supply restore price equilibrium?

Answer 9

When the producers decrease output, this causes a contraction along the supply curve towards the equilibrium
The rationing of scarce resources encourages consumption leading to an expansion along the demand curve towards the equilibrium