Market equilibrium

Question 1

What is the market equilibrium

Answer 1

when demand = supply

Question 2

What happens at a price above and below the equilibrium price

Answer 2

Below means excess demand
Above means excess supply

Question 3

How do the price mechanisms solve excess demand

Answer 3

• If excess demand, consumers are willing to bid higher prices for the good putting upward pressure on prices
• First, higher prices signal to firms that there is excess demand in the market and the need for more resources
• This incentivises firms to increase supply and output as they will make more profit at the higher price. Shown by expansion along supply curve
• Higher prices ration scarce resources by discouraging consumption, causing contraction in demand
• These effects lead to allocative efficiency

(other way around for excess supply)