Market Equilibrium

Question 1

A market is in equilibrium when Supply Equals Demand

Answer 1

1. At equilibrium, price and output are stable - there’s a balance in the market and supply is equal to demand
2. In a free market, supply and demand determine the equilibrium price and quantity.
3. This free interaction of supply and demand is known as market forces
4. The equilibrium point can be found at the point where the supply curve and demand curve meet. This is shown in an example in the textbook * DIAGRAM ON PAGE 26*
5. When supply and demand aren’t equal the market is in disequilibrium
6. If there’s excess supply or excess demand the market will be in disequilibrium

Question 2

Excess Supply and Demand won’t exist in a Free Market for long

Answer 2

Market forces act to remove excess supply or demand
Excess Supply:
1. Excess supply is when the quantity supplied to a market is greater than the quantity demanded.
2. If the price for the teddy bear is set above the equilbrium there would be excess supply of 4000 units. This would cause the price to be forced down, supply to contract and demand to extend until the equilibrium was reached.
LOOK AT DIAGRAM PG 26
Excess Demand:
1. Excess demand is when the demand for a good/service is greater than its supply
2. If the price for the teddy bear is set below the equilibrium there would be excess demand of 4000 units. This would cause the price to be forced up, demand to contract and supply to extend until the equilibrium was reached.
LOOK AT DIAGRAM

Question 3

Shifts in Demand or Supply Curves will change the Market Equilibrium

Answer 3

1. If the demand curve shifts, assuming no change in supply curve, then this will affect supply and price in the following ways LOOK AT DIAGRAM pg 27
   - If demand increases from D to D1 then the price will increase from Pe to P1 and supply will extend from Qe to Q1, creating a new equilibrium
   - If demand decreases from D to D2 then the price will fall to P2 and supply will contract to Q2, again creating a new equilibrium.
2. If the supply curve shifts, assuming no change in the demand curve, then this will affect demand and price in the following ways:
   - If supply increases from S to S1 then the price will fall to P1 and demand will extend to Q1, creating a new equilbrium.

Question 4

Elasticity will affect the Point of the New Equilibrium

Answer 4

1. Price elasticity of supply and price elasticity of demand influence the size of changes in the equilibrium price and quantity caused by supply and demand curve shifts
2. For example, if the demand curve shifts to the right along an elastic supply curve, this will have a larger effect on quantity than price. The opposite is true for an inelastic supply curve.
   * LOOK AT TABLE ON PG 27*

Question 5

The Demand and Supply model involves several Assumptions

Answer 5

1. The demand and supply model involves several assumptions. For example, its assumed that:
   - Supply and demand are independent of each other.
   - All markets are perfectly competitive
   - Ceteris Paribus applies
2. These assumptions mean the model has limited use in the real world. However, the model can be useful as it gives a broad picture of how supply an demand works in a way that’s simple and easy to understand.