Question

When market price is above equilibrium price, (LO3) a) market price will risc b) equilibrium price will rise c) market price will fall d) equilibrium price will fall

Short answer

The correct answer is c) Market price will fall. When the market price is above the equilibrium price, there's a surplus, which means producers will lower their prices to sell the excess supply, causing the market price to fall toward the equilibrium price.

Step-by-step solution

Understand the concept of equilibrium price

Equilibrium price is the price at which the quantity demanded by consumers is equal to the quantity supplied by producers. In other words, it's the price at which the market is balanced, with no surplus or shortage of the product.

Understand the concept of market price

Market price is the current price at which a product or service is being bought and sold in the market. Changes in supply and demand can cause the market price to fluctuate over time.

Analyze the given options

When the market price is above the equilibrium price, it means that the current price is higher than the price at which supply and demand are balanced. Now, let's analyze the given options to determine which one is correct: a) Market price will rise: This statement is not correct because when the market price is already higher than the equilibrium price, it will cause a surplus (quantity supplied exceeds quantity demanded), which will put downward pressure on the market price. b) Equilibrium price will rise: This statement is not correct because the equilibrium price is determined by the balance of supply and demand. The market price being above equilibrium may only influence the short-term adjustments but won't change the equilibrium price itself. c) Market price will fall: This statement is correct. When the market price is above the equilibrium price, there's a surplus, which means producers will lower their prices to sell the excess supply, causing the market price to fall toward the equilibrium price. d) Equilibrium price will fall: This statement is not correct because the equilibrium price is determined by the balance of supply and demand. As mentioned in option b, the market price being above equilibrium may only influence short-term adjustments but will not change the equilibrium price itself.

Choose the correct option

Based on the analysis of the given options, the correct answer to this question is c) Market price will fall, as it describes the accurate relationship between market price and equilibrium price when the market price is above the equilibrium price.

Key concepts

Equilibrium Price

The equilibrium price is an essential concept in understanding market dynamics. Imagine a busy marketplace where buyers are ready to purchase goods and sellers are eager to sell them. The equilibrium price emerges naturally as the price at which the quantity of goods that buyers want to buy equals the quantity that sellers want to sell. At this price, the market is considered balanced because there are no leftover goods (surplus) or dissatisfied buyers (shortage). Adjustments happen automatically. Demand for a product causes its price to change. If the equilibrium is disrupted, say by a change in consumer preference or production costs, prices will adjust until a new equilibrium is reached. This dynamic ensures that resources are utilized efficiently.

Market Price

The market price is the actual price at which goods or services are traded in the marketplace at any given moment. Unlike the equilibrium price, which is more of a theoretical balance point, market prices can vary based on current conditions. For example, during a sale or when seasonal demand spikes, the market price may rise temporarily, even though the equilibrium price remains the same. However, the market price doesn't just fluctuate randomly; it's influenced by the constant interplay of supply and demand forces. Sellers may raise or lower their prices in response to these market signals, seeking to maximize their sales and profits. This is why you'll sometimes see prices drop when there's a surplus of product, as sellers reduce prices to encourage more buying.

Supply and Demand

Supply and demand form the backbone of a free market economy. These are fundamental principles that determine how much of a product is available (supply) and how much people want it (demand). Several factors can affect supply and demand:

• Price: Generally, as the price increases, supply rises because sellers are motivated to sell more, and demand decreases because buyers might seek alternatives.
• Consumer Preferences: Changes in trends or tastes can shift demand. If something becomes fashionable, demand might increase.
• Production Costs: If it becomes cheaper to produce a good, supply may increase.
• Seasonality: Some products have seasonal demand, like umbrellas during the rainy season or gifts during holidays.

When these factors change, they influence market dynamics, often leading to new equilibrium prices. The shifts ensure markets are reactive and can seem seamless, keeping demand and supply in balance in the long run.