Question

Assume that the equilibrium price for a good is \(\$ 10 .\) If the market price is \(\$ 5,\) a a. shortage will cause the price to remain at \(\$ 5\) b. surplus will cause the price to remain at \(\$ 5\) c. shortage will cause the price to rise toward \(\$ 10\) d. surplus will cause the price to rise toward \(\$ 10\)

Short answer

The correct answer is option c, which states that the shortage will cause the price to rise toward $10, as the competition among buyers pushes the price up until the market reaches the equilibrium price.

Step-by-step solution

Identify the market situation at \(5 price

First, let's identify the situation in the market when the price is at \)5, below the equilibrium price of $10. In this situation, the quantity of the good demanded is higher than the quantity supplied, which means there is a shortage of the product.

Evaluate option a - Shortage will cause the price to remain at \(5

In the case of a shortage, the buyers' demand for the product is higher than the suppliers' willingness to sell at the current price. This leads to an increase in competition among buyers, which drives the price up. Therefore, the price will not remain at \)5, and option a is incorrect.

Evaluate option b - Surplus will cause the price to remain at $5

As we determined in Step 1, the current market situation is a shortage, not a surplus. Therefore, option b is not applicable to this problem.

Evaluate option c - Shortage will cause the price to rise toward \(10

When there is a shortage in the market, the competition among buyers pushes the price up. This continues until the market reaches the equilibrium price, at which the quantity demanded equals the quantity supplied. In this specific situation, the equilibrium price is \)10. Therefore, the shortage will cause the price to rise toward $10, making option c the correct answer.

Evaluate option d - Surplus will cause the price to rise toward $10

As we have determined in Step 1 and Step 3, the current market situation is a shortage. Therefore, option d is not applicable to this problem. In conclusion, the correct answer to this problem is option c, which states that the shortage will cause the price to rise toward $10.

Key concepts

Market Shortage

Understanding market shortages is fundamental to grasping why and how prices fluctuate in an economy. A market shortage occurs when the demand for a product exceeds the supply at a particular price. Imagine a newly released gadget that's so popular stores can't keep it on the shelves; that's a market shortage in action.

In our exercise, the market price is set at \(5, which is below the equilibrium price of \)10. At this low price, consumers are quick to buy, but producers aren't as eager to sell. Consumers scramble to purchase the good before it runs out, but there isn't enough to satisfy everyone's needs. This is the perfect recipe for a shortage.

From educational toys to essential commodities, whenever a market shortage transpires, it induces several effects. Consumers face difficulties in finding the product. Some may even be willing to pay more, simply to secure it. This desperation among buyers can intensify competition, leading to price hikes as retailers and producers realize they can fetch a higher price due to the increased demand.

Supply and Demand

The dance between supply and demand is a fundamental economic principle that influences the price and availability of goods and services. It's a relationship that's as intuitive as it is complex; as quantities of a good or service increase, the price tends to drop, whereas when those quantities decrease, the price typically rises.

In the context of our textbook exercise, with the equilibrium price set at \(10, the supply and demand for the good are balanced. This means that producers are willing to supply exactly as much of the good as consumers are willing to buy. However, when the price dips to \)5, demand outpaces supply, creating the aforementioned shortage.

Shifts in Demand and Supply

Several factors can cause shifts in demand and supply, altering the market equilibrium. Demand can increase due to rising incomes or trends, while supply can decrease because of production issues or increased costs. Understanding these shifts is crucial for predicting how market conditions might change the equilibrium price and quantity of goods.

Price Mechanism

The price mechanism refers to the invisible hand that guides the free market and helps allocate resources through the forces of supply and demand. It's like an autopilot system; if a product's price is too low, resulting in high demand but low supply, the price mechanism kicks in, adjusting the price upward until equilibrium is restored.

In our \(5 vs. \)10 scenario, the price mechanism identifies the shortage and responds accordingly. Sellers, capitalizing on the higher demand, start to hike prices closer to the equilibrium, and the market gradually works its way to balancing the quantity supplied with the quantity demanded. It's akin to an auction, where the highest bidder gets the item—which, in this case, means the market will lean towards the higher price where both the seller's and buyer's needs are met.

Understanding Price Signals

Prices are not just numbers tagged on goods—they are signals. A low price signals abundant supply or low demand, signaling producers to cut back on production. Conversely, a high price is a beacon, signaling that there's money to be made, urging businesses to produce more. By comprehending these signals, both consumers and producers navigate the market, all coordinated by the unseen yet powerful hand of the price mechanism.