Question

Explain how the market moves to equilibrium in terms of shortages and surpluses and in terms of maximum buying prices and minimum selling prices.

Short answer

Markets move towards equilibrium through the correction of shortages and surpluses by adjusting prices. A surplus, where supply exceeds demand, forces prices down, whereas a shortage, where demand exceeds supply, pushes prices up. Prices adjust until reaching the equilibrium point, where supply equals demand. At this point, the price should ideally remain stable, with any future price changes reflecting further supply and demand fluctuations leading to a new equilibrium.

Step-by-step solution

Defining Shortages and Surpluses

A shortage occurs when the quantity demanded for a product exceeds the quantity supplied at a given price, while a surplus occurs when the quantity supplied exceeds the quantity demanded. In the case of a shortage, consumers are willing to pay more for the product, which leads to an increase in the price. Conversely, in the case of a surplus, suppliers will aim to sell their excess stock and may therefore lower the price.

Understanding Maximum Buying Prices and Minimum Selling Prices

The maximum buying price is the highest price that buyers are willing and able to pay for a product at a given time. The minimum selling price is the lowest price at which sellers are willing to sell a product. When the price of a product is above the maximum buying price, a surplus occurs because demand drops. When the price is below the minimum selling price, a shortage occurs because supply drops.

Moving Towards Equilibrium

The market moves towards equilibrium when surpluses or shortages occur. In the event of a surplus, the price will decrease until it reaches a level where quantity supplied equals quantity demanded. Conversely, in the case of a shortage, the price will increase until the quantity demanded equals the quantity supplied. This point, where supply equals demand, is known as the equilibrium.

Equilibrium and Price Fluctuations

Once equilibrium is achieved, the price should, in an ideal market, remain stable. However, any fluctuations in supply or demand may upset that balance, leading to a new round of shortages or surpluses – and therefore adjustments in pricing - until a new equilibrium is reached.