Question

When the price is above the equilibrium, explain how market forces move the market price to equilibrium. Do the same when the price is below the equilibrium.

Short answer

When the price is above the equilibrium, a surplus occurs, leading to a decrease in prices as sellers aim to sell excess inventory and attract more buyers. As prices decrease, the quantity demanded increases and the quantity supplied decreases until a new equilibrium is reached. Conversely, when the price is below the equilibrium, a shortage occurs, leading to an increase in prices as buyers bid up the price to obtain the desired quantity. This encourages sellers to supply more, increasing the quantity supplied. As prices rise, the quantity demanded decreases and the quantity supplied increases until a new equilibrium is reached.

Step-by-step solution

Understand the equilibrium concept

The equilibrium in economics is a state in which there is a balance between the supply and demand. In the context of the market, the equilibrium price is the price at which the quantity of a product demanded by consumers is equal to the quantity supplied by producers.

Examine the law of supply and demand

The law of supply and demand states that: 1. When the price of a good increases, the quantity demanded decreases, and the quantity supplied increases. This is because buyers are less willing to pay a higher price, while sellers are more willing to sell at a higher price. 2. When the price of a good decreases, the quantity demanded increases, and the quantity supplied decreases. This is because buyers are more willing to pay at a lower price, while sellers are less willing to sell at a lower price.

Identify the effects of market forces

Market forces are the self-regulating mechanisms that adjust the supply and demand within a market. When there is a surplus or a shortage of a good in the market, market forces work to adjust the price to reach a new equilibrium.

Explain the adjustment of price when it is above the equilibrium

When the price is above the equilibrium price, there is a surplus in the market as the quantity supplied exceeds the quantity demanded. This is due to the law of supply and demand, as sellers are more willing to sell at a higher price, while buyers are less willing to pay the higher price. As a result, sellers will need to lower their prices in order to sell their excess inventory and attract more buyers. As prices continue to decrease, the quantity demanded increases, and the quantity supplied decreases until a new equilibrium price is reached where quantity supplied equals quantity demanded.

Explain the adjustment of price when it is below the equilibrium

When the price is below the equilibrium price, there is a shortage in the market as the quantity demanded exceeds the quantity supplied. This is due to the law of supply and demand, as buyers are more willing to pay at a lower price, while sellers are less willing to sell at a lower price. As a result, buyers will need to bid up the price in order to obtain the desired quantity of the product. Higher prices will incentivize sellers to supply more of the product, thus increasing the quantity supplied. As prices continue to rise, the quantity demanded decreases, and the quantity supplied increases until a new equilibrium price is reached where quantity supplied equals quantity demanded.