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 due to higher quantity supplied and lower quantity demanded. Suppliers lower their prices to clear excess stock, leading consumers to buy more. Conversely, when the price is below the equilibrium, a shortage occurs as quantity demanded exceeds quantity supplied. Suppliers increase prices to meet demand, gradually adjusting the price level. In both cases, market forces of supply and demand push the market price towards equilibrium, aligning with a free, competitive market's self-correcting nature.

Step-by-step solution

Situation 1: Price is Above the Equilibrium Price

In this situation, the price is higher than the equilibrium price level. As a result, the quantity supplied is greater than the quantity demanded. This creates a surplus of goods and services in the market. To understand the forces at play, let's consider the behavior of the suppliers and consumers: 1. Suppliers have excess stock that is not being sold. In order to reduce their stock and not incur higher holding costs, they will likely lower their prices. 2. Consumers see the lower prices and become more willing to purchase the goods and services that were previously too expensive. 3. As prices decrease and demand increases, the market begins to move towards equilibrium.

Situation 2: Price is Below the Equilibrium Price

In this case, the price is lower than the equilibrium price level. Consequently, the quantity demanded exceeds the quantity supplied, which leads to a shortage of goods and services in the market. To comprehend this situation, let's again observe the behavior of suppliers and consumers: 1. Suppliers face a shortage of goods due to the increased demand at lower prices. To counteract this, suppliers start to increase prices so that they can produce more goods. 2. As the market prices rise, some consumers may no longer be willing to purchase the product at the higher price level, resulting in decreased demand. 3. As prices increase and demand decreases, the market moves closer to equilibrium. In both cases, the market forces of supply and demand work together to push the market price towards the equilibrium level, where supply and demand are balanced. This demonstrates the natural self-correcting nature of a free, competitive market.

Key concepts

Price Level Adjustment

Imagine a seesaw perfectly balanced at its center; this is a visual representation of market equilibrium. However, what happens if someone places extra weight on one side? The seesaw shifts, right? This is akin to price level adjustment in the market.
When the price of a product is higher than what people are willing to pay (above equilibrium), sellers end up with a surplus, or excess inventory. This is like having too much weight on one side of the seesaw. To restore balance (equilibrium), sellers reduce prices, making the product more attractive to buyers, which gradually eliminates the surplus.
Conversely, if prices are set too low (below equilibrium), there's a shortage; buyers want more of the product than what's available. Sellers then increase prices, curtailing demand slightly and encouraging the production of more goods, until the seesaw levels out again. The dynamic balancing act between surplus and shortage through changing prices is how the market self-corrects.

Supply and Demand

The concepts of supply and demand are the beating heart of any economy. Supply refers to how much the market can offer, while demand refers to how much of a good or service is desired by buyers.

• Supply is influenced by factors like production costs, seller expectations, and prices of related goods.
• Demand depends on consumers' preferences, income levels, and prices of substitutes or complements.

Imagine an equilibrium point where the amount of goods suppliers want to sell matches exactly what consumers want to buy. This peaceful point is where supply and demand are said to be in harmony; neither too many goods are left unsold, nor are there too many eager buyers without products to buy. Market equilibrium ensures efficiency — every made good is sold, and every consumer looking for a product at the right price can find it.

Market Forces

Think of market forces as the invisible hands governing how supply and demand interact. These forces are the underlying pressures that drive economic activity and guide resources to their most valued uses.
In our seesaw analogy, these invisible hands are what push prices up or down. They are driven by a constellation of elements including consumer behavior, producer decisions, and external factors like technological advancements or regulatory changes. When a market experiences a surplus, it's these forces that nudge suppliers to cut down on production or reduce prices; when a market has a shortage, the same forces prompt suppliers to boost production or raise prices. In essence, market forces are continuously at work, striving to achieve balance in the ecosystem of the economy.

Surplus and Shortage

Surplus and shortage are like the economic equivalents of push and pull. A surplus happens when the quantity of goods supplied exceeds the quantity demanded — the market is essentially flooded with goods that aren't being sold. This is often resolved by a price reduction, encouraging consumption and clearing inventory.
On the flip side, a shortage occurs when there's less supply than demand. Goods fly off the shelves faster than they can be restocked. Sellers can then afford to raise prices, and they are also incentivized to produce more to meet demand.

• In situations of surplus, consumers hold the upper hand because sellers compete to get rid of excess stock, often leading to bargains.
• In a shortage, power shifts to the sellers, as consumers compete to secure limited goods, usually leading to higher prices.

Both states trigger price level adjustments, guiding the market back to equilibrium like a compass finding north.