Question

If the price is above the equilibrium level, would you predict a surplus or a shortage? If the price is below the equilibrium level, would you predict a surplus or a shortage? Why?

Short answer

If the price is above the equilibrium level, we can predict a surplus, as the quantity supplied by producers is greater than the quantity demanded by consumers. This occurs because the high price reduces consumer demand while the supply remains the same or increases. Conversely, if the price is below the equilibrium level, we can predict a shortage, as the quantity demanded by consumers is greater than the quantity supplied by producers. This occurs because the low price increases consumer demand while the supply remains the same or decreases. Maintaining a stable market condition requires prices to be set close to the equilibrium level, where supply and demand are balanced.

Step-by-step solution

1. Understand Equilibrium Level

Equilibrium level is the point at which the quantity demanded by consumers equals the quantity supplied by producers. At this price level, the market is perfectly balanced, and there is neither surplus nor shortage.

2. Understand Surplus

A surplus occurs when the quantity supplied by producers is greater than the quantity demanded by consumers. This usually happens when the price is set too high, which causes the demand to decrease while supply remains the same or even increases.

3. Understand Shortage

A shortage occurs when the quantity demanded by consumers is greater than the quantity supplied by producers. This usually happens when the price is set too low, which causes the demand to increase while the supply remains the same or decreases.

4. Price above Equilibrium Level

If the price is above the equilibrium level, it means that the price is set too high. Consumers’ demand decreases as price goes up beyond the equilibrium point. Producers may still be willing to supply goods, but they cannot sell them due to reduced demand. This results in a surplus of goods in the market.

5. Price below Equilibrium Level

If the price is below the equilibrium level, it means that the price is set too low. Consumers’ demand increases as price goes down below the equilibrium point. Producers, however, may not be willing to supply the increased demand, given the lower price. This results in a shortage of goods in the market.

6. Conclusion

To summarize, when the price is set above the equilibrium level, we can predict a surplus in the market, as there is more supply than demand. On the other hand, when the price is set below the equilibrium level, we can predict a shortage in the market, as the increased demand is not met with an adequate supply. So, to maintain a stable market condition, it's crucial to set prices close to the equilibrium level where supply and demand are balanced.