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 market price is above the equilibrium, excess supply leads to producers lowering the price, making the quantity demanded increase until equilibrium is reached. Conversely, when the market price is below equilibrium, there is a shortage of goods, causing consumers to compete and driving the price up, enticing producers to increase supply until equilibrium is reached. These market forces balance supply and demand, ensuring efficient market functioning.

Step-by-step solution

Understand supply, demand, and equilibrium

First, let's define some basic concepts needed to understand the exercise. Supply refers to the amount of a good that producers are willing and able to sell at a given price, and demand refers to the amount of a good that consumers are willing and able to buy at a given price. Equilibrium is the point where the market price is at a level such that the quantity demanded equals the quantity supplied. This equilibrium point is where the supply and demand curves intersect and indicates that the market has reached a balance between the interests of buyers and sellers.

Scenario 1: Price above equilibrium

In this scenario, the market price is higher than the equilibrium price. When the price is above the equilibrium, the quantity supplied is greater than the quantity demanded. This means that producers are willing to supply more goods than consumers are willing to buy at the given price. As a result, producers will find themselves with unsold goods or excess inventory. In order to sell these unsold goods, producers will be encouraged to lower the price. The lower price will attract more consumers, increasing the quantity demanded. This process will continue until the market price reaches the equilibrium point, where the quantity supplied equals the quantity demanded.

Scenario 2: Price below equilibrium

In this scenario, the market price is lower than the equilibrium price. When the price is below the equilibrium, the quantity demanded is greater than the quantity supplied. This means that consumers are willing to buy more goods than producers are willing to supply at the given price. As a result, there will be a shortage of goods in the market. Consumers will compete to buy the limited supply available, and this competition will drive the market price up. As the price rises, producers will be encouraged to supply more goods to the market, increasing the quantity supplied. This process will continue until the market price reaches the equilibrium point, where the quantity demanded equals the quantity supplied. In summary, when the market price is above or below the equilibrium price, market forces will drive the price towards equilibrium. When the price is above equilibrium, excess supply will cause producers to lower the price since the quantity supplied is greater than the quantity demanded. On the other hand, when the price is below equilibrium, scarcity will drive the price up, as the quantity demanded is greater than the quantity supplied. These natural market forces help to maintain a balance between supply and demand and keep markets functioning efficiently.