This post goes over the economics of market equilibrium, and how the price mechanism in markets can correct for a shortage and a surplus without the need to shift either demand or supply. Check out this past post for more information on determining equilibrium graphically. Or this one on how to determine equilibrium graphically.
The price of a product and the quantity supplied are
directly proportional because of the law of supply. This law states that firms are willing to
supply for of a good or service the higher the price is. This stems from the fact that firms face an
upward sloping marginal cost curve, so they need to receive a higher price for
their product if they are going to produce it (which relates to diminishing
marginal productivity but you probably don’t need to know this yet).
The price of a product and the quantity demanded are negatively related. This is because of the law of demand.
If the market price is higher than the equilibrium price,
then there is a surplus in the market.
This means that firms are willing to supply a greater quantity of a good
or service than consumers are willing and able to pay for. When there is a surplus in the market, market
forces will use the price mechanism, and the price will drop until equilibrium
is reached. This means that quantity
demanded, and quantity supplied will change (as the price goes down) until
equilibrium is reached. No shift in
either demand or supply will occur, the market will reach equilibrium on its
own.
|
Demand Schedule
|
|
|
Quantity Demanded
|
Price
|
|
0
|
10
|
|
2
|
9
|
|
4
|
8
|
|
6
|
7
|
|
8
|
6
|
|
10
|
5
|
|
12
|
4
|
|
14
|
3
|
|
16
|
2
|
|
18
|
1
|
|
20
|
0
|
|
Supply Schedule
|
|
|
Quantity Supplied
|
Price
|
|
0
|
0
|
|
2
|
1
|
|
4
|
2
|
|
6
|
3
|
|
8
|
4
|
|
10
|
5
|
|
12
|
6
|
|
14
|
7
|
|
16
|
8
|
|
18
|
9
|
|
20
|
10
|
For example, look at the supply and demand schedules
above. At a price of $8, quantity
demanded is 4 and quantity supplied is 16, there is a surplus of 12 units. The price in this market will drop, at $7
quantity demanded is 6 and quantity supplied is 14, so there is still a
surplus. The price will continue to drop
until a price of $5 is reached, where quantity demanded = quantity supplied at
10 units.
If the price is lower than the equilibrium price, then there
will be a shortage in the market. This
means that consumer are willing and able to buy more or a good or service than
suppliers are willing and able to produce.
The price will rise in this scenario, changing both quantity supplied
and quantity demanded until equilibrium is reached. No shift in either demand or supply will
occur.
|
Demand Schedule
|
|
|
Quantity Demanded
|
Price
|
|
0
|
10
|
|
2
|
9
|
|
4
|
8
|
|
6
|
7
|
|
8
|
6
|
|
10
|
5
|
|
12
|
4
|
|
14
|
3
|
|
16
|
2
|
|
18
|
1
|
|
20
|
0
|
|
Supply Schedule
|
|
|
Quantity Supplied
|
Price
|
|
0
|
0
|
|
2
|
1
|
|
4
|
2
|
|
6
|
3
|
|
8
|
4
|
|
10
|
5
|
|
12
|
6
|
|
14
|
7
|
|
16
|
8
|
|
18
|
9
|
|
20
|
10
|
For example, look at the supply and demand schedules
above. At a price of $2, quantity supplied
is 4 and quantity demanded is 16, there is a shortage of 12 units. The price in this market will drop, at $3
quantity supplied is 6 and quantity demanded is 14, so there is still a shortage. The price will continue to rise until a price
of $5 is reached, where quantity demanded = quantity supplied at 10 units.
