The Determination of Market Equilibrium (AQA A Level Economics)

Price Determination in Markets

• In a market system, prices for goods/services are determined by the interaction of demand and supply 

  • A market is any place that brings buyers and sellers together

  • Markets can be physical (e.g. McDonald's) or virtual (e.g. eBay)

• Buyers and sellers meet to trade at an agreed-upon price

  • Buyers agree the price by purchasing the good/service

  • If they do not agree on the price, then they do not purchase the good/service and are exercising their consumer sovereignty

• Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties

  • At the equilibrium price, sellers will be satisfied with the rate/quantity of sales

  • At the equilibrium price, buyers are satisfied with the utility that the product provides

Market Equilibrium

• Equilibrium occurs in a market when demand = supply

• At this point, the price is called the equilibrium or market-clearing price

  • This is the price at which sellers are clearing (selling) their stock at an acceptable rate

Diagram: Market Equilibrium

Diagram analysis

• Any price above or below P creates disequilibrium in this market

  • Disequilibrium occurs whenever there is excess demand or excess supply in a market

Market Disequilibrium

• Disequilibrium occurs when demand is not equal to supply

  • If demand > supply, the market is facing excess demand

  • If demand < supply, the market is facing excess supply

Disequilibrium: excess demand

• Excess demand occurs when the demand is greater than the supply

  • It can occur when prices are too low or when demand is so high that supply cannot keep up with it

Diagram: Excess Demand for Electric Scooters 

Diagram analysis

• At a price of P₁, the quantity demanded of electric scooters (Q_d) is greater than the quantity supplied (Q_s)

• There is a shortage (excess demand) in the market equivalent to Q_sQ_d

Market response

• This market is in disequilibrium

  • Sellers are frustrated that products are selling so quickly at a price that is obviously too low

  • Some buyers are frustrated as they will not be able to purchase the product

• Sellers realise they can increase prices and generate more revenue and profits

• Sellers gradually raise prices

  • This causes a contraction in QD as some buyers no longer desire the good/service at a higher price

  • This causes an extension in QS as other sellers are more incentivised to supply at higher prices

• In time, the market will have cleared the excess demand and arrive at a position of equilibrium, P_eQ_e

  • Different markets take different lengths of time to resolve disequilibrium

  • E.g. Retail clothing can do so in a few days. Whereas the housing market may take several months or even years

Disequilibrium: excess supply

• Excess supply occurs when the supply is greater than the demand

  • It can occur when prices are too high or when demand falls unexpectedly 

• During the later stages of the pandemic, the market for face masks was in disequilibrium

Diagram: Excess Supply Covid-19 Face Masks

Diagram analysis

• At a price of P₁, the quantity supplied of face masks (Q_s) is greater than the quantity demanded (Q_d)

• There is a surplus in the market (excess supply) equivalent to Q_dQ_s
  

Market response

• This market is in disequilibrium

  • Sellers are frustrated that the masks are not selling and that the price is obviously too high

  • Some buyers are frustrated as they want to purchase the masks but are not willing to pay the high price

• Sellers will gradually lower prices in order to generate more revenue
  

  • This causes a contraction in QS as some sellers no longer desire to supply masks

  • This causes an extension in QD as buyers are more willing to purchase masks at lower prices

• In time, the market will have cleared the excess supply and arrive at a position of equilibrium, P_eQ_e
  

Equilibrium in Demand & Supply Schedules

• A demand and supply schedule shows the quantity demanded and the quantity supplied of a product at different price levels

• Demand and supply schedules can be used to identify equilibrium and disequilibrium
   

Demand and Supply Schedule Per Week For YEEZY Boost 700 Wave Runner Trainers

• At a price of $500, the market is in equilibrium

  • The QD = QS (800 units)

• At a price of $300 & $400, there is excess demand as the product is more affordable for consumers

  • Producers supply less at lower prices as they make less profit per unit

  • Producers are incentivised to supply more when prices are higher

• At a price of $600 & $700, there is excess supply as the high price has eliminated some buyers from the market

  • Producers would love to sell at this high price but in order to clear their stock, they have to lower the price & move towards equilibrium