Market equilibrium and disequilibrium

1. Determination of Market Equilibrium

• Market equilibrium is the point where the quantity demanded equals the quantity supplied, determining the equilibrium price and quantity.

• Graphical Explanation: At equilibrium, the demand and supply curves intersect.

2. Effects of Changes in Demand and Supply on Market Outcomes

• Increase in Demand: Raises both equilibrium price and quantity.
  Example: Higher incomes increase the demand for electric cars, driving up their prices.

• Decrease in Demand: Reduces both equilibrium price and quantity.
  Example: A decline in tourism lowers hotel prices in holiday destinations.

• Increase in Supply: Lowers price and raises quantity.
  Example: New farming techniques increase crop yields, reducing food prices.

• Decrease in Supply: Raises price and lowers quantity.
  Example: Natural disasters reducing coffee supply increase coffee prices worldwide.

3. Impacts on Market Participants

• Consumer Expenditure:
  Changes in equilibrium price and quantity affect the total amount spent by consumers.
  Formula: Price×Quantity

• Producer Revenue:
  Refers to total income earned by producers.
  Formula: Price×Quantity

• Consumer Surplus:
  The difference between what consumers are willing to pay and what they actually pay.

• Producer Surplus:
  The difference between what producers receive and the minimum price they’re willing to accept.

4. Market disequilibrium

• A market disequilibrium will trigger the price mechanism which is a price adjustment process.

• This may lead to formation of shortage or surplus.

4.1 Shortage Formation and process to reach Market Equilibrium

• Shortage is resulted from excess demand which occurs when quantity demanded (Qd) exceeds quantity supplied (Qs).

• When a shortage occurs, market forces drive the price upward, restoring equilibrium:

  • Consumers compete for the limited quantity of goods available, driving up the price.

  • As the price rises, some consumers reduce their quantity demanded due to the law of demand.

  • Higher prices make production more profitable for producers.

  • As the price rises, producers supply more due to the law of supply.

  • The price continues to rise until the quantity demanded equals the quantity supplied.

  • At this point, the shortage is eliminated, and the market reaches equilibrium price and quantity.

4.2 Surplus Formation and process to reach Market Equilibrium

• When a surplus occurs, market forces drive the price downward, restoring equilibrium:

  • Producers facing unsold stock reduce prices to attract buyers.

  • As prices decrease, the quantity demanded by consumers increases due to the law of demand.

  • Lower prices make production less profitable for producers.

  • As the price falls, producers reduce the quantity supplied due to the law of supply.

  • The price continues to decrease until the quantity supplied equals the quantity demanded.

  • At this point, the surplus is eliminated, and the market reaches equilibrium price and quantity.

5. How changes in demand and supply can affect equilibrium price and quantity, consumer expenditure, producer revenue, consumer surplus and producer surplus

5.1 Effect of Singular demand and supply shifts

5.2 Effect of simultaneous demand and supply shifts

To master the concepts of market equilibrium and disequilibrium, consider applying critical thinking exercises to real-world scenarios. For instance, analyze how changes in global oil supply impact fuel prices and how these shifts influence consumer expenditure and producer revenue. You can also create and interpret demand and supply graphs to explain the price adjustments following a natural disaster or a government policy intervention. Practicing with A Level econs questions on related topics will help deepen your understanding and prepare you for exams.

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