1.2.8

Price Determination

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Market Equilibrium

The equilibrium is the point where the demand curve meets the supply curve.

Illustrative background for Equilibrium priceIllustrative background for Equilibrium price ?? "content

Equilibrium price

  • This is the only price where the amount consumers want to buy is equal to the amount producers want to sell.
  • If the market is at equilibrium, there is no reason to move away.
  • Supply and demand (market forces) dictate the equilibrium quantity and price in a free market.
Illustrative background for DisequilibriumIllustrative background for Disequilibrium ?? "content

Disequilibrium

  • Disequilibrium is when the market is not at a stable price and quantity.
  • If the market is not at equilibrium, economic pressure arises to move the market towards a stable price and quantity.
    • E.g if petrol prices were to rise above their equilibrium level, the market would respond and the quantity demanded would fall.
Illustrative background for Excess supply and demandIllustrative background for Excess supply and demand ?? "content

Excess supply and demand

  • Excess supply and demand occur at disequilibrium.
  • The higher price makes it more profitable for petrol producers, so output expands.
  • The difference between the quantity demanded and quantity supplied is now the excess supply.
  • When quantity demanded exceeds quantity supplied, there is excess demand.
Illustrative background for Pressure to reach equilibriumIllustrative background for Pressure to reach equilibrium ?? "content

Pressure to reach equilibrium

  • The market price is unstable when there is excess demand or supply.
  • Excess supply will force producers to cut the price because it is better to sell at a lower price than not at all. Others will follow.
  • Excess demand will signal to producers they can generate more profit by raising the price and will do so.
  • So excess demand and supply can lead to price change.

Equilibrium vs Disequilibrium in a Market

Equilibrium is a state of rest, where price and quantity are stable. In disequilibrium, there is pressure from market forces to reach equilibrium.

Illustrative background for EquilibriumIllustrative background for Equilibrium ?? "content

Equilibrium

  • The point of equilibrium is determined by the forces of demand and supply in an economy. These are called market forces. Here, supply is equal to demand.
  • This model of equilibrium assumes perfect competition. It also assumes ceteris paribus (everything else equal), as well as independence between supply and demand.
Illustrative background for DisequilibriumIllustrative background for Disequilibrium ?? "content

Disequilibrium

  • At disequilibrium, price and quantity are not stable.
  • Market forces will move the economy back to a position of stability at equilibrium over time.

Shifts in Equilibrium

Demand and supply curve shifts affect where an equilibrium is.

Illustrative background for Demand curve shiftsIllustrative background for Demand curve shifts ?? "content

Demand curve shifts

  • A shift in the demand curve (but not in the supply curve) will have the following effects:
    • An increase in demand (D->D1) will cause an increase in price. Supply will extend and form a new equilibrium (Q1,P1).
    • A decrease in demand (D->D2)will cause the price to fall. Supply will contract and form a new equilibrium (Q2, P2).
Illustrative background for Supply curve shiftsIllustrative background for Supply curve shifts ?? "content

Supply curve shifts

  • A shift in the supply curve (but not in the demand curve) will have the following effects:
    • An increase in supply (S->S1)will cause a decrease in price. Demand will extend and form a new equilibrium (Q1,P1).
    • A decrease in supply (S->S2) will cause an increase in price. Demand will contract and form a new equilibrium (Q2,P2).
Illustrative background for Elasticity (slopes of demand and supply curves)Illustrative background for Elasticity (slopes of demand and supply curves) ?? "content

Elasticity (slopes of demand and supply curves)

  • Price elasticity of demand and supply affect how much the equilibrium price and quantity change by.
    • E.g a rightward shift in the demand curve along an elastic supply curve will influence quantity more than price.
    • An inelastic demand curve is steeper than an elastic demand curve.

Jump to other topics

1Introduction to Markets

2Market Failure

3The UK Macroeconomy

4The UK Economy - Policies

5Business Behaviour

6Market Structures

7A Global Perspective

8Finance & Inequality

9Examples of Global Policy

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