Unit 2.3: Competitive Market Equilibrium Flashcards
Market Equilibrium
When the quantity demanded for a product is equal to the quantity supplied.
(There are no shortages or surpluses.)
Reallocation of resources
In a free market, the price mechanism determines “what to produce”.
Market price is a result of the interaction of the market forces of Demand and Supply.
When D / S changes, there will be a change in market equilibrium price and quantity. This also leads to a change in the amount of resources allocated to the production of a good/service.
Roles of price mechanism
Key to the market’s ability to allocate resources lies in the role of the price mechanism as signals and prices as incentives
Incentive function
An aspect of the price mechanism in allocating resources as price changes provide a motivation for producers and consumers to change their behaviour in order to maximise their benefits
Signalling function
An aspect of the price mechanism in allocating resources by providing information to producers and consumers where resources are required (in markets where prices increase) and where they are not (in markets where prices fail)
Rationing function
Deters some consumers from buying a product or resource owing to higher prices, thereby rationing (preserving) it. Scared resources are rationed when demands for a product exceed supply
Surplus
Created when the supply of a product exceeds its demand because the price is set higher than the market equilibrium price. (Qs > Qd)
When there is excess supply producers will reduce prices until equilibrium is reached.
When price decreases, Qd will increase (movement along demand curve).
Shortage
When the demand of a product exceeds its supply because the price is set lower than the market equilibrium price. (Qd > Qs)
When there is excess demand, consumers will bid up prices until equilibrium is reached.
When price increases, Qs will increase (movement along supply curve).
Consumer surplus
The difference between the maximum price consumers are willing to pay and the price they actually pay
As prices decrease, consumer surplus increases, leading to a consumer welfare gain.
Producer surplus
the difference between the minimum price producers are willing to accept to produce a good and the price they actually sell at
As prices increase, profits increase, therefore there is a producer welfare gain.
Social surplus
The summation of consumer and producer surplus
Social surplus is maximised when market is at equilibrium, state of allocative efficiency
Allocative efficency
The optimal allocation of resources according to society’s point of view.
When a market is in equilibrium, resources are allocated according to the wants/needs of consumers and producers.
Welfare loss
Total surplus is not maximised. Increasing production will result in an increase in social surplus.
Welfare loss = “lost” social surplus
