2.4 The interaction of demand and supply / market equilibrium and disequilibrium

Question 1

What is market equilibrium?

Answer 1

This is when supply meets demand (the market clearing position).

Question 2

What is market disequilibrium?

Answer 2

This is when supply doesn’t meet demand

Question 3

What is excess demand?

Answer 3

This is when the price is too low (below equilibrium) which means the demand is now greater than the supply. This is a state of disequilibrium. This is a shortage in the market. This will cause firms to increase price and supply more in order to restire equilibrium

Question 4

What is excess supply?

Answer 4

This is when the price is too high (above the equilibrium price). There is a now a surplus. Price will fall back to P1 as firms lower their priices and try to sell their goods. The market will clear and return to equilibrium

Question 5

When are new market equilibriums made?

Answer 5

This is when supply or demand shift left or right due to a change in their factors (PIRATES OR PINTSWC)

Question 6

What is joint demand?

Answer 6

This is when goods are bought together, like a camera and a memory card. They are complements

Question 7

What is alternative demand?

Answer 7

This is when one good is demanded in place of another good. These are substitutes. Such as apple phones instead of samsung phones

Question 8

What is joint supply?

Answer 8

This is when the increasing supply of one good causes an increase or decrease in the supply of another good. Producing more lamb will increase the supply of wool

Question 9

What is the price mechanism and what does it entail?

Answer 9

Resources are allocated through the price mechanism in a free market. The price mechanism determines the market price. Adam Smith calls it “the invisible hand”. The economic problem of scarcity is solved through this mechanism.

Question 10

What are the 3 main functions in the price mechanism?

Answer 10

Signalling - The price acts as a signal to consumers and new firms entering the market. The price changes show where resources are needed in the market. A high price signals firms to enter the market as it is profitable. However, this makes consumers decrease demand and leave the market.

Rationing - when there are scarce resources, price increases due to the excess demand. The increase in price discourages demand and consequently rations resources

Incentivising - A high price incentivises firms to increase output as they can make more profit and vice versa