Market equilibrium, shortages, surpluses and price changes

Last time

Before we start: last time, in Demand and supply, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Where buyers and sellers agree

Put the demand curve and the supply curve on one diagram. Where they cross, the amount buyers want is exactly the amount sellers offer. That is the equilibrium, and every market is pulled towards it.

Equilibrium on the diagram

The demand and supply curves cross at E. The equilibrium price is 5 dollars and the equilibrium quantity is 5. At this price, everything offered for sale is bought, and there is no pressure on the price to change.

Disequilibrium

Market disequilibrium is when demand and supply are not equal. There is either a surplus or a shortage. A surplus, or excess supply, is when supply is greater than demand at the current price. A shortage, or excess demand, is when demand is greater than supply at the current price.

A surplus

Suppose the price is 7 dollars. Sellers offer 7 units, but buyers want only 3. The surplus is 7 minus 3, which is 4 units, left unsold.

How a surplus clears

With unsold stock piling up, sellers cut their price to get rid of it. As the price falls, quantity demanded extends and quantity supplied contracts. The price keeps falling until demand equals supply again, at 5 dollars.

A shortage

Now suppose the price is 3 dollars. Buyers want 7 units, but sellers offer only 3. The shortage is 7 minus 3, which is 4 units.

How a shortage clears

Buyers who cannot get the product queue, or offer to pay more. Sellers see they can raise the price. As the price rises, quantity demanded contracts and quantity supplied extends. The price keeps rising until the shortage is gone, at the equilibrium price.

Demand rises

Incomes rise, so demand shifts right from D to D1. At the old price of 5 dollars there is now a shortage. The price rises to a new equilibrium at 6 dollars, with 6 units sold. Both price and quantity have risen.

Supply falls

A drought cuts the harvest, so supply shifts left from S to S1. The new equilibrium is at a price of 6 dollars and a quantity of 4. The price rises, but the quantity sold falls.

The four shifts

Here are the four basic changes and what each does to the equilibrium price and quantity.

Analysing a price change

For any event, write the chain. First, which curve shifts, and which way, and why. Second, what that creates at the old price: a shortage or a surplus. Third, how the price moves, and where the new equilibrium price and quantity end up. If asked for a diagram, label both equilibria.

Mistakes that lose marks

Mistake one: saying a shortage means there is none of the product. It means demand is greater than supply at that price. Mistake two: shifting both curves when only one condition has changed. Mistake three: drawing a diagram with no labels on the axes, the curves or the equilibrium points. The fix: label price, quantity, D, S, and both equilibrium points.

The full-marks tip

The full-marks tip: explain disequilibrium as a gap at the current price, then say how the price moves to close it. On every diagram, label both axes, every curve, and the old and new equilibrium.

On one card

So, on one card: market equilibrium. Keep it for revision.