Price Determination: Disequilibrium Using Demand and Supply Curves

This section focuses on understanding how prices are determined when the quantity demanded and the quantity supplied are not equal, leading to market disequilibrium. We will explore the concepts of surplus and shortage and how they drive prices back towards equilibrium.

Understanding Equilibrium

In a perfectly competitive market, equilibrium occurs where the quantity demanded equals the quantity supplied. This point is determined by the intersection of the demand and supply curves.

Disequilibrium: Surplus

A surplus arises when the quantity supplied exceeds the quantity demanded at a given price. This means producers have more goods available than consumers want to buy.

Graphical Representation: A surplus is visually represented by the supply curve being to the right of the demand curve at a particular price level.

Impact on Price and Quantity: To eliminate the surplus, producers will lower their prices. This lower price will incentivize consumers to buy more, and producers will supply less, moving the market back towards equilibrium.

Example: Consider a situation where the price of wheat is artificially set above the equilibrium level. Farmers will be encouraged to produce more wheat than consumers are willing to purchase, leading to a surplus of wheat.

Disequilibrium: Shortage

A shortage occurs when the quantity demanded exceeds the quantity supplied at a given price. This means consumers want to buy more goods than producers are willing to sell.

Graphical Representation: A shortage is visually represented by the demand curve being to the right of the supply curve at a particular price level.

Impact on Price and Quantity: To eliminate the shortage, consumers will be willing to pay more. This increased willingness to pay will incentivize producers to increase their supply, and consumers will buy less, moving the market back towards equilibrium.

Example: Imagine a sudden increase in demand for a particular smartphone model, but the manufacturer cannot immediately increase production. This will create a shortage of the smartphone.

Graphical Illustration of Disequilibrium

Scenario	Graphical Representation	Impact on Price	Impact on Quantity	Market Mechanism
Surplus	Supply Curve Right of Demand Curve	Price will fall	Quantity will increase	Producers lower prices to sell excess stock.
Shortage	Demand Curve Right of Supply Curve	Price will rise	Quantity will decrease	Consumers are willing to pay more, incentivizing producers to supply more.

Factors Affecting Equilibrium

Several factors can shift the demand and supply curves, leading to changes in the equilibrium price and quantity.

• Changes in Consumer Income: An increase in income typically leads to an increase in demand for normal goods.
• Changes in Consumer Tastes and Preferences: Shifts in consumer tastes can alter the demand curve.
• Changes in the Price of Related Goods:
  • Substitute Goods: An increase in the price of a substitute good increases the demand for the original good.
  • Complementary Goods: An increase in the price of a complementary good decreases the demand for the original good.
• Changes in Input Costs: An increase in input costs (e.g., wages, raw materials) decreases the supply.
• Technological Advancements: Technological improvements typically increase the supply.
• Government Policies: Taxes increase the cost of production, decreasing supply. Subsidies decrease the cost of production, increasing supply.

Conclusion

Understanding price determination through the analysis of demand and supply curves is crucial for analyzing market dynamics. Disequilibrium situations (surplus and shortage) act as market signals, driving prices and quantities back towards equilibrium. Factors that shift the demand and supply curves can lead to continuous adjustments in the market.