Price Determination: Market Disequilibrium

This section focuses on understanding market disequilibrium, which occurs when the quantity demanded and the quantity supplied of a good or service are not equal. This imbalance leads to either a surplus or a shortage, which in turn influences the price.

What is Market Disequilibrium?

Market equilibrium is the state where the quantity demanded by consumers equals the quantity supplied by producers. Disequilibrium refers to any situation where this equality does not hold.

There are two main types of market disequilibrium:

• Surplus: When the quantity supplied is greater than the quantity demanded.
• Shortage: When the quantity demanded is greater than the quantity supplied.

Causes of Market Disequilibrium

Several factors can cause a market to be in a state of disequilibrium:

• Changes in Consumer Income: An increase or decrease in consumer income can shift the demand curve.
• Changes in Consumer Tastes and Preferences: Shifts in what consumers like can also alter demand.
• Changes in the Price of Related Goods: The price of substitute or complementary goods can affect demand.
• Changes in Technology: Technological advancements can impact the cost of production and the quantity supplied.
• Government Policies: Taxes, subsidies, and price controls can disrupt the equilibrium.

Surplus

A surplus occurs when producers have more of a good or service than consumers want to buy at the current price. This leads to:

• Pressure on Prices: Producers will try to lower prices to sell off the excess stock.
• Reduced Production: If the surplus persists, producers may reduce their production levels.
• Inventory Buildup: Unsold goods will accumulate in warehouses.

Shortage

A shortage occurs when consumers want more of a good or service than producers are able to supply at the current price. This results in:

• Pressure on Prices: Consumers are willing to pay more to obtain the limited supply, driving prices up.
• Increased Production: Higher prices incentivize producers to increase their output.
• Empty Shelves: Consumers may be unable to find the desired product.

How Markets Re-achieve Equilibrium

Market forces of supply and demand work to restore equilibrium:

1. Price Adjustment: The price will change. In a surplus, the price falls; in a shortage, the price rises.
2. Quantity Adjustment: As the price changes, the quantity demanded and supplied will adjust until they meet.
3. Feedback Loop: The price and quantity adjustments provide feedback to producers and consumers, guiding their decisions.

Table Summarizing Market Disequilibrium

Type of Disequilibrium	Quantity Demanded	Quantity Supplied	Price Effect	Typical Outcome
Surplus	Greater than Quantity Supplied	Less than Quantity Demanded	Price Falls	Producers reduce production, consumers benefit from lower prices
Shortage	Less than Quantity Supplied	Greater than Quantity Demanded	Price Rises	Producers increase production, consumers face higher prices and potential scarcity