SECTION 2

The allocation
of resources

5 Microeconomics and macroeconomics

6 The role of markets in allocating resources 11 Price elasticity of demand
7 Demand 12 Price elasticity of supply
8 Supply 13 Market economic system
9 Price determination 14 Market failure
10 Price changes 15 Mixed economic system
 Price determination
Market equilibrium

Market equilibrium refers to the position where the demand for a product is
equal to the supply of the product.
At this point, an equilibrium price (also known as the market clearing price) is established.
At the equilibrium price, there is neither excess quantity demanded nor excess quantity
supplied, and thus the equilibrium quantity is determined.
 Price determination
Market disequilibrium

Market disequilibrium occurs when the quantity demanded for a product is

either higher or lower than the quantity supplied.

Disequilibrium is inefficient as it means there are either shortages or surpluses.

A shortage occurs when demand exceeds supply

because the price is lower than the market equilibrium.

Excess demand refers to a situation where the market price is below

the equilibrium price, thus creating a shortage in the market.
 Price determination

Shortages

If the selling price of a

product is set too low (that is,
below the equilibrium price),
then demand will exceed
supply (see Figure 9.2). This
excess demand creates a
shortage in the market. At
a price of P1, demand is Qd,
while supply is only Qs. Hence,
demand exceeds supply at this
price. The excess demand will
tend to cause price to rise back towards the equilibrium price of Pe.
 Price determination

Surpluses
If the price is set too high (above the market clearing price),
then supply will exceed demand, as shown in Figure 9.3.
This results in a surplus, known as excess supply.

In order for fi rms to get rid of their excess supply

(shown by the distance between Qs and Qd
at each price level above the equilibrium price),
they will need to reduce price (from P1 to Pe).

This is a key reason why leftover stocks of

Christmas cards are reduced in price
after 25 December and why unsold summer
clothes go on sale during the autumn.
Price determination
Price determination
 Price determination

1 What is meant by market equilibrium?

2 What is meant by equilibrium price?
3 What is meant by market disequilibrium?
4 What is the difference between excess demand and excess supply?
5 When do surpluses occur?
6 When do shortages occur?