Draw a completely labeled supply and demand graph. Show the equilibrium point, the equilibrium price and...

Draw a completely labeled supply and demand graph. Show the equilibrium point, the equilibrium price and quantity show using the diagram and explain in words, why a price above the equilibrium price would fall given a free market process and the same for a price below the equilibrium price.

Solutions

Expert Solution

In following graph, price (P) and quantity (Q) are depicted vertically & horizontally respectively.

D0 & S0 are initial demand & supply curves, intersecting at point A with equilibrium price P0 & quantity Q0.

If market price is higher at Pf, quantity demanded decreases to Q1 and quantity supplied increases to Q2, causing a surplus of (Q2 - Q1). Therefore, firms agree to accept lower and lower price to increase quantity sold, so price starts falling until it reaches P0 and equilibrium is restored.

If market price is lower at Pc, quantity demanded increases to Q4 and quantity supplied decreases to Q3, causing a surplus of (Q2 - Q1). Therefore, firms agrees to accept lower and lower price to increase quantity sold, so price starts falling until it reaches P0 and equilibrium is restored.

If market price is higher at Pf, quantity demanded decreases to Q1 and quantity supplied increases to Q2, causing a shortage of (Q4 - Q3). Therefore, consumers agree to offer higher and higher price to increase quantity sold by sellers, so price starts rising until it reaches P0 and equilibrium is restored.

Rahul Sunny answered 1 month ago

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