Question

 

Which of the following is the correct sequence of events when a free and competitive market is in a surplus situation?

(a) The market price will increase, which will lead to an increase in Qs and a decrease in Qd until the market reaches another equilibrium position where Qs=Qd.

(b) The market price will increase, which will lead to a decrease in Qs and an increase in Qd until the market reaches another equilibrium position where Qs=Qd.

(c) The market price will decrease, which will lead to an increase in Qs and a decrease in Qd until the market reaches another equilibrium position where Qs=Qd.

(d) . The market price will decrease, which will lead to a decrease in Qs and an increase in Qd until the market reaches another equilibrium position where Qs=Qd.

Answer 1

When quantity supplied by the producer is more than the quantity demanded by the consumer at a given price than there is surplus supply in the market. This price is more than the equilibrium price due to which there is less demand in the market at this price, so it will lead to an increase in the inventories of the producer. To reduce inventories, the producer will start offering lower prices to increase the demand for the good. As he reduces prices, demand will rise which will lead to a reduction in the inventories. Due to the reduction in prices producer will start decreasing the supply of the good. This will happen until the point where the quantity demanded and quantity supplied become equal. At this price, equilibrium will establish.

Now, after the above discussion we will go through all the given options to find the correct answer:

A). In this surplus situation, the market price is already more than the equilibrium price. Hence, to reach equilibrium, the price has to be reduced to increase demand, so market price will decrease not increase as given in the question. Hence, this option is incorrect.

B). This Option is again incorrect as we discussed above, we have to increase demand in the market to eliminate surplus supply for that market price will decrease not increase as given in the option.

C). As the market price decreases, quantity demand will increase as there exists a negative relationship between price and quantity demand whereas due to fall in price producer will reduce supply which will lead to a reduction in the quantity supplied. Hence, this whole option is incorrect.

D). As there is a surplus in the market, the market price will reduce which will increase the quantity demand of the product and decrease the quantity supplied and this whole process will continue, till equilibrium establishes i.e. both quantity supplied and quantity demanded are equal. Hence this option is the correct answer.