In: Economics
Suppose that in a market the current price is P1, a price higher than the equilibrium price, Pe. Is this market in equilibrium or in a disequilibrium state? Please explain by answering the following questions. ( Word answers only )
1. Is Qd=Qs, Qd>Qs or Qd<Qs at P1? Why?
2. Is there any excess (Xss) -- excess demand or excess supply in this market at P1? Why?
3. Will P1 stay the same or will there be a price adjustment? Why?
1)
At the current price of P1, the market is in a disequilibrium state. At a price of P1, Qd < Qs.
Equilibrium price is the price at which quantity demanded by buyers equals quantity supplied by suppliers. According to the law of supply quantity Supplied of a commodity increases as it's price increases and decreases as it's price decreases. According to the law of demand quantity demanded of a commodity increases as it's price falls and decreases as it's price rises. Hence, at a price above than the equilibrium price, quantity supplied by suppliers will increase ( according to the law of supply) and quantity demanded by buyers will decrease ( according to the law of demand). As such, at a price P1 above the Equilibrium price Pe, Quantity Supplied will be more than Quantity demanded. Hence, at a price of P1, Qd < Qs ( Quantity demanded is less than Quantity Supplied).
2)
At a price of P1 , there exists EXCESS SUPPLY.
At a price above above than the Equilibrium price, Quantity Supplied by suppliers will increase and Quantity demanded by buyers will decrease. As such, Quantity Supplied will exceed Quantity demanded at a price of P1 and hence an EXCESS SUPPLY will occur at a price of P1.
3)
There will be a price adjustment and price will fall back to Equilibrium price Pe.
At a price of P1, above than the Equilibrium price Pe, excess supply will occur. Excess supply implies that there would be unsold stock of goods at this price. Buyers seeing the unsold stock of goods may begin to ask for lower prices. Suppliers , on the other hand, may offer lower prices in an attempt to sell the unsold stock of goods. In both the cases, a downward pressure is exerted on the price and prices will fall. As price will fall, quantity demanded by buyers will increase and excess supply will start disappearing from the market . The market will again be in Equilibrium where Quantity demanded equals quantity supplied at the Equilibrium price of Pe.