Question

- What happens in the free market if the market price is set too high for the equilibrium price? Draw a graph and explain the reason logically.

- As the large-scale wild-fire in California is threatening the Napa Valley--which accounts for 90% of wine supply in the United States--a considerable extent of impact is expected on the wine industry. Analyze the effect of the wild-fire on a market with two goods: wines and wine openers.

Answer 1

1. If the market price is set too high for the equilibrium price, there will be excess supply in the market.

Let us illustrate this through the use of diagram given in the image.

The upward sloping curve is the supply curve and the downward sloping curve is the demand curve. P* is the equilibrium price and Q* is the equilibrium quantity.

If the price is set higher than the equilibrium price, say at P dash, we can clearly see that there will be excess supply. Excess supply implies that supply will be higher than the demand.

Due to this, there will be glut in the market. Producers will be ready to sell their produce at the lesser price level. Due to lower price, people will be ready to buy more. Eventually, this cycle will keep on going and price will keep on rising till we reach the equilibrium price level in the economy.

2. Due to the wild fire, the supply side of the wine market will be impacted. Due to the backward shift of the supply curve, the equilibrium price will rise and equilibrium quantity will decline. This is shown in the diagram.

Now, the decline in quantity of wine and rise in its price, the demand of wine will be impacted. Due to this, the market for wine openers will also be affected. This is because people will demand lesser wine openers because they drink lesser wine now. This will lead to decline in equilibrium price and quantity of wine openers. Again this is illustrated in the accompanying diagram.