Question

Discuss how a market determines equilibrium price and quantity of a normal good. Explain the concepts of “excess demand” and “excess supply”. State how market adjusts in response to the above.

Answer 1

For understanding the equilibrium concept we need to understand the meaning of demand and supply

A demand curve shows inverse relationship between price and quantity demanded

It is inverse sloped in nature

A supply curve shows the relationship between price and quantity supplied

The slope is upward in nature

The intersection point of demand and supply is called equilibrium

The price corresponding to equlibrium is called equilibrium price and quantity corresponding to equlibrium is called equilibrium quantity for normal good

So for market, to determine the equilibrium point where the intersection of demand and supply is there

When we talked about the excess demand it is a case when there is a shortage in the market

In case of shortage the demand exceeds the supply and for adjusting this we need to to raise the prices to the equilibrium

Opposite to it is excess supply in which supply exceeds the demand and situation is called surplus

The market adjust for excess supply by lowering the price to the equilibrium

P($) demand Supply Surplus $ * Equilibrium Shortage 70