Question

1. If a price is above the equilibrium price, explain the forces that bring the market back to the equilibrium price and quantity. If a price is below the equilibrium price, explain the forces that bring the market back to the equilibrium price and quantity.

Answer 1

A price above the equilibrium price creates surplus. A surplus refers to the amount by which the quantity supplied is more than the quantity demanded at the current price. A surplus occurs only if the current price exceeds the equilibrium price. In order to sell the greater quantity of goods or services, sellers are more likely to decrease the price. Market forces exert a downward pressure on price towards the equilibrium price. A surplus is eliminated once price falls to the equilibrium price.

A price below equilibrium will create a shortage. A shortage refers to the amount by which the quantity demanded is more than the quantity supplied at the current price. In order to the face of a shortage, sellers are likely to offer a higher price for the good or service. When the price increases, there will be a rise in the quantity supplied (however not a change in supply) and a fall in the quantity demanded (however not a change in demand) until the equilibrium price is achieved.