Market Equilibrium & Disequilibrium (Cambridge International A-Level Economics)

Price determination in markets

• A market is any place or process that brings buyers and sellers together to exchange goods and services

  • This exchange can happen in a physical location (such as a food market in Jakarta) or through a virtual platform (such as Alibaba or Amazon)

Jakarta food market

Roles of buyers and sellers

• In any market, both buyers and sellers play essential roles

  • In an efficient market, sellers respond to what buyers want, and buyers choose between competing sellers
  • This interaction helps determine prices and quantities

The buyer demands and the seller supplies

Buyers

• Also known as consumers or demanders

• Their choices and preferences determine demand for goods and services

• They help to set prices by signalling how much they are willing to pay

  • For example, a buyer in Mexico City searching for the best price on mobile phones influences how firms set prices to compete

Sellers

• Also known as producers or suppliers

• They aim to supply goods or services in order to make a profit

• They decide what to produce, how much and at what price based on costs and expected demand

  • For example, a coconut farmer in the Philippines choosing whether to sell to local markets or export to Singapore

Market equilibrium

• Equilibrium occurs in a market when demand = supply

• At this point, the price is called the equilibrium or market-clearing price

  • This is the price at which sellers are clearing (selling) their stock at an acceptable rate

Equilibrium is at PQ. The market clearing price of P & quantity at Q

Diagram analysis

• Any price above or below P creates disequilibrium in this market

  • Disequilibrium occurs whenever there is excess demand or excess supply in a market

Market disequilibrium

• Disequilibrium occurs when demand is not equal to supply

  • If demand > supply, the market is facing excess demand
  • If demand < supply, the market is facing excess supply

1. Disequilibrium: excess demand

• Excess demand occurs when the demand is greater than the supply

  • It can occur when prices are too low or when demand is so high that supply cannot keep up with it

The quantity demanded is greater than quantity supplied

Diagram analysis

• At a price of P₁, the quantity demanded of electric scooters (Q_d) is greater than the quantity supplied (Q_s)
• There is a shortage (excess demand) in the market equivalent to Q_sQ_d

Market response

• This market is in disequilibrium

  • Sellers are frustrated that products are selling so quickly at a price that is obviously too low
  • Some buyers are frustrated as they will not be able to purchase the product

• Sellers realise they can increase prices and generate more revenue and profits

• Sellers gradually raise prices

  • This causes a contraction in QD as some buyers no longer desire the good/service at a higher price
  • This causes an extension in QS as other sellers are more incentivised to supply at higher prices

• In time, the market will have cleared the excess demand and arrive at a position of equilibrium, P_eQ_e

  • Different markets take different lengths of time to resolve disequilibrium
  • E.g., retail clothing can do so in a few days. Whereas the housing market may take several months or even years

2. Disequilibrium: excess supply

• Excess supply occurs when the supply is greater than the demand

  • It can occur when prices are too high or when demand falls unexpectedly

• During the later stages of the pandemic, the market for face masks was in disequilibrium

The quantity supplied is greater than quantity demanded for Covid-19 face masks during the later stages of the pandemic

Diagram analysis

• At a price of P₁, the quantity supplied of face masks (Q_s) is greater than the quantity demanded (Q_d)
• There is a surplus in the market(excess supply) equivalent to Q_dQ_s

Market response

• This market is in disequilibrium

  • Sellers are frustrated that the masks are not selling and that the price is obviously too high
  • Some buyers are frustrated, as they want to purchase the masks but are not willing to pay the high price

• Sellers will gradually lower prices in order to generate more revenue

  • This causes a contraction in QS as some sellers no longer desire to supply masks
  • This causes an extension in QD as buyers are more willing to purchase masks at lower prices

• In time, the market will have cleared the excess supply and arrive at a position of equilibrium, P_eQ_e

Exam Hint You should memorise the rule that shortages arise when the price is below equilibrium, whereas surpluses arise when the price is above the equilibrium