Equilibrium & Disequilibrium (Cambridge International IGCSE Economics)

Market Equilibrium

Spec point — 2.5.1 · Definition, drawing and curves used to establish equilibrium price and sales in a market.

• In a market system, prices for goods/services are determined by the interaction of demand and supply

  • A market is any place that brings buyers and sellers together
  • Markets can be physical (e.g. McDonald's) or virtual (e.g. eBay)

• Buyers and sellers meet to trade at an agreed price

  • Buyers agree the price by purchasing the good/service
  • If they do not agree on the price then they do not purchase the good/service and are exercising their consumer sovereignty

• Based on this interaction with buyers, sellers will gradually adjust their prices until there is an equilibrium price and quantity that works for both parties

  • At the equilibrium price, sellers will be satisfied with the rate/quantity of sales
  • At the equilibrium price, buyers are satisfied that the product provides benefits worth paying for

Equilibrium

• Equilibrium in a market occurs when demand = supply

• At this point the price is called the market clearing price

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

A graph showing a market in equilibrium with a market clearing price at P & quantity at Q

• 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

Spec point — 2.5.1 · Definition, drawing and interpretation of demand and supply schedules and curves used to identify disequilibrium prices and shortages (demand exceeding supply) and surpluses (supply exceeding demand).

Market Disequilibrium

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

A graph that depicts the condition of excess demand in the market for electric scooters

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 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. For example, retail clothing can do so in a few days. Whereas the housing market may take several months, or even years

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

A graph that depicts the condition of excess supply in the market 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 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 Memorise the rule that shortages arise when the price is below equilibrium whereas surpluses arise when the price is above the equilibrium.

Equilibrium in Demand and Supply Schedules

Spec point — 2.5.1 · interpretation of demand and supply schedules

• A demand and supply schedule shows the quantity demanded and the quantity supplied of a product at different price levels
• Demand and supply schedules can be used to identify equilibrium and disequilibrium

Demand and Supply Schedule per Week for YEEZY Boost 700 Wave Runner Trainers

Table analysis

• At a price of $500, the market is in equilibrium

  • The QD = QS (800 units)

• At a price of $300 and $400, there is excess demand as the product is more affordable for consumers

  • Producers supply less at lower prices as they make less profit per unit
  • Producers are incentivised to supply more when prices are higher

• At a price of $600 and $700, there is excess supply as the high price has eliminated some buyers from the market

  • Producers would love to sell at this high price but in order to clear their stock they have to lower the price and move towards the equilibrium