2.3.1 Market Equilibrium & Disequilibrium

• 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 with the utility that the product provides

Equilibrium

• Equilibrium in a market occurs 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

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
    
    

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 (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

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 (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