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Price Determination and Market Equilibrium

Prices are determined by the interaction of supply and demand in the market. Equilibrium price is reached at the point where quantity supplied equals quantity demanded. This equilibrium price can be identified by comparing supply and demand schedules or examining where the supply and demand curves intersect on a diagram. Disequilibrium occurs when supply and demand are not equal, resulting in either a surplus or shortage. Market forces will act to move the price back towards equilibrium by expanding the lower quantity and contracting the higher quantity until supply and demand are again equal.

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Basheer Khaled
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40 views5 pages

Price Determination and Market Equilibrium

Prices are determined by the interaction of supply and demand in the market. Equilibrium price is reached at the point where quantity supplied equals quantity demanded. This equilibrium price can be identified by comparing supply and demand schedules or examining where the supply and demand curves intersect on a diagram. Disequilibrium occurs when supply and demand are not equal, resulting in either a surplus or shortage. Market forces will act to move the price back towards equilibrium by expanding the lower quantity and contracting the higher quantity until supply and demand are again equal.

Uploaded by

Basheer Khaled
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Price

determination
Note:
When we observe the relation between supply
and demand together (twin market forces) with
price, then price is dependent on demand and
supply. However, when we observe the relation
of demand/supply individually with price, then
demand/supply are dependent on price.
How are prices determined?
Prices are determined in one of two ways:
 Directly: when buyers bargain with market
traders, to drive prices down, and the traders
seek to keep prices relatively high (for
profit).
 Indirectly: by firms estimating and then
charging what they think is the equilibrium
price is. If they find the price too high
(where they can’t sell most/all of their
output) then they will lower it. On the other
hand, if firms charge prices that they think
are too low (where consumers are willing to
buy more than what is offered) then they
will raise prices.
Market equilibrium
Equilibrium price: the price where demand
and supply are equal. It is also sometimes
referred to as market clearing price, as it is the
price where there are no shortages/surpluses of
the product. There are 2 ways of telling what the
equilibrium price is:
 Comparing demand and supply schedules of
the same product, and seeing where the
quantity demanded and quantity supplied are
equal.
 Examining a demand and supply
diagram and seeing where the demand
and supply
curves intersect.
Market disequilibrium
Market forces will always move price from
disequilibrium to equilibrium. Disequilibrium: a
situation where demand and supply are not
equal. Disequilibrium can either be:
 Surplus, (excess supply), (Supply>Demand):
If a firm sets the price above equilibrium level,
then it will not be able to sell all its products,
and there will be a surplus of its product. To
fix this, the firm will keep lowering price so
that demand extends and
supply contracts
until the market
clears.

 Shortage, (Excess demand),


(Demand>Supply): If a firm sets a price below
equilibrium level, the consumers
will demand more than what is
offered, and there will be a shortage of the
product. To fix this, Firms will keep raising
prices so that supply extends and demand
contracts, until the market clears.

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