ECONOMICS

Micro and Macro Economics



Micro and Macro Economics

Critically examine how supply and demand operate to establish an equilibrium price?

The demand means the amount you are willing to buy a certain product at a specified price. Supply is the amount of product a company is willing to sell for a period of time and a given price. The balance refers to the law of supply and demand in the price of any product on the market is determined by the contrast between its supply and demand. The amount of product offered is an increasing fraction of the price, while the quantity demanded is a decreasing function. The quantity and equilibrium price in this equilibrium model parcialson those resulting from the intersection (called the Marshall cross) of the relevant demand and supply curves, as shown in the figure below (Gregory, Romer, 1991, pp. 85-89).

The aggregate market schedule shows the equilibrium price is £1.50 per bag (Table 3.1). At that price, the amount supplied and demanded is 15,000 bags per week. All the chips offered on the market purchased by consumers. Prices set above or below the market price will result in market disequilibrium, because there will be excess supply or demand.

Figure 3.1 shows market equilibrium, with the equilibrium price of £1.50. At that price, an equal amount are demanded and supplied. Thus, the market clears all output at that price.

Market Disequilibrium

Excess Supply

Market disequilibrium is any price at which the demand and supply quantities are not equal. Let's look at examples of market disequilibrium's, and analyse the results of attempting to set prices anywhere other than the equilibrium price (Parkin, M., 2005, pp. 89-95).

Table 3.1 and Figure 3.1 show the market price to be £1.50. If the producers of these potato chips had an exaggerated sense of their value, they might set the price too high. Let's say, for example, that they greedily set the price at £2.50 per bag. At that price, the quantity demanded is much smaller than at the equilibrium price. Quantity demanded drops from 15 000 to 5000 bags per month. This is equivalent to a movement along the demand curve, as shown in Figure 3.2.

As price increases, the quantity demanded decreases or moves upwards and left along the demand curve. At the same time, setting the price higher induces producers to increase production as they expect higher profits at higher prices. Quantity supplied thus moves in the opposite direction, moving upwards along the curve to a quantity of 25,000 Griffiths, Wall, 2007, pp. 31-39).

Figure 3.2: Equilibrium with shortages and surplus

Thus, we can say at £2.50, an excess supply for chips exists, with more quantity supplied than demanded. What happens to this surplus? Producers can only sell the extra goods if they lower the price. As they do so, more quantity is demanded, and producers reduce production. This narrows the gap continuously until the surplus is reduced to zero at the market-clearing, equilibrium price.

Excess Demand

Let's take up the opposite case and assume that firms are not ...