Answer to Question #98903 in Microeconomics for Usman Tariq

Question

Explain the concept of market equilibrium and use a demand and supply diagram to show the equilibrium?

Use demand and supply diagrams to analyse changes to price and quantity following changes in demand and supply?

Explain how changes in the equilibrium price and quantity are influenced by the elasticity of demand and supply?

Explain the difference between shortage and surplus?

Answer 1

Market equilibrium is a market situation where the quantity demanded equals the quantity supplied. It is a point where the demand curve intersects supply curve, as shown in figure 1 below. At this point, the prevailing price and quantity are referred to as equilibrium price and quantity represented by P and Q, respectively, in the figure.

Figure 1. Market equilibrium price and quantity.

Source. Economicsdiscussion

Equilibrium price and quantity are affected by changes in demand and supply. Increase in demand as a result of income rise, rise in prices of substitutes, and other factors lead to a right shift of the demand curve from D to D1 as shown in figure 2 below. Increase in demand leads to excess demand causing price. The increase in price motivates producers to produce more, increasing quantity. The increase in price and quantity leads to a new equilibrium point and new equilibrium price P1 and quantity Q2. Similarly, a decrease in demand as a result of a decrease in income, decrease in the price of substitutes or other factors lead to a leftward shift of the demand curve from D to D2 as shown in figure 2. The decrease in demand leads to excess supply which causes the price to fall discouraging more production which leads to a decrease in quantity. The new equilibrium price and quantity become P2 and Q2 respectively.

Figure 2. Shift in quantity demanded.

Source. Economicsdiscussion

Supply changes due to changes in technology, taxation production cost and other factors. Increase in supply leads to a shift in the supply curve to the right from S to S1 as shown in figure 3 below. The increase leads to excess supply which causes the price to decrease and increase in quantity demanded. The new equilibrium price and quantity become P1 and Q1 respectively. The decrease in supply leads to a shift in the supply curve to the left, from S to S2 in figure 3. The decrease in supply leads to excess demand which causes the price to increase lowering quantity demanded. The new equilibrium leads to lower quantity Q2 and higher price P2.

Figure 3. Shift in quantity supplied.

Source. Economicsdiscussion

Elasticity refers to the responsiveness of demand and supply as a result of changes on their determinants. Elasticity can be elastic, inelastic or unitary. Inelastic elasticity does not affect equilibrium quantity and price, unitary elasticity has a unit change in equilibrium price and quantity and supplied as a result of a unit change in the determinants, while, elastic elasticity leads to a greater change in equilibrium quantity and price as a result of a unit change in the determinants.

Shortage refers to a situation where the quantity demanded exceeds quantity supplied, while surplus refers to a situation when the quantity supplied exceeds quantity demanded.

Reference

Demand and Supply & The Equilibrium Price and Quantity. (2016, January 29). Economicsdiscussion. Retrieved from http://www.economicsdiscussion.net/supply/demand-and-supply-the-equilibrium-price-and-quantity/17037.