2.3 Market Equilibrium and Disequilibrium

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On a demand-supply diagram[both supply and demand curves are present] the point where the curves intersect is the market equilibrium. At this point the corresponding prices and quantity is called the equilibrium price and equilibrium quantity.
A market is any place at which sellers and buyers are brought together. Physical or Virtual
Ex. Grocery shops, Amazon

The price in a free market is determined by the interactions between the supply and demand for the good.
Consumers can decide not to buy a product if they do not agree with the price, this displays consumer sovereignty[consumers have the power to influence production of goods based on their purchases]
Thus sellers will adjust the prices of their products until a middle ground is met where both parties agree.
This is the equilibrium price; here sellers[ revenues and quantity sold]and consumers[satisfaction/utility of the good] are both satisfied.

Any price above or below the equilibrium price creates disequilibrium in market; either there is a surplus or shortage of the good.

A price above equilibrium price[EP] will create a surplus of the good, as at a high price the demand will contract but supply extends. The amount of surplus is equal to the distance between the point on the demand curve and supply curve where price intersects.

A price below EP will result in a shortage, as demand extends but supply contracts. Amount of shortage is equal to distance between the point on the demand curve and point on supply curve where price intersects.

When there is a surplus, producers will realise they cant sell all their products and they are not making as much revenue as they could, and thus the price must be too high.

So, they will begin lowering their prices to earn more revenue. QS will begin to contract and QD will begin gto extend.

After some time the market will clear, meaning there will be no disequilibrium; the market will now be at equilibrium where both consumers and producers are happy.

When there is a shortage, producers will realise their stock is getting exhausted and there is still demand in the market; they are not making as much revenue as they could, and thus the price must be too low.

So, they will begin raising their prices to earn more revenue. QD will begin to contract and QS will begin gto extend.

After some time the market will clear, meaning there will be no disequilibrium; the market will now be at equilibrium where both consumers and producers are happy.

Price mechanism is the aforementioned interactions between demand and supply in a free market.
It is helpful because it helps us understand how to best allocate our scarce resources to meet most of the populations wants.
This was famously called the ‘invisible hand’ by Adam Smith, the father of economics.
Price mechanism has two functions-
Resource allocation and Rationing

Price mechanism acts as a signal; The price changes will tell producers and consumers where resources are needed, when there was a shortage the price was increasing, this told the producer that more resources are needed here, this is the incentive of profit maximisation.
Suppliers realise they can make more money by supplying more of the good, hence supply increases and resources are reallocated to the production of the good. At the same time it was an incentive for consumers to cut back on spending on this good and substitute it for other goods, hence the demand contracted.
Same reasonings for the change due to surpluses. Supply contracts as prices are reducing and demand extends.

Prices will work to ration these scarce goods; people who can buy the goods will receive them, as they get more scarce they will get more expensive;shortage. This is why antiques are so expensive, they are scarce.
In the case of surpluses the prices will drop and more people will buy the products, as they can afford it. Plastic toys are often cheap, because they are not scarce.

Consumer surplus[CS] is the difference between the price consumers are willing to pay and the price they actually pay. If a consumer is ready to pay 18$ but only has to pay 15$ for a product their CS is 3$
Producer surplus`[PS] is the difference between the price producers are willing to sell their goods at and the price they actually sell at. If a producer is ready to sell at 10$ but instead gets to sell at 15$ their PS is 5$
Community/Social surplus is the sum of CS and PS.

A price above equilibrium price[EP] will create a surplus of the good, as at a high price the demand will contract but supply extends. The amount of surplus is equal to the distance between the point on the demand curve and supply curve where price intersects.

A price below EP will result in a shortage, as demand extends but supply contracts. Amount of shortage is equal to distance between the point on the demand curve and point on supply curve where price intersects.

Some questions can ask you to calculate CS, PS and community surplus after there has been a shift in the demand and/or supply curves.
For these, identify the correct demand and supply curves and price then find the surpluses