After you have worked through this section of the learning unit, you should be able to:
- explain the adjustment process to equilibrium if the price of a good or service is higher or lower than the equilibrium price
EXCESS SUPPLY OR SURPLUS
To explain how market equilibrium is reached, you have to understand what happens in the market if the price of a good is set at such a level that the plans of buyers and suppliers are different. This can occur when the price of a product is set at too high a level. When this happens, suppliers will supply a higher quantity of a product than buyers are prepared to buy. As a result, there will be excess supply or a surplus of the product on the market. In terms of fried chicken pieces, this means that the quantity of fried chicken pieces supplied is more that the quantity demanded.
In a surplus situation, even though buyers are still able to buy the quantity of a product they wish to purchase, suppliers become frustrated because they cannot sell the quantity that they plan to sell at the given price. To get rid of their surplus, some suppliers start to change their behaviour – by offering a lower price to buyers. Soon other suppliers follow, and the price of the good or service will decrease. The price of the good will continue to decrease until the market reaches equilibrium (where quantity demanded is equal to quantity supplied).
An excess supply leads to a decrease in price
EXCESS DEMAND OR SHORTAGE
The opposite occurs when the price of a product is set at too low a level. In this situation, buyers will demand a higher quantity than suppliers are willing to or plan to supply. Excess demand or a shortage will thus be created in the market.
During a shortage, suppliers can sell the quantity of a product that they want to sell. Now buyers will become frustrated – they will not be able to obtain the quantity of the product they wish to purchase at this low price. To acquire the product, some buyers will begin to change their behaviour – they will start to offer to buy the product at a higher price. The price of the product will therefore start to increase. This increase in the price of the product will continue until the market is again in equilibrium (where the quantity demanded is equal to the quantity supplied).
Activity
Do the following activity to see if you have grasped the meaning of market equilibrium, excess demand and excess supply:
Indicate whether you agree or disagree with the following statement:
A market is in equilibrium if the quantity demanded is equal to the quantity supplied.
Correct.
The statement is indeed true. A market is in equilibrium if there is no tendency for things to change, and this happens when the quantity demanded is equal to the quantity supplied.
Think again.
The statement is true. A market is in equilibrium if there is no tendency for things to change, and this happens when the quantity demanded is equal to the quantity supplied.
At any price above the equilibrium price, there will be an excess demand for the good in question.
Think again.
If the price is higher suppliers supply a higher quantity but households demand a lower quantity.
Correct.
The statement is indeed false. At any price above the equilibrium price, there will be an excess supply since supplier supply a higher quantity but households demand a lower quantity.
Excess demand for a good will put downward pressure on the price of the good.
Think again.
The statement is false. An excess demand indicate that households demand a higher quantity than what is supplied by suppliers.
Correct.
The statement is indeed false. An excess demand indicate that households demand a higher quantity than what is supplied by suppliers. This will then put upward pressure on the price.
If the price of television sets is lower than the equilibrium price, there will be an excess demand for television sets.
Correct.
The statement is indeed true. At any price below the equilibrium price, there will be an excess demand since households demand a higher quantity while suppliers supply a lower quantity.
Think again.
The statement is true. At a lower price households demand a higher quantity while suppliers supply a lower quantity
If the price of running shoes is above the equilibrium price, there will be an excess supply of running shoes.
Correct.
The statement is indeed true. If the price is higher than the market equilibrium price suppliers supply a higher quantity but households demand a lower quantity resulting in an excess supply.
Think again.
The statement is true. If the price is higher than the market equilibrium price suppliers supply a higher quantity but households demand a lower quantity.
Indicate whether the following represents an excess demand (shortage), an excess supply (surplus) or equilibrium, and what would happen to the price in this situation:
| Excess demand/excess supply/equilibrium | Price increase/price decrease/ price unchanged | |
|---|---|---|
| Buyers are frustrated | ||
| Suppliers are frustrated | ||
| Both buyers and suppliers are satisfied |
| Excess demand/excess supply/equilibrium | Price increase/price decrease/ price unchanged | |
| Buyers are frustrated | Excess demand | Price increase |
| Suppliers are frustrated | Excess supply | Price decrease |
| Both buyers and suppliers are satisfied | Equilibrium | Price unchanged |