The market mechanism is
the tendency for prices to change until the quantity demanded equals the
quantity supplied. Provide an explanation how the market adjusts to the market
equilibrium when the price in the market is not originally set at the market equilibrium
price.
Your Answer:
Market equilibrium is a
situation in which there is no surplus or shortage of output, and no pressure
for the price to change. Free markets have a tendency to settle down in
equilibrium.
When price is higher than
the market equilibrium, a surplus develops. A surplus means that the quantity
supplied is greater than the quantity demanded, and the market is out of
equilibrium. Disequilibrium in this case puts downward pressure on price. As the
price falls, the quantity demanded increases, as more consumers are willing and
able to purchase the good. As the price falls quantity supplied falls, as firms
are less willing to bring the good or service to market. Once the price falls
to the point where the quantity demanded equals the quantity supplied, the
market is in equilibrium with no tendency to change.
When price is lower than
the market equilibrium, a shortage develops. A shortage means that the quantity
demanded is greater than the quantity supplied, and the market is out of
equilibrium. Disequilibrium in this case puts upward pressure on price. As the
price rises, the quantity demanded falls, as fewer consumers are willing and
able to pay for the good or service. Quantity supplied rises as the price
rises, until the market equilibrium price is reached and the quantity demanded
equals the quantity supplied.
Source: Pindyck /
Rubinfeld, Microeconomics, 7th edition, Pearson
