Page 40 - DECO405_MANAGERIAL_ECONOMICS

Unit 3: Market Supply and Equilibrium

Notes
Table 3.1: Market Supply and Demand for Commodity X
Price of Total Quantity Total Quantity Surplus or Shortage
Commodity Supplied per Month Demanded per Month
5 12,000 2,000 +10,000
4 10,000 4,000 +6,000

3 7,000 7,000 0
2 4,000 11,000 –7,000
1 1,000 16,000 –15,000

At a price of 3 units, and only at this price, the quantity which producers are willing to produce
and supply is identical to the amount consumers are willing to buy. As a result, there is neither
a shortage nor a surplus of commodity X at this price. A surplus causes prices to decline and a
shortage causes prices to rise. With neither shortage nor surplus at 3 units, there is no reason for
the actual price of commodity X to move away from this price. This price is called the equilibrium
price. Equilibrium represents a situation from where there is no tendency to change. It is a state of
balance. Stated differently, the price of X will be established where the supply decisions of
producers and demand decisions of buyers are mutually consistent.
Interaction of demand and supply to reach equilibrium is shown in Figure 3.2.

Figure 3.2: Equilibrium Point

e

Graphically, the interaction of supply and demand curves will indicate the equilibrium
point (E).
If market price is OP , the quantity demanded by consumers is OQ , while the quantity which
1 1
producers wish to supply is OQ . There is thus a surplus of Q Q at this price. It is well known that
2 1 2
a surplus leads to a downward pressure on price and so market price will fall. At the lower price
of OP , the quantity supplied is OQ , while the quantity demanded is OQ . There is, therefore, a
2 1 2
shortage at this price, represented by Q Q . This shortage tends to put an upward pressure on
1 2
price and market price is expected to rise.
There is only one price, at which the quantity supplied is equal to the quantity demanded, there
is no surplus or shortage, no rise or fall of price – OP . It is thus referred to as the equilibrium
e
position.

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