<2.5 PRICE DETERMINATION>

--2.5.1 MARKET EQUIIBRIUM--

--HOW PRICES ARE DETERMINED?--

"Consumers want low prices, whilst sellers want high prices. So how is the price of a product determined?"

--THROUGH BARGAINING?--

Yes!, In some cases, there is direct bargaining between buyers and sellers. BUYERS often haggle with sellers, SEEKING TO DRIVE THE PRICE DOWN, and the SELLERS AIM TO KEEP THE PRICE RELATIVELY HIGH. An example of this would be an auction, where the highest bidder wins.

--THROUGH MARKET FORCES--

In most cases, FIRMS ESTIMATE and SET WHAT THEY THINK IS THE CORRECT PRICE to ENSURE MAXIMUM PROFITS or SALES.
In other words, they set the price so that the THE QUANITY THAT THEY ARE WILLING AND ABLE TO SUPPLY is EQUAL TO THE QUANTITY THAT CONSUMERS ARE WILLING AND ABLE TO DEMAND. This way they have SOLD EVERYTHING and have no LEFTOVER STOCK. This price is referred to as the EQUILIBRIUM PRICE.

--EQUILIBRIUM PRICE--

EQUILIBRIUM PRICE is also sometimes referred to as the MARKET CLEARING PRICE. This is because it is the price where DEMAND and SUPPLY are EQUAL, and so there are NO SHORTAGES or SURPLUSES of the product.

--TASK--

Copy this table into your notes and indicate the equilibrium price and quantity.
Now plot it!

--2.5.2 MARKET DISEQUIIBRIUM--

--DEFINITION--

MARKET DISEQULIBRIUM occur whenever the QUANTITY DEMANDED DOES NOT EQUAL THE QUANITY SUPPLIED.

--CAUSE #1: SHORTAGE (EXCESS DEMAND)--

A 'SHORTAGE' occurs when the price of the product is set BELOW the equilibrium price. At this price the quantity demanded is greater than the quantity supplied.

--SHORTAGE to EQUILIBRIUM--

When the price is set below equilibrium the price begins to be 'BID-UPWARDS' by CONSUMERS, like at an AUCTION, which in turn sends a price SIGNAL to producers that they can charge a higher price for the good. With the INCENTIVE of more profit, they will raise their price and REALLOCATE resources towards producing more of this good and hence increase the quantity supplied to satisfy the extra demand and the market will clear at a higher price and quantity.

--CAUSE #2: SURPLUS (EXCESS SUPPLY)--

A 'SURPLUS' occurs when the price of the product is set ABOVE the equilibrium price. At this price the quantity supplied is greater than the quantity demanded.

--SURPLUS to EQUILIBRIUM--

When the price is set ABOVE equilibrium the PRICE TENDS DOWNWARDS as PRODUCERS will need to CUT THEIR LOSSES by offering price reductions. This lower price sends a SIGNAL to producers that they have an INCENTIVE to reduce output in this industry and REALLOCATE their resources towards producing a good with a rising price. The end result is a new lower equilibrium price and quantity.

--PAST PAPER QUESTIONS--

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