Study Notes
Competitive market equilibrium is the point where market demand equals market supply, resulting in no tendency for change. It is achieved when the conditions of demand and supply remain constant.
- Market Equilibrium — the price and quantity at which demand equals supply. Example: At $5, quantity demanded equals quantity supplied.
- Excess Demand (Shortage) — when quantity demanded is greater than quantity supplied. Example: At $2, demand is 160 units, supply is 40 units, creating a shortage of 120 units.
- Excess Supply (Surplus) — when quantity supplied is greater than quantity demanded. Example: At $8, supply is 160 units, demand is 40 units, creating a surplus of 120 units.
- Price Mechanism — a system where demand and supply interact to determine prices, performing signalling, incentivizing, and rationing functions. Example: Rising prices signal producers to increase supply and consumers to decrease demand.
- Consumer Surplus — the gain to consumers when the market price is lower than the price they are willing to pay. Example: Area below the demand curve and above the price line.
- Producer Surplus — the gain to producers when the market price is higher than the price they are willing to sell at. Example: Area above the supply curve and below the price line.
- Community Surplus — total welfare to society from an economic transaction, equal to consumer surplus plus producer surplus. Example: Maximized at market equilibrium.
- Allocative Efficiency — occurs when the price of a good equals the marginal cost of producing it, maximizing community surplus. Example: Achieved at competitive market equilibrium.
Exam Tips
Key Definitions to Remember
- Market Equilibrium
- Excess Demand (Shortage)
- Excess Supply (Surplus)
- Price Mechanism
- Consumer Surplus
- Producer Surplus
- Community Surplus
- Allocative Efficiency
Common Confusions
- Confusing excess demand with excess supply
- Misunderstanding the role of the price mechanism
Typical Exam Questions
- What is market equilibrium? Market equilibrium is the price and quantity where demand equals supply.
- How does the price mechanism work? It uses demand and supply interactions to set prices, performing signalling, incentivizing, and rationing functions.
- What happens when there is excess supply? Prices tend to fall, reducing the surplus until equilibrium is restored.
What Examiners Usually Test
- Ability to define and explain market equilibrium
- Understanding of how changes in demand and supply affect equilibrium
- Calculation of consumer and producer surplus