Explain How The Price Mechanism Brings About The Equilibrium Price And Also How And Why The Government Would Intervene In The Market Place.

1103 words - 4 pages

Market equilibrium is a situation where at a certain price level, the quantity supplied by producer and the quantity demanded by consumers are equal. It is a situation where there is no tendency for change in either price of product or quantity supplied and demanded. This situation is brought about by forces of the price mechanism, the interplay of demand and supply market forces.The situation of market equilibrium is represented by the above figure. Where the two curves of demand and supply intersect at Pe, the equilibrium price Pe and the equilibrium quantity Qe is established. Any other price level other than that of Pe would result in either excess supply or excess demand, which would then lead to the price mechanism equilibrating the market again through interaction between forces of supply and demand.At price level OP1, the quantity demanded is OQ2, which exceeds the quantity supplied OQ1. This means that there is excess demand in the market, because not enough of the product is supplied to consumers to satiate demand. In this situation, the quantity that the consumers demand exceeds the quantity supplied, and so it would be expected that this would put pressure on the price of the commodity to go up. This upward pressure arises from the limited quantity of supply available to consumers, and so they bid up the price in an attempt to secure the limited quantity of the product. The law of supply states that as the price goes up, the quantity supplied will also increase. So the S curve in the figure would experience an expansion, pushing it towards the right as the price goes up. The law of demand states, however, that when price goes up, the quantity demanded goes down. The D curve experiences a contraction as the price goes up, and eventually when the price reaches Pe, the quantity supplied OQe will be equal to the quantity demanded OQe. Consumers would stop bidding up the price at this point, stopping the increase in supply and decrease in demand, keeping quantity demanded and supplied at the same level whilst price remains constant. At this point, market equilibrium is reached.At price level OP2, the quantity supplied OQ2 exceeds the quantity demanded OQ1. This situation of excess demand is called an oversupply, or glut. At this price point, supply is larger than demand. Firms would lower the price of the good using marketing techniques like specials, sales in order to try to raise demand. By doing so, the price level would decline towards OPe, bringing about an expansion in the demand curve towards OQe because consumers will demand more of the product if the price is lowered. The supply curve contracts towards OQe in response to the price drop, because firms supply less if the price is lowered. At price point OPe and quantity OQe equilibrium is reached.It can be seen that any surplus or shortages of supply and demand are only temporary, because the imbalanced match between supply and demand will lead to a change in price, which works to...

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