The Invisible Hand Market Forces restoring equilibrium

The Concept of Market Equilibrium Consumers aim to pay the lowest possible price in order to maximise their purchasing power. Producers aim to sell at the highest possible price so they can maximise their revenue. Market equilibrium occurs at the price where quantity demanded equals quantity supplied.

Equilibrium Price ($) Quantity D S EQUILIBRIUM

Equilibrium PriceQuantity Demanded Quantity Supplied At market equilibrium there will be no surplus or shortage and there is no incentive for the price or quantity to change.

Changes in Supply Four factors that will increase supply (cause a shift to the right ) Decrease in costs of production Decrease in the price of a related good Increase in productivity Increase in Technology

Changes in Demand The four factors that will increase demand ▫Increase in Tastes and preferences ▫Increase in Incomes ▫Increase in the price of a substitute ▫Decrease in the price of a complement

Market reactions to Disequilibrium When the market is not in equilibrium we call this a disequilibrium. When the market is in a disequilibrium, there will be pressure on the market. These pressures are from the needs of consumers for goods and services (demand) and the need of producers to sell their goods and services (supply) These pressures are known as market forces or ‘the invisible hand’.

Market reactions to Disequilibrium When the market is in disequilibrium there will be pressure on market forces to return the market to equilibrium Market forces = Forces of demand and supply

Two Disequilibrium Situations Surplus (Excess supply) = Where quantity supplied is greater than quantity demanded Shortage (Excess demand) = Where quantity demanded is greater than quantity supplied

Disequilibrium ShortageSurplus

Market forces restoring equilibrium Excess Supply ( Surplus) 1.The producer will want to sell their excess stock so will react by dropping the price of their product 2.Consumers will react to lower prices by buying more as the goods become more affordable (Law of demand) 3.As prices fall producers decrease their supply as the good becomes less profitable (Law of supply) 4.QD increases and QS decreases until equilibrium is restored

Market forces restoring equilibrium Excess Demand (Shortage ) 1.The Consumers want to buy more of the goods so they are prepared to pay higher prices. Consumers bid the price up as they don’t want to miss out. 2.Producers will react to higher prices by supplying more as the good becomes more profitable (Law of Supply) 3.As prices increase, consumers demand falls as the good becomes less affordable (Law of demand ) 4.QS increases and QD decreases until equilibrium is regained

Effect of a change in supply or demand on equilibrium A change in market conditions will lead to a change in demand or supply and the market will no longer be at equilibrium at the existing price and quantity. The market will adapt to the new conditions and market forces will return the market to equilibrium

Decrease in demand An decrease in Demand causes a surplus at the existing price Producers will lower the price to get ride of excess stock causing the quantity supplied to fall and quantity demanded to increase. This continues until a new equilibrium price and quantity is established. Quantity S D1 Qe pe D QS QD P1 Q1

An increase in Demand will cause a shortage at the current price

Decrease in Supply A Decrease in supply causes a shortage at the existing price The price will be bid up causing the quantity demanded to decrease and quantity supplied to increase. This continues until a new equilibrium price and quantity is established. Quantity Price S D Qe pe P1 QDQs Q1 S1

An increase in supply will cause a surplus at the existing price.

Why markets tend towards Equilibrium Price ($) Quantity D S D’ D’’ S’ S’’ The shift will lead to either a surplus or a shortage depending on whether demand or supply has increased or decreased

Conclusion A market will tend toward equilibrium If the price is not at equilibrium then market forces will work to move the market back toward equilibrium.