Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Market equilibrium is the price at which quantity demanded equals quantity supplied. On a graph it is where D and S cross.
- At any other price the market is in disequilibrium.
- Surplus: price above equilibrium, Qs > Qd. Sellers cut the price.
- Shortage: price below equilibrium, Qd > Qs. The price is bid up.
- While the price adjusts, buyers and sellers move along the curves. Neither curve shifts.
- Equilibrium changes only when a determinant of demand or supply shifts a curve. At the old price there is then a shortage or surplus, and the price moves to a new equilibrium.
Key relationships
| Situation | Rule | Result |
|---|---|---|
| Surplus | Qs − Qd at the given price | price falls |
| Shortage | Qd − Qs at the given price | price rises |
| Demand increases | D shifts right | P rises, Q rises |
| Demand decreases | D shifts left | P falls, Q falls |
| Supply increases | S shifts right | P falls, Q rises |
| Supply decreases | S shifts left | P rises, Q falls |
| D up and S up | effects on P conflict | P indeterminate, Q rises |
| D down and S down | effects on P conflict | P indeterminate, Q falls |
| D up and S down | effects on Q conflict | P rises, Q indeterminate |
| D down and S up | effects on Q conflict | P falls, Q indeterminate |
Assumptions behind the model
- The market is competitive: many buyers and sellers, and none can set the price alone.
- Prices are free to move up or down.
- When one determinant changes, everything else that affects demand and supply stays the same.
- Out of scope here: consumer and producer surplus, price ceilings and floors, and elasticity (Microeconomics course).
Mistakes to avoid
- Calling a surplus a sign of a low price. It means the price is too high.
- Measuring the gap from Qₑ. Use Qs and Qd at the same price.
- Shifting supply when demand changes. The quantity supplied changes along the same curve.
- Shifting both curves for one event. Ask: does it affect buyers or sellers?
- Giving a definite answer for a conflicting double shift. Say “indeterminate”.
- Unlabelled graphs. Label axes, D₁, D₂ (or S₁, S₂), P₁, P₂, Q₁, Q₂.
Quick self-check
VD is the valda, the currency of the fictional country Valdoria used in the study guide.
- At VD 5, Qd = 90 and Qs = 130 units. Surplus or shortage, and how big? (Surplus of 40)
- At VD 3, Qd = 50 and Qs = 35 units. What happens to the price? (Shortage of 15, so the price rises)
- A new technology cuts production costs. Effect on P and Q? (Supply shifts right: P falls, Q rises)
- Demand falls and supply rises at the same time. What is certain? (The price falls; the quantity is indeterminate)
Next: practice questions.