Question

A situation of excess demand or excess supply is automatically corrected under perfect competition. Comment.

Answer 1

Yes. Under perfect competition, situations of excess demand or excess supply are automatically corrected through the free play of market forces, called price mechanism.

$\to$ When there is excess supply:

• Market price decreases.

• Decrease in market price leads to extension of demand and contraction of supply.

• The process of extension and contraction continues till excess supply is eliminated.

• New equilibrium is established with lower price and higher quantity than before.

$\to$ When there is excess demand:

• Market price increases.
• Increase in market price causes contraction of demand and extension of supply.
• The process of extension and contraction continues till excess demand is eliminated.
• New equilibrium is established with higher price and higher quantity than before.