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Question
Explain the meaning of excess demand and excess supply with the help of a schedule. explain their effect on equilibrium price.
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Solution
Excess Demand and Excess Supply
Excess Demand- It is defined as a situation, where the market demand exceeds the market supply at a particular market price. In other words, if at any price level, the quantity of output supplied by the producers is lesser than what is demanded by all the consumers in the market, then we face the situation of excess demand. Symbolically, the situation of excess demand is represented as:
QD(Pe)>Qs(Pe)
Excess Supply- It is defined as a situation, where the market demand falls short of the market supply at a particular price. In other words, if at any price level, the quantity of output supplied by the producers is more than what is demanded by all the consumers in the market, then we face the situation of excess supply. Symbolically, the situation of excess supply is represented as:
Qs(Pe)>QD(Pe)
Explanation of Excess Demand and Excess Supply- Diagrammatically
Let us understand the concept of excess demand and excess supply with the help of the following schedule and graph.
Suhedule Price Quantity Quantity Supplied 14
12
10 1
2
3 765⎫⎪⎬⎪⎭ Excess Supply
8 4 4 |= Market Equilibrium 6
4
2
5
6
7 321⎫⎪⎬⎪⎭ Excess Demand
From the graph, we can analyse that the market demand curve DD and the market supply curve SS intersects each other at the point 'E', which is known as market equilibrium. The corresponding price and quantity are regarded as equilibrium price and equilibrium quantity, OPe and Oqe. The equilibrium price is Rs 8 and the equilibrium quantity is 4 units.
Now, let us suppose that the price is Rs 12, then at this price as per the market demand curve DD, only 2 units of output is demanded, while as per the market supply curve SS, the producers are ready to sell 6 units of output. As the market supply is more than the market demand, so there is situation of excess supply by 4 units (i.e. 6−2=4 units). This excess supply will increase competition among the sellers; consequently, they will reduce the price in order to sell more of their output. The fall in price will continue until price becomes Rs 8, where market demand equals market supply.
On the contrary, let us suppose that if the market price is Rs 2. At this price, as per the market demand curve DD, 7 units of output will be demanded; while as per the market supply curve SS, the producers are ready to sell only 1 unit of output. As the market demand is more than the market supply, so there is a situation of excess demand by 6 units (i.e. 7−1=6 units). This excess demand of 6 units will increase competition among the buyers; consequently, the buyers will tend to buy output at higher price (due to the competition), which as a result will increase the market price. The market price will continue to rise until it becomes Rs 8, where the equilibrium is restored. Hence, no matter whatever is the initial price, the final price will always be the equilibrium price. That is, why the point of intersection is known as equilibrium. This implies that the market will at a state of rest with no further incentive to deviate from the equilibrium point.
Excess Demand- It is defined as a situation, where the market demand exceeds the market supply at a particular market price. In other words, if at any price level, the quantity of output supplied by the producers is lesser than what is demanded by all the consumers in the market, then we face the situation of excess demand. Symbolically, the situation of excess demand is represented as:
QD(Pe)>Qs(Pe)
Excess Supply- It is defined as a situation, where the market demand falls short of the market supply at a particular price. In other words, if at any price level, the quantity of output supplied by the producers is more than what is demanded by all the consumers in the market, then we face the situation of excess supply. Symbolically, the situation of excess supply is represented as:
Qs(Pe)>QD(Pe)
Explanation of Excess Demand and Excess Supply- Diagrammatically
Let us understand the concept of excess demand and excess supply with the help of the following schedule and graph.
| Suhedule | ||
| Price | Quantity | Quantity Supplied |
| 14 12 10 | 1 2 3 | 765⎫⎪⎬⎪⎭ Excess Supply |
| 8 | 4 | 4 |= Market Equilibrium |
| 6 4 2 | 5 6 7 | 321⎫⎪⎬⎪⎭ Excess Demand |
Now, let us suppose that the price is Rs 12, then at this price as per the market demand curve DD, only 2 units of output is demanded, while as per the market supply curve SS, the producers are ready to sell 6 units of output. As the market supply is more than the market demand, so there is situation of excess supply by 4 units (i.e. 6−2=4 units). This excess supply will increase competition among the sellers; consequently, they will reduce the price in order to sell more of their output. The fall in price will continue until price becomes Rs 8, where market demand equals market supply.
On the contrary, let us suppose that if the market price is Rs 2. At this price, as per the market demand curve DD, 7 units of output will be demanded; while as per the market supply curve SS, the producers are ready to sell only 1 unit of output. As the market demand is more than the market supply, so there is a situation of excess demand by 6 units (i.e. 7−1=6 units). This excess demand of 6 units will increase competition among the buyers; consequently, the buyers will tend to buy output at higher price (due to the competition), which as a result will increase the market price. The market price will continue to rise until it becomes Rs 8, where the equilibrium is restored. Hence, no matter whatever is the initial price, the final price will always be the equilibrium price. That is, why the point of intersection is known as equilibrium. This implies that the market will at a state of rest with no further incentive to deviate from the equilibrium point.
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