If the prevailing market price is above the equilibrium price, explain its chain of effects.

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Solution

If the prevailing market price is above the equilibrium price, then there occurs the situation of excess supply. Let us assume that the market price $P^{k}$ is above the equilibrium price $P^{e}$ . According to the demand curve, quantity demanded is $q_{d}^{'}$ . Whereas, according to the supply curve, the quantity supplied is $q_{s}^{'}$ . So, it can be seen that there emerges the situation of excess supply equivalent to $(q_{s}^{'} - q_{d}^{'})$ . 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 $P^{e}$ , where market demand equals market supply.

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