Question

What will happen if the price prevailing in the market is

(i) above the equilibrium price?

(ii) below the equilibrium price?

Answer 1

(i) If the market price is above the equilibrium price, there occurs the situation of excess supply.

In the given figure, the equilibrium price and quantity is demoted by P^e and q^e.

Let us assume that the market price (P₁) is above the equilibrium price P^e. Now, according to the demand curve, the quantity demanded is q_d. Whereas, according to the supply curve, the quantity supplied is q_s. Thus, there exists a situation of excess supply equivalent to (q_s − q_d).

(ii) If the market price is below the equilibrium price, there occurs the situation of excess demand.

Let us assume that the market price P₂ is below 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′_d − q′_s).