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Equilibrium, Surplus, and Shortage

This document discusses market equilibrium using the example of the gasoline market. It explains that equilibrium occurs when the quantity demanded equals the quantity supplied at a particular price. The document notes that when the price is above the equilibrium level, a surplus will exist where quantity supplied exceeds quantity demanded. In the case of gasoline at $1.80 per gallon, the quantity supplied is 680 million gallons but quantity demanded is only 500 million gallons, creating a surplus. This surplus puts pressure on prices to fall until equilibrium is reached and the surplus is eliminated.

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Carla Mae F. Dadural
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212 views4 pages

Equilibrium, Surplus, and Shortage

This document discusses market equilibrium using the example of the gasoline market. It explains that equilibrium occurs when the quantity demanded equals the quantity supplied at a particular price. The document notes that when the price is above the equilibrium level, a surplus will exist where quantity supplied exceeds quantity demanded. In the case of gasoline at $1.80 per gallon, the quantity supplied is 680 million gallons but quantity demanded is only 500 million gallons, creating a surplus. This surplus puts pressure on prices to fall until equilibrium is reached and the surplus is eliminated.

Uploaded by

Carla Mae F. Dadural
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Equilibrium, Surplus, and Shortage

Demand and Supply

In order to understand market equilibrium, we need to start with the laws of demand and
supply. Recall that the law of demand says that as price decreases, consumers
demand a higher quantity. Similarly, the law of supply says that when price decreases,
producers supply a lower quantity.

Because the graphs for demand and supply curves both have price on the vertical axis
and quantity on the horizontal axis, the demand curve and supply curve for a particular
good or service can appear on the same graph. Together, demand and supply
determine the price and the quantity that will be bought and sold in a market. These
relationships are shown as the demand and supply curves in Figure 1, which is based
on the data in Table 1, below.
Figure 1. The supply and demand curves for gasoline.

Table 1. Price, Quantity Demanded, and Quantity Supplied

Price (per Quantity demanded Quantity supplied


gallon) (millions of gallons) (millions of gallons)

$1.00 800 500

$1.20 700 550

$1.40 600 600

$1.60 550 640

$1.80 500 680

$2.00 460 700

$2.20 420 720


If you look at either Figure 1 or Table 1, you’ll see that at most prices the amount that
consumers want to buy (which we call the quantity demanded) is different from the
amount that producers want to sell (which we call the quantity supplied). What does it
mean when the quantity demanded and the quantity supplied aren’t the same? The
answer is: a surplus or a shortage.

Surplus or Excess Supply

Let’s consider one scenario in which the amount that producers want to sell doesn’t
match the amount that consumers want to buy. Consider our gasoline market
example. Imagine that the price of a gallon of gasoline were $1.80 per gallon. This price
is illustrated by the dashed horizontal line at the price of $1.80 per gallon in Figure 2,
below.

Figure 2. A price above equilibrium creates a surplus.

At this price, the quantity demanded is 500 gallons, and the quantity of gasoline
supplied is 680 gallons. You can also find these numbers in Table 1, above. Now,
compare the quantity demanded and quantity supplied at this price. Quantity supplied
(680) is greater than quantity demanded (500). Or, to put it in words, the amount that
producers want to sell is greater than the amount that consumers want to buy. We call
this a situation of excess supply (since Qs > Qd) or a surplus. Note that whenever we
compare supply and demand, it’s in the context of a specific price—in this case, $1.80
per gallon.

With a surplus, gasoline accumulates at gas stations, in tanker trucks, in pipelines, and
at oil refineries. This accumulation puts pressure on gasoline sellers. If a surplus
remains unsold, those firms involved in making and selling gasoline are not receiving
enough cash to pay their workers and cover their expenses. In this situation, some firms
will want to cut prices, because it is better to sell at a lower price than not to sell at all.
Once some sellers start cutting prices; others will follow to avoid losing sales. These
price reductions will, in turn, stimulate a higher quantity demanded.

How far will the price fall? Whenever there is a surplus, the price will drop until the
surplus goes away. When the surplus is eliminated, the quantity supplied just equals the
quantity demanded—that is, the amount that producers want to sell exactly equals the
amount that consumers want to buy. We call this equilibrium, which means “balance.”
In this case, the equilibrium occurs at a price of $1.40 per gallon and at a quantity of
600 gallons. You can see this in Figure 2 (and Figure 1) where the supply and demand
curves cross. You can also find it in Table 1 (the numbers in bold).

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