Unit 1
Unit 2
The Market Mechanism
Shortage Situations
So far everything that we have discussed has been relatively theoretical. Many people would argue that the assumptions on which this model is based are flawed, and as such any conclusions that we might come to are useless. We can examine this claim by looking at what might happen in the real world if the price was not set at the equilibrium point.
To begin, imagine that the price was set at a point which was below the market equilibrium. In this instance, the market would look something like this:
In this case we can see that consumers are willing to buy 500 units at $2.50, because that is where that price intersects with the demand curve. On the other hand, producers are only willing to provide us with 300 units, because that is where that price intersects with the supply curve. In Economics we say that the quantity demanded is greater than the quantity supplied, and we express it as:
In this case, what would happen?
Consider what YOU would do if you were the supplier of this item. Each time you offered your items for sale they would sell out very quickly. It is probable that you would increase the price, so that you can make some more money from this item in future. It is also very likely that you will offer a higher quantity for sale.
On the graph, we can represent this as follows:
In other words, in response to the actions of consumers, the suppliers will move along the supply curve, and towards equilibrium. At the same time, if the price increases then consumers will reduce their level of consumption. As a result, they will also move back towards equilibrium.
From this we can conclude that when the price is set below the equilibrium point there will be a shortage in the market. However this shortage will be temporary, as suppliers will respond to the actions of consumers (consumer sovereignty) and move towards equilibrium.
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