Unit 1
Unit 3
Achieving Equilibrium
Shortages
The market mechanism works because of the principle of consumer sovereignty. This principle states that in any market it is the consumers who ultimately force the direction of production. In a simple manner this is quite easy to understand – if no one buys an item that is produced, then it is probable that the producers will not make any more of that item. On the other hand if an item sells out very quickly, then producers will allocate more of their resources to the production of that item, and therefore a higher quantity will be produced.
We can also represent the concept of consumer sovereignty on a supply and demand graph. In this instance, let’s imagine that the price decided upon by the producers of a particular item is below the equilibrium point. At this stage, the market would look 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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