Question

Explain supply and demand equilibrium and how a departure from the point of equilibrium can cause a shortage or surplus.

Answer 1

Answer: Equilibrium in a market occurs when the demand curve intersects the supply curve and the market clears. At equilibrium, quantity demanded becomes equal to the quantity supplied and there is no shortage or surplus. This is given by point “a” or at price level of P*.

Now when due to government intervention or due to some external shocks, if price is forced to stay at a level lower than the equilibrium price of P*, that is at price P1, then at that price quantity demanded is Qd1 and quantity supplied is Qs1. At price P1, as Qd1 is greater than Qs1, hence quantity demanded becomes greater than the quantity supplied and there arises a shortage.

Also when due to government intervention or due to some external shocks, if price is forced to stay at a level higher than the equilibrium price of P*, that is at price P2, then at that price quantity supplied is Qs2 and quantity demanded  is Qd2. At price P2,  as Qs2 is greater than Qd2, hence quantity supplied  becomes greater than the quantity demanded and there arises a surplus.

Hence we can conclude that, any departure from point of equilibrium causes either shortage or a surplus.

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