In the previous section we explained markets and the rules of supply and demand. We now move on to examine market equilibrium, the price mechanism and market efficiency.
By the end of this section you should be able to:
- Explain, using diagrams, how demand and supply interact to produce market equilibrium.
- Analyse, using diagrams and with reference to excess demand or excess supply, how changes in the determinants of demand and/or supply result in a new market equilibrium.
- Explain why scarcity necessitates choices that answer the "What to produce?" question.
- Explain why choice results in an opportunity cost.
- Explain, using diagrams, that price has a signalling function and an incentive function, which result in a reallocation of resources when prices change as a result of a change in demand or supply conditions.
- Explain the concept of consumer surplus.
- Identify consumer surplus on a demand and supply diagram.
- Explain the concept of producer surplus.
- Identify producer surplus on a demand and supply diagram.
- Explain that the best allocation of resources from society's point of view is at competitive market equilibrium, where social (community) surplus (consumer surplus and producer surplus) is maximized (marginal benefit = marginal cost).
- Calculate the equilibrium price and equilibrium quantity from linear demand and supply functions.
- Plot demand and supply curves from linear functions, and identify the equilibrium price and equilibrium quantity.
- State the quantity of excess demand or excess supply in the above diagrams.