Created by Harry Lewis
about 7 years ago
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Law of demand All other things being equal, demand will increase when the price of a good falls. This is because as a product becomes cheaper, the opportunity cost of buying it decreases.
Law of supply All other things being equal, as the price of a good increases, so will the supply of that good. This is because when the price increases, so does the incentive to provide that good because of the profit motive.
The relationship between demand and supply If there is more demand for a good than there is supply, the price will increase. This is both due to the scarcity of the resource and the opportunity for the business to earn higher profits by charging a higher price, which will 'kill off' the high demand as the opportunity
Equilibrium When the supply and demand curves intersect, they are said to be in equilibrium. At this point, the market is in complete allocative efficiency - all demand for goods is being met, and all supplied goods are bought. The price and quantity when this occurs are referred to as equilibrium price and equilibrium quantity - P* and Q* on the graph.
Disequilibrium - excess supply If the price is set too high, excess supply will be created. This is allocative inefficiency. At P1, the quantity supplied is denoted by Q2. However, the quantity demanded - Q2 - is much lower. If there is too much supplied, the price will fall in order to lower the opportunity cost of purchasing the product. This will increase demand and reduce supply, hence returning the market to equilibrium.
Disequilibrium - excess demand When the price is set too low, excess demand is created. The quantity demanded, Q2, is much higher than the quantity supplied, Q1. Therefore, suppliers will raise the price of their good in order to raise the opportunity cost of purchasing the product. As a result, quantity demanded will rise, quantity demanded will fall, and the market returns to equilibrium.
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