Factors influencing decisions    What is a market? Demand Supply Equilibrium Excess demand   Excess supply   Shifts of demand  Shifts of supply Convergence to equilibrium  Economicstutor..com.au

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1 Introductory concepts 2  Market mechanism  3 Elasticities  4 Market structures 5  Market failures  6  Macro economic activity/eco growth  7 Inflation 8  Employment & unemployment  9  External Stability  10  Income distribution 11.Factors affecting economy  12  Fiscal/Budgetary policy  13  Monetary Policy   14 Aggregate Supply Policies  15 The Policy Mix

Assume that the price in a market is too high because shifts have occurred in demand or supply.  [We will explore these shifts soon, but at this stage just think about this as either the demand for the product decreasing or supply increasing.] Alternatively, the price might be too high because a supplier has only recently entered the market and has set a price to ‘test the market'.  

At the price P1, the supplier produces QS [read this off the Quantity axis as marked in the diagram QS] but consumers are only prepared to demand QD [again, read this off the Quantity axis as marked in the diagram QD].  It will become apparent that this price is too high because supplies will begin to build up (e.g. too much stock left on the shelves and this surplus (or excess) is represented by the difference between QD and QS.  The supplier will then reduce the price in order to eliminate the surplus.  

As price falls below P1, consumers will demand more of the product (an expansion of demand) and the supplier will be willing to supply less on the market (a contraction of supply).  While the supplier will notice that the excess supply is certainly falling (represented by the smaller distance between the D and S curves), there is still too much stock remaining on the shelves.  This process of lowering the price to remove surplus stock will continue until a price is reached (Pe), where there is neither a surplus of stock nor a shortage of stock (Qe).

Note that it is possible for the supplier to 'overshoot' and reduce the price to one that is below Pe.  This would result in 'excess demand', which will eventually result in the price being driven up towards Pe.  The disequilibrium situation of excess demand is examined in the next section.

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