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 low.  With price set at P1, the supplier is producing QS whilst consumers are demanding QD.  It becomes apparent to the supplier that this price is too low because supplies are depleted relatively quickly and production is not keeping up with demand for the product.  Excess demand (or a shortage) is represented as the difference between QD and QS.  Accordingly the supplier will raise the price to take advantage of the fact that demand for the product is relatively strong (or excessive at the relatively low price).  

As price rises towards the equilibrium price (Pe), the shortage will get smaller as consumers demand less of the product (a contraction of demand) and the suppliers will be willing to supply more to the market (an expansion of supply).  Price will continue to rise until the market rests at Pe. If the supplier 'overshoots' by raising the price above Pe, then a excess supply will develop and price will then converge down towards Pe (as explained on the previous page).

In reality, suppliers do not know the precise location of the equilibrium price and quantity.  They simply respond to conditions that present themselves in markets via shortages or surpluses that develop over time.  In addition, the equilibrium price and quantity levels continually move up or down in response to ever changing conditions within markets. This dynamic nature of markets is caused by the numerous factors that determine both the demand for and supply of products.  When there is an independent change in demand or supply (i.e. a change in demand or supply that has not been caused by a price change) it takes the form of a shift of either the demand or supply curves.  These shifts of curves will be examined in the next section.

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