Definition of market disequilibrium

Allocation of Resources – Price Determination

1. The Role of Markets

• Market: Any setting where buyers and sellers interact to exchange goods or services (e.g., a local fruit market, an online retailer, the world oil market).
• Key participants
  • Buyers – households, firms or the government that demand goods.
  • Sellers – firms or individuals that supply goods.
• Why markets matter: Through the price mechanism markets answer the three basic economic questions:
  1. What to produce – determined by what consumers are willing to buy.
  2. How to produce – reflected in the costs that producers face and the prices they receive.
  3. For whom to produce – decided by who can afford to pay the market price.

2. Demand

• Definition (ceteris paribus): The quantity of a good that consumers are willing and able to buy at each possible price, holding all other factors constant.
• Law of Demand: As price falls, the quantity demanded rises, and vice‑versa (downward‑sloping demand curve).
• Demand curve: Price (P) on the vertical axis, quantity demanded (Q_d) on the horizontal axis.
• Movements vs. shifts
  • Movement along the curve: Caused by a change in the good’s own price.
    Example: If the price of oranges falls from £1.00 to £0.80, quantity demanded might rise from 200 kg to 240 kg – a movement up the demand curve.
  • Shift of the curve: Caused by a change in any other factor (income, tastes, price of related goods, expectations, number of buyers).

• Elasticity categories (Cambridge requirement)
  • Perfectly inelastic demand – vertical demand curve; quantity does not change when price changes.
  • Inelastic demand – steep but downward‑sloping; |PED| < 1.
  • Unit‑elastic demand – rectangular hyperbola; |PED| = 1.
  • Elastic demand – flatter curve; |PED| > 1.
  • Perfectly elastic demand – horizontal demand curve; any price increase reduces quantity demanded to zero.

3. Supply

• Definition (ceteris paribus): The quantity of a good that producers are willing and able to sell at each possible price, holding all other factors constant.
• Law of Supply: As price rises, the quantity supplied rises, and vice‑versa (upward‑sloping supply curve).
• Supply curve: Price (P) on the vertical axis, quantity supplied (Q_s) on the horizontal axis.
• Movements vs. shifts
  • Movement along the curve: Caused by a change in the good’s own price.
    Example: If the price of wheat rises from £1.20 to £1.40 per kg, quantity supplied might increase from 80 000 t to 95 000 t – a movement up the supply curve.
  • Shift of the curve: Caused by a change in any other factor (technology, input prices, taxes, expectations, number of sellers, mobility of factors).

4. Market Equilibrium and Disequilibrium

• Market equilibrium: The point where quantity demanded equals quantity supplied (Q_d = Q_s) at the equilibrium price (P_e). The market “clears” – no surplus or shortage.
• Market disequilibrium: Any situation where Q_d ≠ Q_s at the prevailing price.
  • Surplus (excess supply): Q_s > Q_d – creates pressure for price to fall.
  • Shortage (excess demand): Q_d > Q_s – creates pressure for price to rise.
• Adjustment mechanism (competitive market)
  • Surplus → producers lower price → quantity demanded rises, quantity supplied falls → movement toward equilibrium.
  • Shortage → producers raise price → quantity demanded falls, quantity supplied rises → movement toward equilibrium.

5. Price Changes – Causes and Consequences

When either the demand curve or the supply curve shifts, the equilibrium price and quantity change as shown below.

6. Price Elasticity of Demand (PED)

• Definition: The responsiveness of the quantity demanded to a change in price.
• Formula (mid‑point method): \[ \text{PED} = \frac{\frac{Q_2-Q_1}{(Q_1+Q_2)/2}}{\frac{P_2-P_1}{(P_1+P_2)/2}} \]
• Interpretation
  • |PED| > 1 – elastic demand.
  • |PED| = 1 – unit‑elastic demand.
  • |PED| < 1 – inelastic demand.
  • |PED| = 0 – perfectly inelastic (vertical curve).
  • |PED| → ∞ – perfectly elastic (horizontal curve).
• Determinants of PED
  • Availability of close substitutes.
  • Proportion of income spent on the good.
  • Nature of the good (luxury vs. necessity).
  • Time horizon (long‑run demand is more elastic).
• Impact on total revenue
  • If demand is elastic, a price fall increases total revenue.
  • If demand is inelastic, a price rise increases total revenue.

7. Price Elasticity of Supply (PES)

• Definition: The responsiveness of the quantity supplied to a change in price.
• Formula (mid‑point method): \[ \text{PES} = \frac{\frac{Q_2-Q_1}{(Q_1+Q_2)/2}}{\frac{P_2-P_1}{(P_1+P_2)/2}} \]
• Interpretation
  • PES > 1 – elastic supply.
  • PES = 1 – unit‑elastic supply.
  • PES < 1 – inelastic supply.
  • PES = 0 – perfectly inelastic (vertical supply curve).
  • PES → ∞ – perfectly elastic (horizontal supply curve).
• Determinants of PES (Cambridge syllabus)
  • Time period – supply is more elastic in the long run.
  • Availability of spare production capacity.
  • Mobility of factors of production (e.g., labour, capital).
  • Complexity of the production process.
• Diagram tip: A steep supply curve indicates inelastic supply; a flat supply curve indicates elastic supply.

8. Market Economic System

• Definition: An economic system in which decisions about what to produce, how to produce and for whom to produce are made primarily by private individuals and firms interacting in markets.
• Advantages (pros)
  • Efficient allocation of resources through the price mechanism.
  • Encourages innovation and entrepreneurship.
  • Consumers enjoy a wide choice of goods and services.
• Disadvantages (cons)
  • Can lead to inequality of income and wealth.
  • May produce market failures (e.g., pollution, public goods).
  • Profit motive can sometimes override social welfare.

9. Market Failure

Situations where the market does not allocate resources efficiently on its own.

10. Summary

Markets allocate scarce resources through the interaction of demand and supply. The equilibrium price (where Q_d = Q_s) clears the market. When the market is in disequilibrium – a surplus or a shortage – price pressures drive the market back toward equilibrium. The speed and direction of these adjustments depend on the elasticities of demand and supply, which are shaped by factors such as substitutes, income, technology, and the mobility of factors of production. Understanding the broader context – the role of markets, price changes, elasticity, the nature of a market economy, and possible market failures – equips students to analyse real‑world economic issues and to answer both AO1 (knowledge) and AO2 (application/analysis) questions in the IGCSE/A‑Level examinations.