Interpretation of disequilibrium using demand and supply schedules

Allocation of Resources – Price Determination

1. Introduction

In a market economy the price of a good or service is determined by the interaction of demand and supply. Understanding how these forces work together helps us interpret what happens when the market is not in equilibrium (disequilibrium).

2. Demand and Supply Schedules

A schedule shows the quantity that buyers are willing to purchase (demand) or that sellers are willing to produce (supply) at different price levels.

The schedules can be expressed algebraically as:

\$Q_d = a - bP\$

\$Q_s = c + dP\$

where a, b, c, d are constants that reflect consumer preferences and producer costs.

3. Market Equilibrium

Equilibrium occurs where the quantity demanded equals the quantity supplied:

\$Qd = Qs\$

Using the tables above, the equilibrium price is $16 and the equilibrium quantity is 60 units, because at that price both schedules give the same quantity.

4. Disequilibrium – Surplus and Shortage

When the market price is above or below the equilibrium price, the market is in disequilibrium.

• Surplus (Excess Supply): Price > Equilibrium Price. Quantity supplied exceeds quantity demanded.
• Shortage (Excess Demand): Price < Equilibrium Price. Quantity demanded exceeds quantity supplied.

5. Interpreting Disequilibrium Using Schedules

Follow these steps to analyse a given price:

1. Locate the price in both the demand and supply tables.
2. Read the corresponding quantities Q_d and Q_s.
3. Compare the two quantities:

   • If Q_s > Q_d, a surplus exists. Sellers will tend to lower the price.
   • If Q_d > Q_s, a shortage exists. Buyers will bid up the price.

4. Predict the direction of price movement until equilibrium is reached.

6. Worked Example

Assume the government sets a price ceiling of $12 for the good.

Interpretation:

• At $12, the quantity demanded (80) exceeds the quantity supplied (40). The market experiences a shortage of 40 units, putting upward pressure on price.
• Because the price is legally capped at $12, the shortage persists unless the government intervenes (e.g., rationing).
• If the price were allowed to rise, sellers would increase output and buyers would reduce demand, moving the market toward the equilibrium price of $16.

7. Summary of Key Points

• Equilibrium price is where \$Qd = Qs\$.
• Surplus occurs when \$P > P{eq}\$; shortage occurs when \$P < P{eq}\$.
• Demand and supply schedules provide a clear, numerical way to identify disequilibrium.
• Market forces (price adjustments) tend to eliminate surplus or shortage, restoring equilibrium.