2. Consumer Sovereignty The interaction of supply and demand in the market mechanism.

3. Lesson Overview Finding equilibrium Shortage and surplus situations Necessary assumptions

4. Finding Equilibrium At some point, the demand curve will cross the supply curve. This point is known as equilibrium; which is the moment at which the quantity producers are willing to supply exactly equals the quantity consumers will purchase.

5. Finding Equilibrium Price Quantity Equilibrium Supply Demand

6. Equilibrium It is very important to realise that this point represents both an equilibrium price AND an equilibrium quantity. In other words, that quantity will be produced and consumed (ie purchased) at that price.

7. Shortages By examining this graph, we can identify a situation in which a shortage may arise. This would occur if demand exceeded supply. In other words, it would occur if the price was too low.

8. Finding Equilibrium Price Quantity Equilibrium Supply Demand $1 50 150 $1.50

9. So What Would Happen? In this situation, one of two things could happen … As demand exceeds supply, producers may increase the price to take advantage of this and make higher profits. If the profit margin is high, they may decide to allocate more resources to this item and therefore make more of them.

10. Consumer Sovereignty Either way, we would find that we move back towards equilibrium. However, it is important to note that this only occurs because suppliers react to the actions of consumers. This is called “ consumer sovereignty ”.

11. A Surplus? A surplus could also occur, if the level of supply exceeded demand. This would happen if the price was set too high. In this case, it is likely that producers will lower their price to clear stock, and again return to equilibrium.

12. Assumptions During this year, we will look at these graphs many times. It is important to note that the theory used here is based on certain, quite restrictive assumptions.

13. Assumptions These assumptions include: Resources are quickly transferable from one item to another. The market is highly competitive; there are many buyers and sellers. All participants have perfect knowledge of the market. There are no barriers to entry or exit for any market. There is no government intervention. Participants will always behave in a logical way (eg, they will buy the cheapest option).