The arrows indicate the effect on price.

The arrows indicate the effect on price.

surplus The amount by which the quantity supplied of a product exceeds the quantity demanded at a specific (above-equilibrium) price.

Effectiveness of Markets .

Effectiveness of Markets .

We can now bring together supply and demand to see how the buying decisions of households and the selling decisions of businesses interact to determine the price of a product and the quantity actually bought and sold. In Table -8, columns 1 and 2 repeat the market supply of corn (from Table -6), and columns 2 and repeat the market demand for corn (from Table - ). We assume that this is a competitive market—neither buyers nor sellers can set the price.


We have limited our example to only five possible prices. Of these, which will actually prevail as the market price for corn? We can find an answer through trial and error. For no particular reason, let's start with $5. We see immediately that this cannot be the prevailing market price. At the $5 price, producers are willing to produce and offer for sale 12,000 bushels of corn, but buyers are willing to buy only 2000 bushels. The $5 price encourages farmers to produce lots of corn but discourages most consumers from buying it. The result is a 10,000-bushel surplus or excess su ly of corn. This surplus, shown in column 4 of Table -8, is the excess of quantity supplied over quantity demanded at $5. Corn farmers would find themselves with 10,000 unsold bushels of output.

A price of $5, even if it existed temporarily in the corn market, could not persist over a period of time. The very large surplus of corn would drive competing sellers to lower the price to encourage buyers to take the surplus off their hands.

Suppose the price goes down to $4. The lower price encourages consumers to buy more corn and, at the same time, induces farmers to offer less of it for sale. The surplus diminishes to 6000 bushels. Nevertheless, since there is still a surplus, competition among sellers will once again reduce the price. Clearly, then, the prices of $5 and $4 will not survive because they are "too high." The market price of corn must be less than $4.


The amount by which the quantity demanded of a product exceeds the quantity supplied at a particular (below-equilibrium) price.


Let's jump now to $1 as the possible market price of corn. Observe in column 4 of Table -8 that at this price, quantity demanded exceeds quantity supplied by 15,000 units. The $1 price discourages farmers from devoting resources to corn production and encourages consumers to attempt to buy more than is available. The result is a 15,000-bushel shortage of, or excess demand for, corn. The $1 price cannot persist as the market price. Many consumers who want to buy at this price will not get corn. They will express a willingness to pay more than $1 to get some of the available output. Competition among these buyers will drive up the price to something greater than $1.

Suppose the competition among buyers boosts the price to $2. This higher price will reduce, but will not eliminate, the shortage of corn. For $2, farmers devote more chapter three resources to corn production, and some buyers who were willing to pay $1 per bushel will not want to buy corn at $2. But a shortage of 7000 bushels still exists at $2. This shortage will push the market price above $2.

EquiLlbRiuM price The price in a competitive market at which the quantity demanded and the quantity supplied are equal.

EquiLibRium quaNTiTY The quantity demanded and supplied at the equilibrium price in a competitive market.

RaTlONlNg function of prices The ability of market forces in a competitive market to equalize quantity demanded and quantity supplied and to eliminate shortages via changes in prices.

Equilibrium Price and Quantity

By trial and error we have eliminated every price but $. At $, and only at this rice, the quantity of corn that farmers are willing to produce and supply is identical with the quantity consumers are willing and able to buy. There is neither a shortage nor a surplus of corn at that price.

With no shortage or surplus at $ , there is no reason for the price of corn to change. Economists call this price the market-clearing or equilibrium price, equilibrium meaning "in balance" or "at rest." At $ , quantity supplied and quantity demanded are in balance at the equilibrium quantity of 7000 bushels. So $ is the only stable price of corn under the supply and demand conditions shown in Table -8.

The price of corn, or of any other product bought and sold in competitive markets, will be established where the supply decisions of producers and the demand decisions of buyers are mutually consistent. Such decisions are consistent only at the equilibrium price (here, $ ) and equilibrium quantity (here, 7000 bushels). At any higher price, suppliers want to sell more than consumers want to buy and a surplus results; at any lower price, consumers want to buy more than producers make available for sale and a shortage results. Such discrepancies between the supply and demand intentions of sellers and buyers then prompt price changes that bring the two sets of intentions into accord.

A graphical analysis of supply and demand should yield these same conclusions. igure -5 (Key Graph) shows the market supply and demand curves for corn on the same graph. (The horizontal axis now measures both quantity demanded and quantity supplied.)

Graphically, the intersection of the supply curve and the demand curve for a product indicates the market equilibrium. Here, equilibrium price and quantity are $ per bushel and 7000 bushels. At any above-equilibrium price, quantity supplied exceeds quantity demanded. This surplus of corn causes price reductions by sellers who are eager to rid themselves of their surplus. The falling price causes less corn to be offered and simultaneously encourages consumers to buy more. The market moves to its equilibrium.

Any price below the equilibrium price creates a shortage; quantity demanded then exceeds quantity supplied. Buyers try to obtain the product by offering to pay more for it; this drives the price upward toward its equilibrium level. The rising price simultaneously causes producers to increase the quantity supplied and prompts many buyers to leave the market, thus eliminating the shortage. Again the market moves to its equilibrium.

Rationing Function of Prices

The ability of the competitive forces of supply and demand to establish a price at which selling and buying decisions are consistent is called the rationing function of prices. In our case, the equilibrium price of $ clears the market, leaving no burdensome surplus for sellers and no inconvenient shortage for potential buyers. And it is the combination of freely made individual decisions that sets this marketclearing price. In effect, the market outcome says that all buyers who are willing and able to pay $ for a bushel of corn will obtain it; all buyers who can not or will not

Part One • An Introduction to Economics and the Economy

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