1.3.3 Price determination

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    When the demand and supply curves are brought together on the same diagram, there is a point at which the curves cross each other. This is known as equilibrium.

    Equilibrium – the point at which consumers will demand the exact amount that is                                    supplied. All that is produced by suppliers is bought by consumers.

    There will be no unsold goods and we say that the market clears as surpluses and shortages are eroded away which allows them to arrive at a equilibrium price at which market clearing occurs.

    Equilibrium price – the price at which there are no shortages or surpluses.

    THE LIMITATIONS OF DEMAND AND SUPPLY DIAGRAMS

    • Diagrams only show what happens in certain markets e.g. in competitive markets where there are many buyers.
    • It assumes that when making economic decisions, that business have complete knowledge whereas in real life this is often not the case.
    • Some markets/products do not reduce in demand if the prices increase e.g. designer clothes/ticket prices.
    • There is an assumption that if price falls, demand increases which is not always the case in real life.
    • Brand loyalty is a factor which is not taken into account.
    • Supply curves assume that as prices rise, suppliers will produce more which is not always the case as suppliers may not have sufficient resources to do so.
    • Consumers are not always rational e.g. despite the fact that products are cheaper after Christmas, consumers still buy before Christmas when prices are high.

     

    CETERIS PARIBUS (all other things being equal)

    • When we look at supply in the market, we assume demand stays the same.
    • Demand and supply might change at the same time which diagrams do not take into account.

     

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