Market Equilibrium, Price Mechanism, Consumer and Producer Surplus (PDF)

TOPIC: PRICE MECHANISM, EQUILIBRIUM PRICE, CONSUMER AND PRODUCER SURPLUS. What is 'Price Mechanism'? Definition: Price mechanism refers to the system where the forces of demand and supply determine the prices of commodities and the changes therein. It is the buyers and sellers who actually determin...

TOPIC: PRICE MECHANISM, EQUILIBRIUM PRICE, CONSUMER AND PRODUCER SURPLUS. What is 'Price Mechanism'? Definition: Price mechanism refers to the system where the forces of demand and supply determine the prices of commodities and the changes therein. It is the buyers and sellers who actually determine the price of a commodity. Video https://www.youtube.com/watch?v=952XMJ03lCs Functions of the price mechanism? Prices rise and fall to reflect scarcities and surpluses. Excess demand and excess supply can be used to explain the price mechanism. 1. Signaling function – If prices rise because of high demand from consumers, this is a signal to suppliers to expand production to meet the higher demand. If there is excess supply in a market, the price mechanism will help to eliminate a surplus of a good by allowing the market price to fall. 2. Incentive function – When prices rise, it provides an incentive for suppliers to supply more and take advantage of higher profits. 3. Rationing function - Prices ration scarce resources when demand outstrips supply. When there is a shortage, price is bid up – leaving only those with willingness and ability to pay to buy. 4. Allocation function– i.e. they adjust to demonstrate where resources are required. Prices rise and fall to reflect scarcities and surpluses. Equilibrium price Equilibrium price can be defined as the price at which the quantity demanded is equal to the quantity supplied. Disequilibrium price – this occurs when the quantity demanded is not equal to quantity supplied resulting in excess demand and supply. Excess supply involves price above the equilibrium Excess demand involves price below the equilibrium Consumer Surplus and Producer Surplus Consumer surplus This is the benefit that consumers receive when they pay a price less than what they were willing to pay. It is the difference between your maximum willingness to pay and the actual price that was paid for a given quantity of good. The consumer surplus is the area under the demand curve and the area above the market price or selling price. Here, total benefits are given by the shaded area OCDE; total expenditures are given by the rectangle OBDE. The difference, shown by the triangle BCD, is consumer surplus. Videos https://www.youtube.com/watch?v=4D1c2YJLNc4 Producer Surplus Producer surplus This is the benefit that producers receive when they receive a price higher than what they were willing to sell. The difference between the amount that a producer is willing and able to supply a good for and the amount that they actually receive for the good. The difference, or surplus amount, is the benefit that the producer receives for selling the good in the market. Producers' surplus exists when actual price exceeds the minimum price sellers will accept. Here, total revenue is given by the rectangle OBDE, and total costs are given by the area OADE. The difference, shown by the triangle ABD is producer surplus. Community Surplus This is the welfare of society and it is made up of a consumer surplus plus a producer surplus. It exists when it is impossible to make someone better off without making someone else worse off. When the consumer surplus is equal to producer surplus It exists when the market is in equilibrium, with no external influences and no external effects. Market is said to be socially efficient and community surplus is at its maximum.