Theory question 103
Price DeterminationSection B: answer three questions only from this section.
'Price tends towards the level which equates supply with demand'. Explain this statement.
Show the model answer
In a free market, price is determined by the forces of demand and supply
Demand falls as price rises; supply rises as price rises
Equilibrium price is the price at which quantity demanded equals quantity supplied (where the curves intersect)
Above equilibrium there is excess supply (surplus): sellers cut prices to clear stocks, so price falls
Below equilibrium there is excess demand (shortage): buyers compete and bid prices up, so price rises
These movements continue until the market clears at equilibrium, so price 'tends towards' that level
A diagram showing D and S curves, equilibrium price and quantity, surplus and shortage earns marks
A change in demand or supply sets a new equilibrium price
Explain the surplus and shortage on either side of equilibrium and how they push price back.