Question

Explain the meaning of excess demand and excess supply with the help of a schedule. Explain their effect on equilibrium price.

Answer 1

Excess demand refers to a situation when quantity demanded is more than quantity supplied at the prevailing market price.

Price of Toy (Rs)	Market Demand (Units)	Market Supply (Units)	Shortage (-) or Surplus (+)
2	100	20	(-)80	Excess demand Market demand < Market supply
4	80	40	(-) 40
6	60	60	0	Equilibrium Market demand = Market supply
8	40	80	(+)40	Excess supply Market demand > Market supply
10	20	100	(+)80

Here both buyers and sellers are negotiating to buy and sell toys. Both have different prices to offer. Buyers will like to pay as low as possible and sellers will like to charge as high as possible. But market equilibrium will be determined only when both agree to a common price and a common quantity at that price. When an increase in price from Rs 2 to Rs 4, market demand falls from 100 to 80 toys and market supply rises from 20 to 40 toys.

When the price is lower than the equilibrium market price of a good (OPe), the price ceiling leads to an excess of demand. Now, the excess demand will increase the competition among consumers in the market. Thereby they consume the good at a higher price which leads to an increase in the price level, i.e. OP^e.

Excess supply refers to a situation when the quantity supplied is more than the quantity demanded at the prevailing price

When the price is above the equilibrium market price of a good (OP), the price ceiling leads to an excess of supply. In the diagram, the equilibrium price and quantity are OP and OQ. As the equilibrium price is low for farmers, the government fixes the price floor, i.e. the price level increased from OP to OP1 which leads to a decline in the quantity demand, and therefore, there is excess supply in the market. Here, the competition will increase among the sellers, and hence, the price will come down to the equilibrium point where market demand is equal to the market supply