Core Concepts & Learning Goals
This topic explores what happens when a competitive market is not in equilibrium and how it responds to changes. The "big idea" is that markets are dynamic. When the price is too high or too low, forces are automatically triggered that push the market back toward equilibrium. Furthermore, when underlying conditions change, the equilibrium itself moves, and we can predict the direction of these changes and their impact on buyers and sellers.
After studying this topic, you should be able to:
Define market surplus and shortage and explain how they are resolved.
Use a supply and demand model to explain how shifts in demand or supply affect equilibrium price, quantity, consumer surplus, and producer surplus.
Calculate the changes in price, quantity, and surplus using data from a graph or table.
Key Concepts Breakdown
1. Market Disequilibrium: Surpluses and Shortages
A market is in disequilibrium whenever the quantity supplied is not equal to the quantity demanded at the current price. This imbalance creates either a surplus or a shortage, which signals that the price needs to adjust.
Surplus: A surplus occurs when the quantity supplied of a good exceeds the quantity demanded at a given price ((Q_s > Q_d)). This happens when the market price is set above the equilibrium price.
Causation: A high price incentivizes firms to produce more but discourages consumers from buying as much.
Market Response: To sell their excess inventory, producers will lower their prices. This downward pressure on price continues until the market reaches equilibrium, where the surplus is eliminated.
Shortage: A shortage occurs when the quantity demanded of a good exceeds the quantity supplied at a given price ((Q_d > Q_s)). This happens when the market price is set below the equilibrium price.
Causation: A low price encourages consumers to buy more but discourages firms from producing as much.
Market Response: With too many buyers chasing too few goods, consumers will bid the price up. This upward pressure on price continues until the market reaches equilibrium, where the shortage is eliminated.
In both cases, these market forces automatically drive the price and quantity toward equilibrium without central planning.
2. Changes in Market Equilibrium
Equilibrium is not static. It changes whenever one of the underlying determinants of demand or supply changes, causing a curve to shift. These shifts create a temporary disequilibrium at the original price, which then resolves to a new equilibrium.
Consumer Surplus (CS) is the difference between the maximum price a consumer is willing to pay and the price they actually pay. It is the area below the demand curve and above the market price.
Producer Surplus (PS) is the difference between the price a producer receives and the minimum price they are willing to accept. It is the area above the supply curve and below the market price.
Changes in equilibrium affect both CS and PS. The table below summarizes the effects of the four basic shifts on equilibrium price (P*), quantity (Q*), and economic surplus.
| Shift Type | Effect on P* | Effect on Q* | Effect on CS | Effect on PS |
|---|---|---|---|---|
| Increase in Demand | Increase | Increase | Ambiguous | Increase |
| Decrease in Demand | Decrease | Decrease | Decrease | Ambiguous |
| Increase in Supply | Decrease | Increase | Increase | Ambiguous |
| Decrease in Supply | Increase | Decrease | Ambiguous | Decrease |
Note on "Ambiguous" Effects: For example, when demand increases, the price rises. This hurts consumers (reducing CS), but more units are sold, which helps consumers (increasing CS). The net effect depends on the specific shapes (elasticities) of the curves. The same logic applies to the other ambiguous cases.
3. The Role of Elasticity
The price elasticities of demand and supply determine the magnitude of the changes in price and quantity following a shift.
If demand is relatively inelastic: Consumers are not very responsive to price changes. A shift in supply will cause a large change in price and a small change in quantity.
If demand is relatively elastic: Consumers are very responsive to price changes. A shift in supply will cause a small change in price and a large change in quantity.
If supply is relatively inelastic: Producers are not very responsive to price changes. A shift in demand will cause a large change in price and a small change in quantity.
If supply is relatively elastic: Producers are very responsive to price changes. A shift in demand will cause a small change in price and a large change in quantity.
Graphical Analysis (Text-Only)
1. The Market in Disequilibrium
Axes: Vertical axis is Price (P). Horizontal axis is Quantity (Q).
Curves:
Demand (D) is a downward-sloping line.
Supply (S) is an upward-sloping line.
The intersection of S and D determines the equilibrium price, P*, and equilibrium quantity, Q*.
Scenario A: Surplus
A price, P_high, is set above the equilibrium price P*.
At P_high, find the quantity demanded (Q_d) by finding the point on the Demand curve.
At P_high, find the quantity supplied (Q_s) by finding the point on the Supply curve.
Because P_high > P*, it follows that Q_s > Q_d.
The horizontal distance between Q_s and Q_d at P_high represents the market surplus. Market forces will push P down toward P*.
Scenario B: Shortage
A price, P_low, is set below the equilibrium price P*.
At P_low, find the quantity demanded (Q_d) on the Demand curve.
At P_low, find the quantity supplied (Q_s) on the Supply curve.
Because P_low < P*, it follows that Q_d > Q_s.
The horizontal distance between Q_d and Q_s at P_low represents the market shortage. Market forces will push P up toward P*.
2. Analysis of a Shift in Demand
Initial State:
The market is in equilibrium at point E1, where the initial supply (S1) and demand (D1) curves intersect.
Equilibrium price = P1. Equilibrium quantity = Q1.
Consumer Surplus (CS1) = Area below D1 and above P1, out to Q1.
Producer Surplus (PS1) = Area above S1 and below P1, out to Q1.
The Shock: An event causes demand to increase (e.g., a positive report on the health benefits of the good).
Shift: The demand curve shifts to the right, from D1 to a new curve, D2. The supply curve S1 does not change.
Initial Disequilibrium: At the original price P1, the new quantity demanded (on D2) is now greater than the quantity supplied (on S1). This creates a shortage.
Market Adjustment: The shortage puts upward pressure on the price. As the price rises:
The quantity supplied increases (a movement up along the S1 curve).
The quantity demanded decreases (a movement up along the new D2 curve).
New Equilibrium: The market settles at a new equilibrium, E2, where S1 intersects D2.
New equilibrium price = P2 (where P2 > P1).
New equilibrium quantity = Q2 (where Q2 > Q1).
Change in Surplus:
New Consumer Surplus (CS2) = Area below D2 and above P2, out to Q2.
New Producer Surplus (PS2) = Area above S1 and below P2, out to Q2.
Result: Producer surplus has unambiguously increased because both the price (P2) and quantity (Q2) are higher. The change in consumer surplus is ambiguous without specific values, as consumers pay a higher price but consume a greater quantity. Total economic surplus increases.
Step-by-Step Example
Scenario: Analyze the market for avocados after a severe drought in major growing regions damages the crop.
Step 1: Identify the Shock and the Curve
The drought is a natural disaster that affects production. This is a determinant of supply. It negatively impacts the ability of firms to produce, so it will decrease the supply of avocados.
Step 2: Determine the Direction of the Shift
A decrease in supply is represented by a leftward shift of the supply curve. Let's call the original supply curve S1 and the new supply curve S2. The demand curve (D1) remains unchanged.
Step 3: Analyze the Initial Disequilibrium
The market starts at equilibrium E1 (P1, Q1). After the supply curve shifts left to S2, at the original price P1, the quantity demanded (on D1) is now greater than the new, lower quantity supplied (on S2). This creates a shortage of avocados.
Step 4: Determine the New Equilibrium
The shortage causes consumers to bid up the price of the remaining avocados. As the price rises from P1, two things happen:
The quantity demanded decreases (a movement up along the demand curve D1).
The quantity supplied increases (a movement up along the new supply curve S2).
This process continues until the market reaches a new equilibrium, E2, where D1 intersects S2. The result is a higher equilibrium price (P2 > P1) and a lower equilibrium quantity (Q2 < Q1).
Step 5: Analyze the Impact on Surplus
Producer Surplus: The effect is ambiguous. Producers receive a higher price (P2), which increases surplus, but they sell a lower quantity (Q2), which decreases it. The final outcome depends on the price elasticity of demand.
Consumer Surplus: This unambiguously decreases. Consumers now pay a higher price and get a smaller quantity, reducing the area of consumer surplus.
AP Exam Tips & Common Pitfalls
[FRQ Task]: You will frequently be asked to draw a correctly labeled supply and demand graph for a specific market, then show the effect of a given scenario (a "shock") by shifting one of the curves. You must then identify the resulting change in equilibrium price and quantity. You may also be asked to shade and/or calculate the change in consumer or producer surplus.
[MCQ Task]: A common question will describe a change in a market determinant and ask you to predict the outcome for equilibrium price and quantity. For example: "If the price of steel, an input for car production, increases, what will happen in the market for cars?" (Answer: Price increases, Quantity decreases).
[Common Pitfall ①]: Shift vs. Movement. Do not confuse a change in supply/demand (a shift of the entire curve) with a change in quantity supplied/demanded (a movement along a curve). A change in the good's own price causes a movement along the curve. A change in any other determinant (income, input prices, technology, etc.) causes a shift. The market adjustment process back to equilibrium involves movements along the curves.
[Common Pitfall ②]: Identifying Surplus Areas. Remember the boundaries for calculating surplus. Consumer surplus is the area below the demand curve and above the price. Producer surplus is the area above the supply curve and below the price. Always use the equilibrium price and quantity as the boundaries for these areas when the market is in equilibrium.
Key Vocabulary
Disequilibrium: A state in a market where the quantity demanded is not equal to the quantity supplied at the prevailing price.
Surplus: A situation where quantity supplied is greater than quantity demanded, occurring at prices above equilibrium. Also known as excess supply.
Shortage: A situation where quantity demanded is greater than quantity supplied, occurring at prices below equilibrium. Also known as excess demand.
Consumer Surplus: The monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay.
Producer Surplus: The monetary gain obtained by producers because they are able to sell a product for a price that is greater than the lowest price they would be willing to accept.