5.1 Deviation of the price from equilibrium

In the previous section, the market equilibrium was derived as the intersection of the demand and supply curve. This point represents the price-quantity combination at which a so-called market clearance takes place, i.e. there is no supplier who cannot sell his produced goods at this price, nor a buyer whose demand cannot be satisfied at this price.
In the following sections we want to clarify whether and how this balance is achieved. In our simple models we assume that all market participants have complete information and we neglect local and temporal differences as well as transport and transaction costs. In reality, however, markets are not exactly in equilibrium because the immediate realization of the equilibrium is prevented by constant changes in demand, supply and information, and the delay in implementing decisions (lags).
There is also the question of the stability of the equilibrium: Is the market equilibrium stable like a ball in a bowl that returns to the lowest point after it was pushed to the side, or is it unstable like a ball on the tip of a pencil that does not return once it was pushed down?
The above graph "Price Deviation from the Equilibrium" shows that the market equilibrium is stable. The "Cobweb theorem" shows a multi-period view.
Causes for market imbalances can also be government interventions in the market, such as minimum or maximum prices.
Regardless of the different causes of higher or lower prices, their occurrence leads to certain consequences. If the price is above the equilibrium price, it leads to an excess of supply. If the price is below the equilibrium price, it leads to an excess of demand. These situations lead to downward or upward price pressure on the part of the suppliers, which pushes the prices towards equilibrium.
The horizontal line at the level of the current price intersects the demand and supply curve. The x-value of these intersections represents the quantity demanded or offered at this price.
Price above the equilibrium price: More is supplied than demanded. Thus, there is an excess of supply. In order to get rid of the products anyway, the sellers can either invest in advertising or reduce the price (discounts, special offers, bonuses, etc.). There is a downward price pressure, towards the equilibrium price.
Price below the equilibrium price: More is demanded than supplied. Thus, there is an excess of demand or a gap in supply. As soon as the sellers realize the high demand, they will adjust the price upwards to increase their profit. In the case of special offers, it is possible that demand will remain unsatisfied when the offers are out of stock and goods can only be bought again at the higher regular price. There is an upward price pressure, towards the equilibrium price.

(c) by Christian Bauer
Prof. Dr. Christian Bauer
Chair of monetary economics
Trier University
D-54296 Trier
Tel.: +49 (0)651/201-2743
E-mail: Bauer@uni-trier.de
URL: https://www.cbauer.de