Competitive market equilibrium

· Market equilibrium occurs where demand intersects supply.
· At equilibrium, quantity demanded = quantity supplied.
· The equilibrium gives the equilibrium price and equilibrium quantity.
· In a competitive market, no single buyer or seller sets the price; the price mechanism coordinates decisions.
· On a diagram, equilibrium is the point where the downward-sloping demand curve crosses the upward-sloping supply curve.

This diagram shows the basic market equilibrium where demand and supply intersect. It is useful for identifying equilibrium price and equilibrium quantity on a standard diagram. Source

Excess demand (shortage) and excess supply (surplus)

· If price is below equilibrium, quantity demanded > quantity supplied, creating excess demand (shortage).
· A shortage puts upward pressure on price.
· If price is above equilibrium, quantity supplied > quantity demanded, creating excess supply (surplus).
· A surplus puts downward pressure on price.
· In exam answers, explain that market forces push price towards equilibrium.
· Always link shortage to rising price and surplus to falling price.

Changes in equilibrium

· A shift in demand or shift in supply creates a new equilibrium price and new equilibrium quantity.
· Increase in demand → usually higher equilibrium price and higher equilibrium quantity.
· Decrease in demand → usually lower equilibrium price and lower equilibrium quantity.
· Increase in supply → usually lower equilibrium price and higher equilibrium quantity.
· Decrease in supply → usually higher equilibrium price and lower equilibrium quantity.
· In exams, identify which curve shifts, why it shifts, and then state the effect on price and quantity.
· Use the phrase ceteris paribus when appropriate.

This diagram shows how a shift in supply changes the equilibrium point. It is useful for explaining how the market moves from one equilibrium to another after a change in conditions. Source

Functions of the price mechanism

· Resource allocation: resources move towards markets where prices and profits are more attractive.
· Signalling: changes in price signal information to consumers and producers.
· A higher price signals producers to supply more and consumers to buy less.
· Incentive: price changes create incentives for producers and consumers to change behaviour.
· Rationing: when goods are scarce, higher prices ration limited output to those willing and able to pay.
· Strong exam phrasing: the price mechanism helps allocate scarce resources through signalling, incentives, and rationing.

Consumer surplus

· Consumer surplus is the difference between what consumers are willing to pay and what they actually pay.
· On a diagram, it is the area below the demand curve and above the market price, up to equilibrium quantity.
· A larger consumer surplus means consumers gain more benefit from market exchange.
· The demand curve reflects marginal benefit (MB).

Producer surplus

· Producer surplus is the difference between the price producers receive and the minimum price they would be willing to accept.
· On a diagram, it is the area above the supply curve and below the market price, up to equilibrium quantity.
· A larger producer surplus means producers gain more benefit from selling in the market.
· The supply curve reflects marginal cost (MC) in the competitive market model.

This graph shows consumer surplus and producer surplus as two shaded areas around the equilibrium price. It is ideal for learning how welfare is divided between consumers and producers in a competitive market. Source

Social/community surplus

· Social/community surplus = consumer surplus + producer surplus.
· It represents the total gains from trade in the market.
· In IB Economics, social/community surplus is used to show overall welfare in a competitive market.
· At the competitive market equilibrium, social/community surplus is maximized.

Allocative efficiency at competitive market equilibrium

· Allocative efficiency occurs when resources are allocated to produce the combination of goods most wanted by society.
· In a competitive market, allocative efficiency occurs where marginal benefit (MB) = marginal cost (MC).
· Since demand = MB and supply = MC, the equilibrium gives MB = MC.
· At this point, social/community surplus is maximized.
· If output is below equilibrium, extra units would bring more benefit than cost.
· If output is above equilibrium, extra units would cost more than the benefit they generate.
· Strong exam phrase: competitive market equilibrium is allocatively efficient because MB = MC and total social/community surplus is maximized.

How to answer diagram questions well

· Label axes correctly: Price on the vertical axis and Quantity on the horizontal axis.
· Label D, S, equilibrium, consumer surplus, and producer surplus clearly when needed.
· If a curve shifts, show the original equilibrium and the new equilibrium.
· In written explanation, always state whether there is shortage or surplus and how this changes price.
· For efficiency questions, explain that equilibrium is allocatively efficient because MB = MC.