When the price is wrong
This topic is examined on Paper 1 (Microeconomics and Business Economics). In the last lesson, Market Equilibrium, you found the one price where buyers and sellers match. But markets do not always start at that price. A seller might guess too low, or too high. This lesson shows what happens then.
Key terms:
- Excess demand: when the quantity demanded is greater than the quantity supplied at a given price. It happens when the price is below the equilibrium price. It is also called a shortage.
- Excess supply: when the quantity supplied is greater than the quantity demanded at a given price. It happens when the price is above the equilibrium price. It is also called a surplus.
- Market forces: the pressures of demand and supply that push prices up or down until the market is balanced again.
The schedule we will use
Every Saturday, a street food market sells pizzas from a van. The table shows how many pizzas buyers want and how many the van can supply at each price.
| Price per pizza | Quantity demanded | Quantity supplied |
|---|
| £4 | 500 | 100 |
| £6 | 400 | 200 |
| £8 | 300 | 300 |
| £10 | 200 | 400 |
| £12 | 100 | 500 |
The equilibrium price is £8 and the equilibrium quantity is 300 pizzas. Now look at the other rows.
Excess demand: the price is too low
A long queue for tickets is excess demand: at this price more people want to buy than there are tickets
Suppose the van charges only £6. Buyers want 400 pizzas but the van only supplies 200. There are more buyers than pizzas. That is excess demand.
Worked example: calculating excess demand
Excess demand = quantity demanded − quantity supplied.
At £6: 400 − 200 = 200 pizzas.
At £4: 500 − 100 = 400 pizzas.
The lower the price, the bigger the excess demand.
Customers queue and some go home hungry. The van owner sees pizzas selling out fast. Buyers who really want a pizza may offer more money.
Excess supply: the price is too high
Now suppose the van charges £10. Buyers want only 200 pizzas but the van makes 400. There are more pizzas than buyers. That is excess supply.
Worked example: calculating excess supply
Excess supply = quantity supplied − quantity demanded.
At £10: 400 − 200 = 200 pizzas.
At £12: 500 − 100 = 400 pizzas.
The higher the price, the bigger the excess supply.
The unsold pizzas go cold and the owner loses money.
How to show them on a diagram
Describe or draw it in this order. Each step is worth doing in the exam.
📇 Excess demand
1. Put price (P) on the vertical axis and quantity (Q) on the horizontal axis.
2. Draw a downward-sloping curve labelled D and an upward-sloping curve labelled S.
3. Mark the equilibrium where they cross, with P1 and Q1.
4. Pick a price below P1 and draw a horizontal line across.
5. Where it hits S, drop down to the axis (quantity supplied). Where it hits D, drop down to the axis (quantity demanded).
6. Quantity demanded is further right. The gap between the two is the excess demand.
📦 Excess supply
1. Draw the same axes, D, S and equilibrium P1 and Q1.
2. Pick a price above P1 and draw a horizontal line across.
3. Where it hits D, drop down to the axis (quantity demanded). Where it hits S, drop down to the axis (quantity supplied).
4. Quantity supplied is further right. The gap between the two is the excess supply.
A good tip: label the gap clearly and write "excess demand" or "excess supply" on it.
Market forces bring the price back
Unsold stock piling up is excess supply, so sellers cut prices until the market clears
Prices do not stay wrong for long in a free market. Market forces push the price back to equilibrium.
📈 Removing excess demand
1. At £6 there are too few pizzas, so the van runs out.
2. The owner realises people will pay more, so the price rises.
3. As the price rises, some buyers give up. Demand contracts.
4. The higher price makes it worth making more pizzas. Supply extends.
5. This carries on until quantity demanded equals quantity supplied at £8.
📉 Removing excess supply
1. At £10 there are unsold pizzas.
2. The owner cuts the price to attract buyers.
3. As the price falls, more people buy. Demand extends.
4. The lower price makes making pizzas less worthwhile. Supply contracts.
5. This carries on until quantity demanded equals quantity supplied at £8.
Notice that these are movements along the curves. The curves themselves do not shift. Only the price changes.
Worked example: a different market
A second-hand games console sells for £150. At that price 80 people want one and 200 are for sale.
Quantity supplied is bigger, so there is excess supply.
Excess supply = 200 − 80 = 120 consoles.
Sellers will lower the price until the market clears.
Common mistakes
- Mixing up the two. Remember: price too low means excess demand, price too high means excess supply.
- Subtracting the wrong way round. Always take the smaller quantity from the bigger one, so the answer is not negative.
- Saying the demand curve shifts. When price moves to remove the gap, it is a movement along the curve.
- Forgetting to say what happens to both buyers and sellers when you explain market forces.
Exam-style question
A farm shop sells punnets of strawberries. The table shows the weekly market.
| Price per punnet | Quantity demanded | Quantity supplied |
|---|
| £1 | 900 | 300 |
| £2 | 700 | 500 |
| £3 | 500 | 700 |
| £4 | 300 | 900 |
(a) State the equilibrium price. [1 mark]
(b) The shop charges £2 per punnet. Calculate the excess demand. [2 marks]
(c) Explain how market forces would remove this excess demand. [3 marks]
Model answer
(a) £3, because quantity demanded and quantity supplied are both 500 (1).
(b) Excess demand = quantity demanded − quantity supplied (1) = 700 − 500 = 200 punnets (1).
(c) At £2 there are not enough punnets for everyone who wants one, so the price will rise (1). As the price rises, demand contracts because some buyers are no longer willing to pay (1). The higher price also encourages the shop to supply more, so supply extends, until quantities match at £3 (1).
Exam tip
In part (c), use the words "demand contracts" and "supply extends" and finish by saying the gap closes at equilibrium.