Supply & Demand

-Disequilibrium-

The intersection of the Supply and Demand curves is known as the market clearing or equilibrium level of Price and Quantity, but what happens at the other prices?  If we are not in equilibrium, then we have the wrong price and there will be either a surplus or shortage. 

Surplus

In the diagram below we see the current price (p1) is above the equilibrium price (P*). At that price the amount suppliers are willing to bring to the market is QS1, while the amount demanders are willing to purchase is QD1. It is clear supply is greater than demand (QS1 > QD1) and the gap between the two is the surplus. Left alone, the market would correct the surplus with a price decrease - sellers are likely to see their inventories (unsold goods) rise and they cannot bring supply and demand back into balance without lowering prices.

P* = Equilibrium Price

Q* = Equilibrium Quantity

Shortage

In the diagram below we see the current price (p1) is below the equilibrium price (P*). At that price the amount suppliers are willing to bring to the market is QS1, while the amount demanders are willing to purchase is QD1. It is clear demand is greater than supply (QS1 > QD1) and the gap between the two is the shortage. Left alone, the market would correct the shortage with a price increase - sellers are likely to see that they cannot keep up with demand and they will raise their price to balance supply and demand.