Question

If excess demand exists in the market, what should happen to restore equilibrium?

• A. Prices should increase
• B. Prices should decrease
• C. Government should set a price cap
• D. Firms should stop production

Hint:

Excess demand: \[ Q_d > Q_s \] Leads to: \[ \mathrm{Rise\ in\ Price} \]

Answer 1

The Correct Option is A

Step 1: Understanding the Concept:
Excess demand (shortage) occurs when the current market price is lower than the equilibrium price. At this low price, the quantity demanded (\(Q_D\)) exceeds the quantity supplied (\(Q_S\)).
Step 2: Detailed Explanation:
When there is a shortage (Excess Demand):
1. Consumers cannot find enough goods to satisfy their needs. They are willing to pay a little more to ensure they get the product.
2. This "competition among buyers" puts upward pressure on the price.
3. As the price increases:
- The Law of Demand states that consumers will reduce their quantity demanded (moving up along the demand curve).
- The Law of Supply states that producers will be encouraged to supply more (moving up along the supply curve).
4. This process continues until the gap between \(Q_D\) and \(Q_S\) is closed.
If we chose (B) (Price decrease), the shortage would become even larger because demand would rise further while supply would shrink.
Step 3: Final Answer
To clear the market of excess demand, the price must rise until it reaches the equilibrium level where \(Q_D = Q_S\).