Business Valuation Quiz: Demand, Supply, and Market Equilibrium

Market equilibrium occurs when quantity demanded exactly equals quantity supplied. At this point, buyers and sellers agree on price, and there is no tendency for change. If price is higher, surplus forms. If price is lower, shortage appears. Equilibrium reflects efficient allocation of resources where market forces balance naturally without external pressure.

Market demand is calculated by horizontally adding individual demand curves. At each price, economists sum the quantities demanded by all consumers. This method reflects total market demand rather than individual behavior. Vertical summation would incorrectly combine prices instead of quantities, violating demand theory.

When economists draw a demand curve, they assume price is the only changing variable. Other influences such as income, tastes, and substitute prices are held constant. This assumption allows economists to clearly observe how price alone affects quantity demanded, simplifying analysis and comparison.

Price is the central variable influencing both production and consumption decisions. Producers decide how much to supply based on potential revenue, while consumers decide how much to buy based on affordability. Demand and supply curves are built around price to show these coordinated decisions.

A shortage happens when price is set below equilibrium, causing quantity demanded to exceed quantity supplied. Consumers want more than is available. This scarcity pushes prices upward as buyers compete, restoring balance between demand and supply.

Technological improvements reduce production costs and allow firms to produce more efficiently. This shifts the supply curve rightward, increasing quantity supplied at every price. Lower costs often result in lower prices and higher output in the market equilibrium.

A surplus occurs when price is set above equilibrium, causing quantity supplied to exceed quantity demanded. Producers are unable to sell all their goods. To eliminate surplus, sellers typically lower prices, moving the market back toward equilibrium.

The demand curve shows how quantity demanded responds to changes in price, assuming other factors remain constant. It isolates price as the key variable influencing consumer decisions. Movements along the curve represent price changes, while shifts indicate changes in non-price determinants like income or preferences.

When demand increases and supply remains constant, consumers compete for limited goods. This competition raises prices and encourages sellers to supply more along the existing curve. The final result is a higher equilibrium price and greater equilibrium quantity.

Government policies such as taxes, subsidies, or regulations can affect both producers and consumers. Taxes may reduce supply and demand, while subsidies can increase them. Because policies influence market incentives on both sides, they shift both curves simultaneously.

An increase in supply means more goods are available at every price level. Producers can offer greater quantities without raising prices. This pushes equilibrium price downward while increasing equilibrium quantity. Consumers benefit from lower prices, while sellers compensate through higher sales volume. This outcome follows standard supply-and-demand intersection analysis.

The law of demand explains consumer behavior by showing that as prices fall, quantity demanded rises. Lower prices increase purchasing power and encourage substitution away from expensive alternatives. Conversely, higher prices discourage consumption. This inverse relationship is fundamental to understanding downward-sloping demand curves in microeconomics.

Quantity supplied has a direct relationship with price because higher prices encourage producers to supply more. Quantity demanded has an inverse relationship because higher prices discourage consumers. These opposing reactions explain why supply curves slope upward and demand curves slope downward in standard economic models.

A change in buyer tastes directly affects demand. If consumers develop a stronger preference for donuts, demand increases even if prices stay the same. This shifts the demand curve rightward, reflecting higher quantity demanded at every price level, independent of production costs.

A change in product price causes movement along the demand curve, not a shift. Demand changes only when non-price factors like preferences, income, or substitute prices change. This distinction helps economists separate quantity demanded from overall demand changes.