Question

3. What is a market-clearing model? When is it appropriate to assume that markets clear?

Answer 1

Answer

3.The two main pillars of a market are the buyers and sellers. The sellers supply products and enter the market for selling their products.On the other hand, the buyers have a demand for a product and enter the market for buying those products.The buying and selling of products depend on the price of the product. The selling or supply of a product is directly related to the price,i.e., if price of the product rises, then the supply of the product also rises. The buying or demand for a product is inversely related to the price,i.e., if price of the product rises, then the demand for the product decreases. The market is cleared when the quantity demanded for a product, and the quantity supplied of a product are equal. Now, as the demand for and the supply of a commodity both depend on price; the market is cleared at the price at which both the buyers and sellers are satisfied. This price is called the equilibrium price, at which both the quantity demanded and quantity supplied are equal. The quantity demanded and supplied at equilibrium price, is called the equilibrium quantity.

So the market-clearing model is the model that shows how the price mechanism equilibrates demand and supply in the market , so that there is no shortage, and no surplus in the market.

The market-clearing model is also applicable in labor market. In this market, the price of labor is called, wage.

In the above figure, the quantity of a product is measured on the horizontal axis, and the price of the product is measured on the vertical axis. 'D' is the demand curve, and 'S' is the supply curve of the product. The market is cleared at price 'P_e. So, P_e is equilibrium price, and the equilibrium point is point 'e', where the demand curve and supply curve intersects. When price is below the equilibrium price, demand for the product is more than supply of the product, and there emerges shortage of supply. So, the market mechanism of price will force the price to rise, and it will go up to the equilibrium price. Similarly, When price is above the equilibrium price, demand for the product is less than supply of the product, and there emerges surplus of supply. So, then the market mechanism of price will force the price to decrease, and it will go down to the equilibrium price.

So the market is clear at price P_e, at which there is no shortage or surplus.

The long-run is appropriate to assume that market is clear. In long-run everything can be adjusted.In the short-run, the sellers may find it impossible to increase the supply of the product and thus the shortage can not be cured unless the price rise. The price mechanism works well in the long-run.In the short-run, most of the time, the price remains sticky,that causes either shortage or surplus in the market. It takes some time for the price to be flexible, and makes the market clear.

So we may assume that markets clear in the long-run.

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