ECS2601
Assignment 1
Semester 1
Due 19 March 2026
, Intermediate Microeconomics
QUESTION 1 – MARKET MECHANISM, CONCEPTS & CURVES
1.1 The Market Mechanism and Price Adjustments
The market mechanism refers to the process through which prices are determined by the
interaction of buyers (demand) and sellers (supply), without any central authority directing these
decisions. Prices act as signals that coordinate economic activity (Mankiw, 2021).
When consumers want to buy a product, they express demand. Producers respond by supplying
that product. The price at which the quantity demanded equals the quantity supplied is called the
equilibrium price. This is the market's "resting point" — the price that clears the market
(Pindyck & Rubinfeld, 2018).
How Price Adjustments Eliminate Shortages and Surpluses:
Shortage (Excess Demand): This occurs when quantity demanded exceeds quantity
supplied — typically when price is set below equilibrium. For example, if concert tickets are
priced at R100 but the equilibrium is R200, many more people want tickets than are
available. Producers respond by raising prices. As price rises, quantity demanded falls and
quantity supplied increases, until equilibrium is restored (Sloman, Wride & Garratt, 2015).
Surplus (Excess Supply): This happens when quantity supplied exceeds quantity
demanded — typically when price is above equilibrium. If a clothing store prices jackets at
R800 but equilibrium is R500, unsold stock piles up. The store lowers prices to clear
inventory. As price falls, quantity demanded rises and quantity supplied falls, restoring
equilibrium (Mankiw, 2021).
In short: prices rise to eliminate shortages and fall to eliminate surpluses. This self-correcting
process is what economists call the "invisible hand" (Smith, as cited in Mankiw, 2021).
1.1 (Alt Version) – Price Ceilings and Price Floors
, Price Ceiling: A price ceiling is a government-imposed maximum price set below the
equilibrium price. Because the legal price is lower than what the market would set, quantity
demanded exceeds quantity supplied — creating a shortage. A well-known example is rent
control: when government caps rent below market rates, more people want to rent than
landlords are willing to supply (Pindyck & Rubinfeld, 2018). A binding price ceiling is one set
below equilibrium and does create a shortage — not a surplus.
Price Floor: A price floor is a government-imposed minimum price set above the
equilibrium price. Because the legal price is higher than the market-clearing price, quantity
supplied exceeds quantity demanded — creating a surplus (excess supply). South Africa's
national minimum wage is an example: if set above equilibrium wages, it can lead to
unemployment (excess labour supply) (Mohr & Associates, 2015).
1.2 Concept Differentiation – Substitution Effect vs Income Effect & Normal Good
vs Inferior Good
(a) Substitution Effect vs Income Effect
Substitution Effect Income Effect
Occurs because, when the price of a good falls, it Occurs because a fall in price increases the
becomes relatively cheaper compared to other consumer's real purchasing power — they can
goods. The consumer substitutes away from the afford more with the same money income. This
now-more-expensive alternative toward the cheaper change in real income affects the quantity
good (Varian, 2014). demanded (Pindyck & Rubinfeld, 2018).
Example: If chicken (R50/kg) falls to R30/kg
Example: The same price drop on chicken means
while beef stays at R80/kg, the consumer buys more
the consumer effectively has more buying power
chicken instead of beef because chicken is now
and may buy more chicken (and other goods too).
relatively cheaper.
Always moves in the opposite direction to the Direction depends on whether the good is normal
price change (always negative for own-price). or inferior.
Assignment 1
Semester 1
Due 19 March 2026
, Intermediate Microeconomics
QUESTION 1 – MARKET MECHANISM, CONCEPTS & CURVES
1.1 The Market Mechanism and Price Adjustments
The market mechanism refers to the process through which prices are determined by the
interaction of buyers (demand) and sellers (supply), without any central authority directing these
decisions. Prices act as signals that coordinate economic activity (Mankiw, 2021).
When consumers want to buy a product, they express demand. Producers respond by supplying
that product. The price at which the quantity demanded equals the quantity supplied is called the
equilibrium price. This is the market's "resting point" — the price that clears the market
(Pindyck & Rubinfeld, 2018).
How Price Adjustments Eliminate Shortages and Surpluses:
Shortage (Excess Demand): This occurs when quantity demanded exceeds quantity
supplied — typically when price is set below equilibrium. For example, if concert tickets are
priced at R100 but the equilibrium is R200, many more people want tickets than are
available. Producers respond by raising prices. As price rises, quantity demanded falls and
quantity supplied increases, until equilibrium is restored (Sloman, Wride & Garratt, 2015).
Surplus (Excess Supply): This happens when quantity supplied exceeds quantity
demanded — typically when price is above equilibrium. If a clothing store prices jackets at
R800 but equilibrium is R500, unsold stock piles up. The store lowers prices to clear
inventory. As price falls, quantity demanded rises and quantity supplied falls, restoring
equilibrium (Mankiw, 2021).
In short: prices rise to eliminate shortages and fall to eliminate surpluses. This self-correcting
process is what economists call the "invisible hand" (Smith, as cited in Mankiw, 2021).
1.1 (Alt Version) – Price Ceilings and Price Floors
, Price Ceiling: A price ceiling is a government-imposed maximum price set below the
equilibrium price. Because the legal price is lower than what the market would set, quantity
demanded exceeds quantity supplied — creating a shortage. A well-known example is rent
control: when government caps rent below market rates, more people want to rent than
landlords are willing to supply (Pindyck & Rubinfeld, 2018). A binding price ceiling is one set
below equilibrium and does create a shortage — not a surplus.
Price Floor: A price floor is a government-imposed minimum price set above the
equilibrium price. Because the legal price is higher than the market-clearing price, quantity
supplied exceeds quantity demanded — creating a surplus (excess supply). South Africa's
national minimum wage is an example: if set above equilibrium wages, it can lead to
unemployment (excess labour supply) (Mohr & Associates, 2015).
1.2 Concept Differentiation – Substitution Effect vs Income Effect & Normal Good
vs Inferior Good
(a) Substitution Effect vs Income Effect
Substitution Effect Income Effect
Occurs because, when the price of a good falls, it Occurs because a fall in price increases the
becomes relatively cheaper compared to other consumer's real purchasing power — they can
goods. The consumer substitutes away from the afford more with the same money income. This
now-more-expensive alternative toward the cheaper change in real income affects the quantity
good (Varian, 2014). demanded (Pindyck & Rubinfeld, 2018).
Example: If chicken (R50/kg) falls to R30/kg
Example: The same price drop on chicken means
while beef stays at R80/kg, the consumer buys more
the consumer effectively has more buying power
chicken instead of beef because chicken is now
and may buy more chicken (and other goods too).
relatively cheaper.
Always moves in the opposite direction to the Direction depends on whether the good is normal
price change (always negative for own-price). or inferior.
