Finding Market Equilibrium

Finding Market Equilibrium

In this lesson, you’re expected to:
– understand how demand and supply interact with one another
– discover the conditions required for attaining market equilibrium
– learn about the concepts of Excess Demand and Excess Supply

Even though the concepts of supply and demand are introduced separately, it’s the combination of these forces that determine how much of a good or service is produced and consumed in an economy and at what price.

In the supply and demand model, the equilibrium price and quantity in a market is located at the intersection of the market supply and market demand curves.

Note that the equilibrium price is generally referred to as P* and the equilibrium quantityis generally referred to as Q*.
Combining Demand & Supply Curves

Since the graphs for demand and supply curves both have price on the vertical axis and quantity on the horizontal axis, the demand and supply curve for a particular good or service can appear on the same graph.

Together, demand and supply determine the price and the quantity that will be bought and sold in a market.

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What is Equilibrium?

The word equilibrium means balance. If a market is at its equilibrium price and quantity, then it has no reason to move away from that point.

At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being demanded.

However, if a market is not at equilibrium, then economic pressures arise to move the market toward the equilibrium price and the equilibrium quantity.

Equilibrium Price & Quantity

Supply and demand curves intersect at the equilibrium price. This is the price at which the market will operate.

The equilibrium price is the only price where the plans of consumers and producers agree — that is, where the amount consumers want to buy of the product (quantity demanded) is equal to the amount producers want to sell (quantity supplied).

This common quantity is called the equilibrium quantity. At any other price, the quantity demanded does not equal the quantity supplied, so the market is not in equilibrium at that price.

Identifying Equilibrium Price & Quantity
Equilibrium Price: the price that equates quantity supplied with quantity demanded.
Equilibrium Quantity: the quantity supplied and quantity demanded at the equilibrium price.

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Condition for Market Equilibrium

In general, the condition for equilibrium in a market is that the quantity supplied is equal to the quantity demanded.

This equilibrium identity determines the market price P*, since quantity supplied and quantity demanded are both functions of price.

Quantity Demanded = Quantity Supplied

Why does Equilibrium occur at a specific Price & Quantity?

At a higher price, there would be more quantity supplied than demanded so the seller would have to lower his price to sell his goods.

If the sellers raise their price too high, where the demand is less than what they have to offer, then they will have a surplus that will force them to lower their price until they can sell their entire supply.

At a lower price, there would be more quantity demanded than supplied so the buyer would have to spend more to buy goods.

If the sellers set their price too low, then they will sell their entire supply before they can satisfy the demands of the market. This would result in a shortage in the market.

[Optional] Market Equilibrium
Watch this 10-minute video to learn more.
Link to the video:
Markets Are Not Always in Equilibrium

It’s important to keep in mind that markets are not necessarily in equilibrium at all points in time, since there are various shocks that can result in supply and demand being temporarily out of balance.

That said, markets tend toward the equilibrium over time and remain there until there is a change to either supply or demand.

How long it takes a market to reach equilibrium depends on the specific characteristics of the market, most importantly how often firms have the chance to change prices and production quantities.

Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*.
Excess Demand

When quantity demanded is greater than quantity supplied.

Excess demand is created when price is set below the equilibrium price. Because the price is so low, too many consumers want the good while producers are not making enough of it.

Facing a shortage, sellers raise the price, causing Qd to fall and Qs to rise (which reduces the shortage).

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Excess Supply

When quantity supplied is greater than quantity demanded.

If the price is set too high, excess supply will be created within the economy and there will be allocative inefficiency.

Facing a surplus, sellers try to increase sales by cutting price. This causes Qd to rise and Qs to fall (which reduces the surplus). 

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Changes in Market Equilibrium

Let’s start thinking about changes in equilibrium price and quantity by imagining a single event has taken place. It might be an event that affects demand or supply.

So how do we know how an economic event will affect equilibrium price and quantity? 

There’s a four-step process that allows us to predict how an event will affect the equilibrium price and quantity using the supply and demand framework:

Step 1: Draw a demand and supply model representing the situation before the economic event took place.

Step 2: Decide whether the economic event being analyzed affects demand or supply.

Step 3: Decide whether the effect on demand or supply causes the curve to shift to the right or to the left and sketch the new demand or supply curve.

Step 4: Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.

[Optional] Changes in Equilibrium Prices
Watch this 3-minute video to learn more.
Link to the video:
[Optional] Labor Market Disequilibrium
Read this blog article to understand how disequilibrium occurs in the labor market:
How do households behave when faced with income and price constraints? Does this affect a consumers’ preferences? Find out in the next lesson!
Jim Rohn Sứ mệnh khởi nghiệp