Finding Market 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.

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.

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

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.

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.

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.

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 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.