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
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.
Together, demand and supply determine the price and the quantity that will be bought and sold in a market.
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.
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.
Equilibrium Quantity: the quantity supplied and quantity demanded at the equilibrium price.
Enlarged version: http://bit.ly/2maW2rT
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.
Link to the video: https://www.youtube.com/watch?v=PEMkfgrifDw
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.
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).
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).
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.
Link to the video: https://www.youtube.com/watch?v=TUtgxJO8ggE