MARKET EQUILIBRIUM

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When the supply and demand curves intersect, the market is in equilibrium.  This is where the quantity demanded and quantity supplied are equal.  The corresponding price is the equilibrium price or market-clearing price, the quantity is the equilibrium quantity.

   
Putting the supply and demand curves from the previous sections together. These two curves will intersect at Price = $6, and Quantity = 20. 

In this market, the equilibrium price is $6 per unit, and equilibrium quantity is 20 units.

At this price level, market is in equilibrium. Quantity supplied is equal to quantity demanded ( Qs = Qd). 

Market is clear.

Surplus and shortage:

If the market price is above the equilibrium price, quantity supplied is greater than quantity demanded, creating a surplus.  Market price will fall.

Example: if you are the producer, you have a lot of excess inventory that cannot sell. Will you put them on sale? It is most likely yes. Once you lower the price of your product, your product’s quantity demanded will rise until equilibrium is reached. Therefore, surplus drives price down.

If the market price is below the equilibrium price, quantity supplied is less than quantity demanded, creating a shortage. The market is not clear. It is in shortage. Market price will rise because of this shortage.

Example: if you are the producer, your product is always out of stock. Will you raise the price to make more profit? Most for-profit firms will say yes. Once you raise the price of your product, your product’s quantity demanded will drop until equilibrium is reached.  Therefore, shortage drives price up.

If a surplus exist, price must fall in order to entice additional quantity demanded and reduce quantity supplied until the surplus is eliminated.  If a shortage exists, price must rise in order to entice additional supply and reduce quantity demanded until the shortage is eliminated.

If the market price (P) is higher than $6 (where Qd = Qs),

for example,  P=8, Qs=30, and Qd=10.

Since  Qs>Qd, there are excess quantity supplied  in the

market, the market is not clear. Market is in surplus.

THE PRICE WILL DROP BECAUSE OF THIS SURPLUS.

 

If the market price is lower than equilibrium price,  $6,

for example,  P=4, Qs=10, and Qd=30.

Since Qs<Qd, There are excess quanitty demanded in the

market. Market is not clear. Market is in shortage.

THE PRICE WILL RISE DUE TO THIS SHORTAGE.

 

Government regulations will create surpluses and shortages in the market.  When a price ceiling is set, there will be a shortage. When there is a price floor, there will be a surplus.

Price Floor: is legally imposed minimum price on the market. Transactions below this price is prohibited.
Policy makers set floor price above the market equilibrium price which they believed is too low.
Price floors are most often placed on markets for goods that are an important source of income for the sellers, such as labor market.  Price floor  generate surpluses on the market. Example: minimum wage.
 
Price Ceiling: is legally imposed maximum price on the market. Transactions above this price is prohibited. Policy makers set ceiling price below the market equilibrium price which they believed is too high. Intention of price ceiling is keeping stuff affordable for poor people. Price ceiling generates shortages on the market. Example: Rent control.
 
Changes in equilibrium price and quantity:

Equilibrium price and quantity are determined by the intersection of supply and demand. A change in supply, or demand, or both, will necessarily change the equilibrium price, quantity or both. It is highly unlikely that the change in supply and demand perfectly offset one another so that equilibrium remains the same.

Example: This example is based on the assumption of Ceteris Paribus.

1) If there is an exporter who is willing to export oranges from Florida to Asia, he will increase the demand for Florida’s oranges. An increase in demand will create a shortage, which increases the equilibrium price and equilibrium quantity.        

 2) If there is an importer who is willing to import oranges from Mexico to Florida, he will increase the supply for Florida’s oranges. An increase in supply will create a surplus, which lowers the equilibrium price and increase the equilibrium quantity.              

 3) What will happen if the exporter and importer enter the Florida’s orange market at the same time? From the above analysis, we can tell that equilibrium quantity will be higher. But the import and exporter’s impact on price is opposite. Therefore, the change in equilibrium price cannot be determined unless more details are provided. Detail information should include the exact quantity the exporter and importer is engaged in. By comparing the quantity between importer and exporter, we can determine who has more impact on the market.

In the following table, an example of demand and supply increase is illustrated. 

In this graph, supply is constant, demand increases. As the new demand curve (Demand 2) has shown, the new curve is located on the right hand side of the original demand curve.

The new curve intersects the original supply curve at a new point. At this point, the equilibrium price (market price) is higher, and equilibrium quantity is higher also.

In this graph, demand is constant, and supply increases. As the new supply curve (SUPPLY 2) has shown, the new curve is located on the right side of the original supply curve.

The new curve intersects the original demand curve at a new point. At this point, the equilibrium price (market price) is lower, and the equilibrium quantity is higher.

In this graph, the increased demand curve and increased supply were drawn together.  The new intersection point is located on the right hand side of the original intersection point.

This new equilibrium point indicated an equilibrium quantity which is higher than the original equilibrium quantity. The equilibrium price is also higher. It is because demand has increased relatively more than supply in this case.

This supply and demand factor exercises may help you better apply these concepts. 

 

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