Market Equilibrium

A market is an arrangement that brings buyers and sellers together. Markets exist in all types of goods and services, and as economists, we are interested in how they work and what causes them to change.

 

The market price is determined by the interaction of market supply (producers) and market demand (consumers).

When the quantity of a product demanded equals the quantity supplied at the prevailing market price, this is called market equilibrium. When a market reaches equilibrium, there is no pressure to change the price.

The point at which the quantity demanded equals the quantity supplied is the equilibrium point. This point states the price of the good (P1) and the market quantity (Q1)

Market Equilibrium 01

Let us look at an example to understand how it works:

The below schedule shows the quantity supplied and demanded are equal at Rs.40. This is the intersection of supply and demand of the price of sugar people are willing to buy 1 kg sugar and retailer willing to sell sugar at a price for 1 kg

Supplied Price / kg Demanded

20

30

80

50

40

50

80

50

20

If you plot the above able on the graph, you will get the demand and supply diagram of sugar at three various prices. And the equilibrium i.e. the quantity demanded equal to the quantity supplied is at Rs. 40 per kg.

The diagram is shown below:

Market Equilibrium

Mathematically this can be shown with the supply curve that is the function: Qs = 2P where Qs is the quantity supplied at each price, P. The demand curve is QD = 200 ā€“ 3P where QD us quantity demanded at each price, P.

The equilibrium can then be calculated by setting the equation for quantity supplied equal to the equation for quantity demanded:

QS = QD

2P = 200 ā€“ 3P

Solve to find P

5P = 200

P = 40

The equilibrium quantity can then be calculated by substituting the equilibrium price of Rs. 40 for P in the equations and solving for quantity supplied, QS, or quantity demanded QD

QS = 2(40) = 80

QD = 200-3(40) = 80

Assuming that neither curve shifts, then market forces will maintain the equilibrium price. For instance, assume that the price rises above P1, then the firms will react by wishing to supply more (the price is higher, therefore, the revenue will be higher), at the same time consumers will demand less. The outcome is that there is excess supply. In other words, supply is greater than demand.

This situation results in producers having unsold stocks. In this case, producers will wish to sell stocks as they cost money to produce and maintain. Therefore, to sell them they will reduce the price of the good (contraction in supply). The lower price will encourages more demand for the good (extension in demand). This process continues until the supply and demand are again in equilibrium.

If the position of either the demand and / or supply curve shifts, then the equilibrium price and quantity will change. For instance, if the good becomes more fashionable, then the demand curve will shift from D1 to D2

Market Equilibrium 02

 

The new equilibrium price will be P

In conclusion, the market forces of supply and demand interact to bring about the equilibrium price, clearing the market of excess demand or supply. In this way, it is said that the market mechanism achieves consistency between the plans and outcomes for consumers and producers without explicit coordination.

 

 

 

 

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