What market equilibrium is and how it is determined

Market equilibrium occurs when the quantity supplied in a market exactly matches the quantity demanded, resulting in a stable price and output level. At this point, the market clears, meaning all goods offered for sale are purchased, with no shortages or surpluses.

How market equilibrium is determined

In a free market, equilibrium is set by the interaction of supply and demand, often called market forces. The equilibrium price and quantity are found where the supply curve (upward-sloping) and demand curve (downward-sloping) intersect.

Example of market equilibrium using a table

The table below shows supply and demand for chocolate bars at different prices.

From the data, the equilibrium price is £4.00, where quantity demanded (6000) equals quantity supplied (6000). If plotted on a graph, this would be the intersection point of the curves.

Disequilibrium

When supply and demand do not match, the market is in disequilibrium, leading to either excess supply or excess demand. These imbalances are temporary in a free market, as prices adjust to restore balance. Supply and demand curves can represent entire markets or individual firms and consumers.

Excess supply and excess demand in markets

Excess supply and excess demand create imbalances that market forces correct by adjusting prices. These situations arise when prices are set away from the equilibrium level.

Excess supply

Excess supply, or a surplus, happens when quantity supplied exceeds quantity demanded, often because the price is too high. For example, if chocolate bars are priced at £5.00, supply might be 8000 units while demand is only 4000, creating a surplus of 4000 units. This forces prices down, causing supply to decrease and demand to increase until equilibrium is reached at £4.00 and 6000 units.

Excess demand

Excess demand occurs when quantity demanded exceeds quantity supplied, usually due to a price that is too low. For instance, at £2.00 per chocolate bar, demand could be 10000 units but supply only 4000, resulting in a shortage of 6000 units. Prices then rise, reducing demand and increasing supply until equilibrium is restored at £4.00 and 6000 units.

How shifts in demand or supply change market equilibrium

Shifts in the demand or supply curve, while the other remains unchanged, alter the equilibrium price and quantity. These shifts create new intersection points on graphs.

Effects of shifts in the demand curve

• Increase in demand - The demand curve shifts right (e.g., from D to D₁), raising the equilibrium price (from P_e to P₁) and increasing quantity (from Q_e to Q₁).
• Decrease in demand - The demand curve shifts left (e.g., from D to D₂), lowering the equilibrium price (to P₂) and reducing quantity (to Q₂).

Effects of shifts in the supply curve

• Increase in supply - The supply curve shifts right (e.g., from S to S₁), decreasing the equilibrium price (to P₁) and increasing quantity (to Q₁).
• Decrease in supply - The supply curve shifts left (e.g., from S to S₂), increasing the equilibrium price (to P₂) and decreasing quantity (to Q₂).

The influence of elasticity on new equilibrium points

Price elasticity of supply (PES) and price elasticity of demand (PED) determine how much equilibrium price and quantity change after a curve shift. Elasticity measures responsiveness to price changes.

How elasticity affects equilibrium changes

• Price inelastic supply or demand - Shifts have a greater impact on price than on quantity, as responses to price changes are limited.
• Price elastic supply or demand - Shifts affect quantity more than price, due to high responsiveness.

For example, a rightward demand shift along an elastic supply curve mainly increases quantity, with a small price rise. Along an inelastic supply curve, the same shift causes a larger price increase but a smaller quantity change.