What market equilibrium is

Market equilibrium occurs through the interaction of consumers and producers, where demand and supply balance each other out.

Market equilibrium exists when the quantity demanded equals the quantity supplied, with no pressure for the price to adjust. This point is found at the intersection of the demand and supply curves. At this intersection, the price is known as the equilibrium price, and the quantity is the equilibrium quantity.

The equilibrium stays the same only if both demand and supply do not change. If a factor alters either demand or supply, the relevant curve shifts, leading to a new equilibrium point.

Excess demand and excess supply

Imbalances in demand and supply create pressures that move the market towards equilibrium.

Excess demand

Excess demand, or a shortage, happens when the quantity demanded is greater than the quantity supplied at the current price. This creates upward pressure on the price.

Excess supply

Excess supply, or a surplus, occurs when the quantity supplied exceeds the quantity demanded at the current price. This leads to downward pressure on the price.

Key conditions for equilibrium:

• If quantity demanded > quantity supplied: excess demand causes prices to rise, so not equilibrium.
• If quantity supplied > quantity demanded: excess supply causes prices to fall, so not equilibrium.
• If quantity demanded = quantity supplied: the market clears with no price pressure, achieving equilibrium.

Effects of changes in demand on equilibrium

Shifts in demand alter the equilibrium by changing the balance between buyers and sellers.

Increase in demand

An increase in demand shifts the demand curve to the right. At the original price, this creates excess demand, pushing the price up. The new equilibrium has a higher price and a higher quantity.

For example, if consumer incomes rise and coffee is a normal good, demand for coffee increases.

Decrease in demand

A decrease in demand shifts the demand curve to the left. At the original price, this results in excess supply, pulling the price down. The new equilibrium features a lower price and a lower quantity.

For instance, if the price of tea (a substitute) falls, demand for coffee decreases.

Effects of changes in supply on equilibrium

Changes in supply affect how much producers are willing to offer, impacting the market balance.

Increase in supply

An increase in supply shifts the supply curve to the right. At the original price, excess supply emerges, driving the price down. The new equilibrium shows a lower price but a higher quantity.

For example, advances in farming methods boost rice supply.

Decrease in supply

A decrease in supply shifts the supply curve to the left. At the original price, excess demand arises, forcing the price up. The new equilibrium has a higher price but a lower quantity.

For instance, removing government subsidies for soybeans reduces supply.

Effects when both demand and supply change

When factors affect both demand and supply at the same time, both curves shift, and the new equilibrium depends on the size of each shift.

The final impact on price and quantity is determined by comparing the magnitudes of the shifts, often shown on a diagram.