Imagine you are with a friend, and they are trying to sell you their iPhone for £800, but you can’t pay that amount. You ask them to bring the price down. After some negotiations, they bring the price down to £600. This is perfect for you, as that is the amount you were willing to buy an iPhone for. Your friend is also very happy because they managed to sell their iPhone at a sufficiently high price. You both made a transaction where market equilibrium occurred.
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Jetzt kostenlos anmeldenImagine you are with a friend, and they are trying to sell you their iPhone for £800, but you can’t pay that amount. You ask them to bring the price down. After some negotiations, they bring the price down to £600. This is perfect for you, as that is the amount you were willing to buy an iPhone for. Your friend is also very happy because they managed to sell their iPhone at a sufficiently high price. You both made a transaction where market equilibrium occurred.
Market equilibrium is the point where the demand and supply for a good intersect. In other words, the point where they are equal. This article will teach you the ins and outs you need to know about market equilibrium.
A market is a place where buyers and sellers meet. When those buyers and sellers agree on what the price and quantity will be, and there’s no incentive to change the price or the quantity, the market is in equilibrium. In other words, market equilibrium is the point where the demand and supply are equal.
Market equilibrium is the point where the demand and supply are equal.
Market equilibrium is one of the main fundamentals of the free market. Prominent economists have argued that the market will always go towards equilibrium regardless of the circumstances. Whenever there’s an external shock that might cause disturbance in the equilibrium, it is a matter of time before the market regulates itself and goes to the new equilibrium point.
Market equilibrium is most efficient in markets close to perfect competition. When a monopoly power exerts control over the prices, it prevents the market from reaching the equilibrium point. That’s because companies with monopoly power often set prices above the market equilibrium price, thereby harming consumers and economic welfare.
Market equilibrium is a vital tool to assess how efficient a particular market is. Additionally, it provides useful insights to analyse whether the price is at an optimal level and whether the stakeholders are harmed by a price that’s above the equilibrium point.
In industries where firms can exert their market power to raise prices, this prevents some people who demand the product from attaining it as the price is unaffordable. However, firms in this situation can still increase their prices above equilibrium as, usually, they face little to no competition.
The graph of market equilibrium provides useful insights into the dynamics of a market. Why do some economists argue that a market is destined to reach the equilibrium point in a free market setting?
To understand how and why the market reaches the equilibrium point consider Figure 1 below. Imagine that the free market equilibrium is at the intersection of supply and demand at the price of £4.
Imagine that transactions currently occur at a price of £3, which is £1 below the equilibrium price. At this point, you would have a firm willing to supply 300 units of goods, but consumers are willing to buy 500 units. In other words, there is excess demand for the good of 200 units.
The excess demand will push the price up to £4. At £4, firms are willing to sell 400 units, and buyers are ready to buy 400 units. Both sides are happy!
Fig 1. - Price below market equilibrium
Excess demand occurs when the price is below equilibrium and the consumers are willing to buy more than the firms are prepared to supply.
But what if the price at which transactions currently occur is £5? Figure 2 illustrates this scenario. In such a case, you would have the opposite. This time, you have buyers willing to buy only 300 units at £5, but sellers are willing to supply 500 units of goods at this price. In other words, there is an excess supply of 200 units on the market.
The excess supply will push the price down to £4. The equilibrium output occurs at 400 units where everyone is happy again.
Fig 2. - Price above market equilibrium
Excess supply occurs when the price is above equilibrium and the firms are prepared to supply more than the consumers are willing to buy.
Due to the incentive provided by the dynamics of prices being above or below the equilibrium, the market will always have the tendency to move towards the equilibrium point. Figure 3 shows the market equilibrium graph. At the equilibrium point both the demand curve and the supply curve intersect, creating what is known as equilibrium price P and equilibrium quantity Q.
Fig 3. - Market equilibrium graph
One important thing to consider is that the equilibrium point is not static but subject to change. The equilibrium point can change when external factors cause a shift either in the supply or demand curve.
Fig 4. - A change in market equilibrium as a result of a demand shift
As Figure 4 shows, an outward shift in the demand curve would cause the market equilibrium to move from point 1 to point 2 at a higher price (P2) and quantity (Q2). The demand could shift either inwards or outwards. There are many reasons why the demand could shift:
To learn more about the determinants of demand check our explanation on Demand.
Fig 5. - A change in market equilibrium as a result of a shift in supply
In addition to demand shifts, you also have supply shifts that cause the market equilibrium to change. Figure 5 shows what happens to the equilibrium price and quantity when there’s a supply shift to the left. This would cause the equilibrium price to increase from P1 to P2, and the equilibrium quantity to decrease from Q1 to Q2. The market equilibrium will move from point 1 to point 2.
Many factors cause the supply curve to shift:
To learn more about the determinants of supply check our explanation on Supply.
If you are looking at how to estimate the market equilibrium demand and supply, the main formula to consider is Qs=Qd.
Assume that the demand function for the apple market is Qd=7-P, and the supply function is Qs= -2+2P.
How to estimate equilibrium price and quantity?
The first step is to calculate the equilibrium price by equalizing the quantity demanded and quantity supplied.
The price equilibrium, in this case, is P*=3 and the equilibrium quantity is Q*=4.
Keep in mind that the market equilibrium will always occur when the Qd=Qs.
A market is in equilibrium for as long as the planned supply and planned demand intersect. That is when they are equal to each other.
What would happen if there’s a change in the market equilibrium for some reason? That’s when disequilibrium occurs.
Disequilibrium occurs when the market cannot reach the equilibrium point due to external or internal factors that act upon the equilibrium.
When situations like this emerge, you would expect to see an imbalance between the quantity supplied, and the quantity demanded.
Consider the case of a fish market. Figure 6 below illustrates the market for fish that is initially in equilibrium. At point 1, the supply curve for fish intersects the demand curve, which provides the equilibrium price and quantity in the market.
Fig 6. - Excess demand and excess supply
What would happen if the price was P1 instead of Pe? In that case, you would have fishermen wishing to supply much more than the number of people who want to buy fish. This is a market disequilibrium known as excess supply: sellers wanting to sell more than the demand for the good.
On the other hand, you would have less fish supplied when the price is below the equilibrium price but significantly more fish demanded. This is a market disequilibrium known as excess demand. Excess demand happens when the demand for the good or service is much higher than the supply.
Many real-world examples point to disequilibrium in the market. One of the most common ones is the disruption in the supply chain process, especially in the US. The worldwide supply chain process has been tremendously impacted by Covid-19. As a result, many stores have had trouble having the raw materials shipped to the US. This, in turn, has contributed to an increase in prices and created a market disequilibrium.
When buyers and sellers come to the point of agreement on what the price and quantity will be, and there’s no incentive to change the price or the quantity, the market is in equilibrium.
The price for which the buyer and the seller agree.
The quantity agreed by the buyer and the seller.
What is a market?
A market is a place where buyers and sellers meet.
What is market equilibrium?
When buyers and sellers come to the point of agreement on what the price and quantity of a good will be, and there’s no incentive to change the price or the quantity, the market is in equilibrium.
When is market equilibrium most efficient?
In market close to perfect competition.
What's the impact of monopoly in market equilibrium?
When a monopoly power exerts control over the prices, it prevents the market from reaching the equilibrium point. That’s because companies with monopoly power often set prices above the market equilibrium price, harming consumers and economic welfare.
Can market equilibrium inform on how efficient a market is?
Market equilibrium is a vital tool to assess how efficient a particular market is.
Is market equilibrium static?
No, it is subject to change.
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