In order to keep a market going, both consumers and manufacturers should be on the same page and come up with a convenient price range. When that part is done, the market goes through more demands of certain products and requires enough supply to keep the balance. This way, a market manages to be in equilibrium, and both customers and enterprises achieve contentment.
While consumers focus on getting their desired products at an affordable rate, manufacturers focus on achieving a maximum amount of profits. The focus should be to find the balance so that there is no excess demand and excess supply to affect the equilibrium graph.
Following the curve of demand and supply, a price gets shifted by the market forces to its equilibrium level, and there can be two possibilities for that, excess demand or excess supply.
Excess Demand and Excess Supply
According to the market equilibrium formula, both demand and supply should be on an equal level. When the price gets lower than its equilibrium price, excess demand occurs, and the quantity received from manufacturers are lower than what consumers have demanded.
On the other hand, Excess supply is the kind of situation where a price is more than its equilibrium price. This situation occurs when the manufacturers or suppliers impose an excess quantity of products than the quantity expected from them.
Here is a chart to explain an excess demand and supply condition of a market.
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In order to keep the balance, market forces focus on driving the prices to its equilibrium level. In the case of higher supply, manufacturers will have to make more products and that the competition also increases for that. More suppliers will be eager to make those same products and sell them at a lower cost, resulting in achieving limited market revenue.
When excess demand occurs, a market automatically suffers from a shortage of products, which adds extra pressure on the price since more consumers will be interested in buying those same goods. An increase in price helps the suppliers to produce more in order to fulfil the demand, and that eventually drives both quantity and price to its equilibrium level.
Market Equilibrium Represented Under Perfect Competition
The concept of market equilibrium refers to keeping a balance between market supply and market demand. When this balance is achieved, the quantity of goods is called equilibrium quantity and similarly the price is referred to as equilibrium price.
Considering the market equilibrium graph, a market demand curve moves downwards because of the excessive demand. On the other hand, a market supply curve goes to upwards direction because of excessive supply. Both the market demand curve and the market supply curve are supposed to intersect with each other to attain that balance. The point where these two intersect is called the point of equilibrium.
Although a perfect competition price is always set by the industry and nobody from the consumer’s or the manufacturer’s side can alter that price. Market equilibrium depends on the requirements of both these parties and things related to this gets shifted accordingly.
FAQs on Equilibrium, Demand, and Supply Explained
1. What is meant by market equilibrium in economics?
Market equilibrium is a state in a market where the quantity of a good or service demanded by consumers is exactly equal to the quantity supplied by producers. At this point, the market is said to 'clear'. The price at which this occurs is called the equilibrium price, and the corresponding quantity is the equilibrium quantity. There is no tendency for the price or quantity to change unless an external factor affects demand or supply.
2. How does the market mechanism correct a situation of excess demand or excess supply?
The market has a self-correcting mechanism driven by price changes:
- Excess Demand (Shortage): If the price is below equilibrium, demand will exceed supply. This creates competition among buyers, who will be willing to pay more. This upward pressure on the price encourages suppliers to produce more and discourages some consumers, moving the market back towards equilibrium.
- Excess Supply (Surplus): If the price is above equilibrium, supply will exceed demand. This leads to competition among sellers, who will lower their prices to sell their surplus stock. The falling price encourages more consumption and reduces production until the surplus is eliminated and equilibrium is restored.
3. What happens to the equilibrium price and quantity when the demand for a product increases?
An increase in demand, caused by factors like rising incomes or changing consumer preferences, shifts the entire demand curve to the right. With the supply remaining unchanged, this creates a situation of excess demand at the original price. As a result, both the equilibrium price and equilibrium quantity will increase until a new equilibrium point is reached.
4. Can you explain the effect of a decrease in supply on market equilibrium?
A decrease in supply, perhaps due to higher input costs or new regulations, shifts the supply curve to the left. Assuming demand stays constant, this creates a shortage at the initial price. The competition for the fewer available goods pushes the price up. The final result is a higher equilibrium price and a lower equilibrium quantity.
5. Could you provide a real-world example of demand, supply, and equilibrium?
Consider the market for smartphones. The equilibrium price is the price at which the number of phones Apple or Samsung are willing to sell matches the number of phones consumers want to buy. If a popular new model is released (increase in demand), the price and quantity sold will rise. Conversely, if a major component becomes cheaper to produce (increase in supply), companies can supply more phones at each price, leading to a lower market price and more phones being sold.
6. What is the key difference between a 'change in demand' and a 'change in quantity demanded'?
This is a crucial distinction. A 'change in quantity demanded' refers to a movement along the same demand curve, caused only by a change in the product's own price. In contrast, a 'change in demand' refers to a shift of the entire demand curve (either left or right), caused by non-price factors like consumer income, tastes, or the price of related goods. Only a shift in the curve can change the market's equilibrium point; a movement along the curve simply leads to it.
7. How does a government-imposed price ceiling disrupt market equilibrium?
A price ceiling is a legal maximum price set by the government. If it is set below the natural equilibrium price, it becomes binding and disrupts the market. At this artificially low price, the quantity demanded by consumers will be far greater than the quantity producers are willing to supply. This creates a persistent shortage, and unlike in a free market, the price cannot rise to resolve it. This can lead to non-price rationing mechanisms, queues, or even black markets.
8. Why is the concept of market equilibrium so important for understanding how markets function?
Understanding market equilibrium is fundamental because it provides a framework for predicting how markets will behave. It is important for:
- Businesses: To make informed decisions about production levels and pricing strategies based on expected market conditions.
- Policymakers: To analyse the potential impact of government interventions like taxes, subsidies, or price controls on consumers and producers.
- Consumers: To understand why prices for goods and services fluctuate and how their collective behaviour influences the market.
It is the core model used to explain price determination in a market economy.
