What is Equilibrium Price?
Equilibrium occurs when there is a state of no change. This tells us that equilibrium price is a price where both the seller and the buyer are in the position of no change.
Theoretically speaking, at this price,
Amount of goods demanded by the buyers = Amount of goods supplied by the sellers
Therefore, both the demand and supply work in synchronisation with the equilibrium price. In other words, the equilibrium price is where the state of the market supply and demand get equally balanced, which also then makes the prices for that certain product steady.
Cause and Results
Generally, when this happens, prices of these goods go down and this happens because of an oversupply of goods and services, this as result, increases the demand for these goods and services.
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Here in the diagram above, we can observe that the equilibrium price shows through the intersection of the supply and demand curve in the equilibrium price graph.
Equilibrium Price is also known as market-clearing price.
Characteristics
The equilibrium of a market has certain major characteristics:
The behaviour of the agents is consistent.
Agents are not given any incentives in exchange for a change in behaviour.
The equilibrium price formula calculates the equilibrium outcome that is governed by a dynamic process.
Example
We can take an example to understand the definition of Equilibrium Price better:
If we calculate this table with the help of the equilibrium price formula:
In the given table, the quantity of demand is equal to the supply at the price of Rs. 60. This makes the Rs. 60 price as the equilibrium price. If instead of this price, we take any other price from the table, there can be a shortage or a surplus.
The surplus would occur because if we take any value lower than 60, the quantity of supply would be more than the demanded quantity.
The shortage would occur if we take a value of more than 60, the amount of the demand would be bigger than the available supply.
Equilibrium Price Definition
When the quantity of supply of goods matches the demand for goods, it is called the equilibrium price. The market is said to be in a state of equilibrium when the main experience is in the phase of consolidation or oblique momentum. Then, it can be concluded that demand and supply are comparatively equal. Equilibrium price examples are discussed below as well.
Equilibrium price definition can be understood this way, the neutral point of price where both the buyers and sellers are satisfied. An equilibrium price example: at equilibrium, there is neither scarcity nor state of abundance unless there is a change in the elements of demand and supply. With the increase or decrease in demand and supply, inverse behaviour occurs.
Finding the Equilibrium Price
We can find the equilibrium price by using the equilibrium price formula. These are the steps:
Calculate the supply function
Calculate the demand function
Set the equal amount of quantities for the demand and supply and solve these to get an equilibrium price
Put this equilibrium price into a supply function
Check the result by putting the equilibrium price into the demand function
Equilibrium Price Example
Let’s take an example for better understanding of equilibrium price definition:
Calculating with the Help of the Equilibrium Price Formula:
In this table, the quantity of demand is the same as the supply at the price of Rs. 60. Hence, the price of Rs. 60 is the equilibrium price. If we take any other value, there can be either shortage or surplus. Particularly, for any value lower than Rs 60, the quantity of supply is more than demanded, hence there is a surplus. Similarly, for any value more than Rs. 60, the amount of demand is more than the supply, creating a shortage. This type of question can also be solved by the equilibrium price graph.
This equilibrium price example shows that an equilibrium price can change the quantity of demand and supply.
More About Equilibrium Theory
A state of no change is called equilibrium. So clearly, at the equilibrium price, both buyer and seller are in the position of no change. Theoretically, at this price, the amount of goods demanded by buyers is equal to the amount supplied by the sellers. Hence, both demand and supply work in synchronization with the equilibrium price; this is an equilibrium price example. Equilibrium is the state of balancing of market supply and demand, and consequently, prices become steady. Generally, the reason for prices to go down is an oversupply of goods or services, resulting in higher demand for goods or services. Equilibrium price definition explains the state of equilibrium is the result of the balancing effect of demand and supply.
The equilibrium price is showing through the intersection of the demand and supply curve in an equilibrium price graph. It is also called the market-clearing price. The determination of the market price is the purpose of microeconomics, and hence microeconomic theory is also known as price theory.
Equilibrium Price Graph
Here, given below is a graphical representation of demand and supply at an equilibrium price which validates the equilibrium price definition.
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How does a Supply Shock Affect Equilibrium Price and Quantity?
A supply shock affects equilibrium price and quantity positively and negatively. Supply shock indicates a sudden good change that means if it is a positive shock, the equilibrium price and quantity go up, and if it is a negative shock, it will be vice versa.
How do Supply and Demand Affect Equilibrium Price?
With the upward shift, the supply decreases, the equilibrium price increases and demand stays stable. With the downward change in supply, the supply increases and the equilibrium price falls.
With the upward shift, demand increases, equilibrium price increases and supply stays stable. With the downward change in demand, demand decreases, equilibrium price decreases and supply remains steady.
It can be calculated using the equilibrium price formula.
Did you know?
The equilibrium theory was introduced and developed by a French economist, Leon Walras, in the late 19th century.
Walras used this theory to multi-market settings by bringing in another good into his model, which then helped him to calculate price ratios.
The contribution of Walras' to the theory helped economics to grow into a study that includes mathematical analysis at its centre.
FAQs on Equilibrium Price: Determination and Importance
1. What is meant by equilibrium price in Economics?
The equilibrium price is the specific price in a market where the quantity of a good demanded by consumers is exactly equal to the quantity supplied by producers. At this point, the market is in a state of balance, with no inherent pressure for the price to change. It is often referred to as the market-clearing price because at this level, there is neither a surplus nor a shortage of the product.
2. How is the equilibrium price determined using a demand and supply schedule?
The equilibrium price is determined by finding the price level in a demand and supply schedule where the quantity demanded is exactly equal to the quantity supplied. For instance, if at a price of ₹50, consumers demand 100 units and producers are willing to supply 100 units, then ₹50 is the equilibrium price. Any other price would result in either a surplus (supply > demand) or a shortage (demand > supply).
3. Why is achieving equilibrium price important for a market's stability?
Achieving equilibrium price is vital for market stability because it ensures an efficient allocation of resources. At this price:
- Producers can sell all the units they are willing to produce, avoiding wasteful surpluses.
- Consumers can buy all the units they are willing to purchase, preventing frustrating shortages.
- It eliminates the pressures of excess supply or excess demand, creating a stable price and quantity that satisfies both sides of the market.
4. What happens to the equilibrium price if the cost of raw materials for a product increases?
An increase in the cost of raw materials raises the cost of production. This leads to a decrease in supply, which is shown as a leftward shift of the supply curve. Assuming demand remains constant, this shift creates a shortage at the old price, forcing the market to adjust to a new, higher equilibrium price and a lower equilibrium quantity.
5. How do you calculate the equilibrium price using demand and supply equations?
To calculate the equilibrium price, you must set the demand equation equal to the supply equation (Qd = Qs) and solve for the price (P). For example, if the demand is Qd = 200 - 5P and supply is Qs = -40 + 7P, you would proceed as follows:
- Set equations equal: 200 - 5P = -40 + 7P
- Rearrange the terms: 240 = 12P
- Solve for P: P = 20
Therefore, the equilibrium price is ₹20. You can find the equilibrium quantity by substituting this price back into either equation.
6. What is the difference between equilibrium price and equilibrium quantity?
While determined simultaneously, they represent different things. The equilibrium price is the specific price level where the market balances (e.g., ₹20 per unit), measured on the vertical (Y) axis of a graph. The equilibrium quantity is the total amount of the good bought and sold at that price (e.g., 100 units), measured on the horizontal (X) axis.
7. How do situations of 'excess demand' and 'excess supply' push the market toward equilibrium?
These states of disequilibrium trigger automatic market adjustments through the price mechanism:
- Excess Demand (Shortage): Occurs when the price is below equilibrium. Competition among buyers for limited goods pushes the price up. This rise encourages suppliers to offer more and discourages some buyers, moving the market back towards equilibrium.
- Excess Supply (Surplus): Occurs when the price is above equilibrium. To sell their excess inventory, producers lower the price. This drop encourages consumers to buy more and signals producers to supply less, guiding the market back down to equilibrium.
8. How can government policies like price ceilings and price floors disrupt market equilibrium?
Government interventions can prevent a market from reaching its natural equilibrium. A price ceiling (a legal maximum price) set below the equilibrium price creates a persistent shortage because demand exceeds supply. Conversely, a price floor (a legal minimum price) set above the equilibrium price results in a persistent surplus because supply exceeds demand. Both disrupt the market's natural balancing function.
9. Why is the equilibrium price concept considered the foundation of microeconomics?
The concept of equilibrium is central to microeconomics because it explains how prices are formed in a market economy. It demonstrates how the independent decisions of millions of self-interested buyers and sellers interact to determine a price that allocates scarce resources efficiently, a process known as the price mechanism or the 'invisible hand'. This forms the basis for analysing all market structures and government policies.
