Introduction to Market
A market can be defined as the particular things sold in an area. So, for example, we can talk here about :
The eggs market in Nashville, Tennessee in April of 2016.
The rolled aluminum market in the U.S. in 2015.
Also, the market for radiological diagnostic services worldwide in the last decade also emerged as a market.
So in describing a market there should be the presence of sellers and buyers. A market is a place where buyers and sellers exchange their things.
When we study economics then the market emerges as an important concept. For example, we can discuss the market for mango juice and can ignore the time and place in order to keep things simple. We can also just say that we are looking for jeans in the market of Mumbai. However here the difficulty is that we can lose the important things which are essential to describe a market.
Assumptions of Market
The six most important assumptions for a market will be :
A market is known for a single type of good or service.
All of the goods or services bought and sold in a market are identical.
In a single Market, The goods or services sell for a single price.
All consumers should have enough knowledge about the product.
Many of the buyers and sellers have good relations between them.
The costs and benefits of a transaction will be acquired only by buyers and sellers.
These assumptions are easy to understand. They guarantee that the buyers who value the good more than it costs will find a customer.
In other words, there are no transactions that don’t happen because of the less information to the buyers or sellers.
These assumptions can also be true definitions to define an ideal market. But in reality, it is difficult to find such a market as all of the markets are not like this. We will also discuss what will happen if these conditions fail to hold.
Market Equilibrium
Market equilibrium is the condition where the production by the sellers and the demand of that product by the buyer becomes equal. We can find the equilibrium price by putting the demand equal to the demand. The equilibrium price is the price at which the quantity demanded equals the quantity supplied.
The demand curve is the curve that depicts the quantity demanded at any price while the supply curve depicts the quantity supplied at any price. So there is one price on the graph that they have in common, which is at the intersection of the two curves.
The equilibrium price is the intersection of the demand curve and supply curve. We can also derive it mathematically.
Market Equilibrium Graph
Consider a demand curve for a headphone that is described by the following function:
QD = 1800 – 20P
Note that in general while drawing graphs of functions, draw with the independent variable on the horizontal axis and the dependent variable on the vertical axis. In the case of supply and demand curves, we always draw the quantity on the horizontal axis and price on the vertical axis. Because of this, it is easier to draw the demand relationship as an inverse demand curve. Here the demand curve is expressed as a function of quantity, that is price. So, In our example this would be:
P = 90 – 0.05QD
This is the original demand curve solved for P instead of QD. In the inverse demand curve, the vertical intercept is easy to see from the equation: demand for television stops at the price of $90. No customer is willing to pay more than $90 for headphones.
Similarly, we can also represent the supply curve as a mathematical function. For example, consider the supply curve described here :
QS = 50P – 1000
As we depicted it as a demand curve, we can also depict it as an inverse supply curve.
The supply curve is expressed as price as a function of the quantity of the product. In this case, the inverse supply curve is derived from the following equation:
P = 20 – 0.03QS
Here the vertical intercept, $20, gives us the minimum price to get a seller to sell his television. At prices of $20 or less, supply would not be possible. So from here, we can conclude that the equilibrium price should be between $20 and $90.
To find equilibrium price and quantity is simply, we have to set only QD = QS and solve. We have to find the price that makes this equality happen. In our example, setting QD = QS yields:
1800 – 20P = 50P – 1000
or
70P = 2800
or
P = $40
At P = $40, the quantity demanded at the demand curve would be:
QD = 1800 – 20(40) = 1000
Similarly, At P = $40, the quantity supplied at the supply curve would be:
QS = 50(40) – 1000 = 1000.
FAQs on Market Equilibrium 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 that consumers are willing and able to buy (quantity demanded) is exactly equal to the quantity that producers are willing and able to sell (quantity supplied). At this point, the market is said to be 'cleared' or in balance. This balance occurs at a specific price, known as the equilibrium price, and a specific quantity, known as the equilibrium quantity.
2. How is the equilibrium price and quantity determined using a demand and supply graph?
On a standard market graph, the equilibrium point is found at the intersection of the demand curve and the supply curve. The demand curve slopes downwards, showing that consumers buy more at lower prices, while the supply curve slopes upwards, showing that producers sell more at higher prices. The price level (on the vertical axis) corresponding to this intersection point is the equilibrium price, and the quantity level (on the horizontal axis) is the equilibrium quantity.
3. What happens to the market equilibrium if there is an increase in consumer income?
An increase in consumer income for a normal good will lead to an increase in demand, causing the demand curve to shift to the right. This shift results in a new equilibrium point with both a higher equilibrium price and a higher equilibrium quantity. This is because more consumers are now able to afford the product at various price points, leading to increased competition for the available supply.
4. How does a technological improvement in production affect the market equilibrium?
A technological improvement reduces the cost of production, which leads to an increase in supply. This is shown as a rightward shift of the supply curve. As a result, the market moves to a new equilibrium with a lower equilibrium price and a higher equilibrium quantity. Consumers benefit from lower prices, and more of the product is bought and sold in the market.
5. What are the consequences of a government imposing a price floor above the equilibrium price?
A price floor is a minimum price mandated by the government. When this price is set above the natural equilibrium price, it creates an imbalance. At this higher price, producers are incentivised to supply more, but consumers demand less. This leads to a situation of excess supply, also known as a surplus, where the quantity supplied is greater than the quantity demanded. An example is the Minimum Support Price (MSP) for agricultural crops.
6. What happens if the government sets a price ceiling below the equilibrium price?
A price ceiling is a maximum price set by the government. If it is set below the equilibrium price, the low price will encourage consumers to demand more of the good, while discouraging producers from supplying it. This results in a situation of excess demand, also known as a shortage, where the quantity demanded exceeds the quantity supplied. This can often lead to non-price rationing mechanisms like queues or even illegal black markets.
7. Why is market equilibrium considered an efficient state in a perfectly competitive market?
Market equilibrium is considered efficient because it maximises the total economic welfare, which is the sum of consumer and producer surplus. At the equilibrium price, every consumer who values the good more than its price gets to buy it, and every producer whose cost is less than the price gets to sell it. There are no unfulfilled, mutually beneficial trades, meaning resources are allocated in the most allocatively efficient manner without any deadweight loss.
8. Can you explain the concept of market equilibrium with a real-world example?
Consider the market for a popular brand of running shoes. The manufacturer (supplier) decides how many pairs to produce based on production costs and expected selling price. Consumers decide how many to buy based on the price, their needs, and alternatives. The market equilibrium is the price at which the number of shoes produced by the company exactly matches the number of shoes consumers want to buy. If the price is too high, unsold shoes (surplus) will pile up, and the price will likely be lowered. If the price is too low, shoes will sell out quickly, creating a shortage and signalling that the price could be raised.
9. What happens to equilibrium price and quantity when both demand and supply increase at the same time?
When both demand and supply increase simultaneously (both curves shift to the right), the effect on equilibrium price and quantity depends on the magnitude of the shifts.
- The equilibrium quantity will definitely increase because both changes push quantity higher.
- The effect on equilibrium price is ambiguous. If the increase in demand is greater than the increase in supply, the price will rise. If the increase in supply is greater than the increase in demand, the price will fall. If they increase by the same amount, the price may remain unchanged.
