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Microeconomics: Market Equilibrium

Since we now know what the demand and supply are in an economic model, we can combine both curves to determine the equilibrium price in the market.

A market is in equilibrium at the point where the demand curve intersects the supply curve. In other words, where the supplied quantity is equal to the quantity demanded. The equilibrium price is the point in the market where there is no shortage or surplus.
  • Markets do not automatically reach equilibrium. Instead, it is achieved after a number of trials and errors. The more information both the buyers and suppliers have, the faster the process.
  • If a price is higher than the market equilibrium price, then the quantity supplied is higher than the quantity demanded, this results in a surplus. These excess units of goods produced incentives the producers to reduce the price and thereby reduces the quantity produced until the market reaches equilibrium.
  • If a price is less than the market equilibrium price, then the quantity supplied is smaller than the quantity demanded. This results in a shortage. In the long run, the shortage causes consumers to drive up the price, which causes the quantity demanded to decrease and the quantity supplied to increase until the price reaches equilibrium.
From the graph, the price PE represents the equilibrium price. At the price P1, the amount producers offer for sale is less than the amount consumers are willing to buy (i.e: there is a shortage). Finally, the price P2 illustrates a case of surplus, where the number of goods produced is higher than the amount consumers are willing to buy.



Reference: Mayer,David. AP Microeconomics Crash Course. Research & Education Association (2014). p 54-55.
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