Price Determination

Market Equilibrium

Market equilibrium is a state where the quantity demanded by consumers equals the quantity supplied by producers. At this point, the market price is stable and there is no tendency for the price to change.

In simpler terms, it's the point where the supply and demand curves intersect on a graph. This intersection determines the equilibrium price and equilibrium quantity.

Understanding Supply and Demand

Before diving deeper into equilibrium, it's crucial to understand the basic concepts of supply and demand:

• Demand: The quantity of a good or service that consumers are willing and able to purchase at different prices. Generally, as the price increases, the quantity demanded decreases (law of demand).
• Supply: The quantity of a good or service that producers are willing and able to offer for sale at different prices. Generally, as the price increases, the quantity supplied increases (law of supply).

How Equilibrium is Established

The interaction of supply and demand determines the market price. Let's look at how equilibrium is established:

1. Surplus: If the price is above the equilibrium price, the quantity supplied will be greater than the quantity demanded. This creates a surplus. Producers will then lower their prices to sell off the excess stock.
2. Shortage: If the price is below the equilibrium price, the quantity demanded will be greater than the quantity supplied. This creates a shortage. Consumers will be willing to pay more, and producers will be incentivized to raise prices.
3. Movement to Equilibrium: These surpluses and shortages act as forces that push the market price towards the equilibrium point where supply and demand balance.

Graphical Representation of Equilibrium

The relationship between supply, demand, and equilibrium can be clearly illustrated using a graph:

Price (P)	Quantity Demanded (Qd)	Quantity Supplied (Qs)
Pe	Qe	Qe
Pe - (Price above equilibrium)	Qe + (Surplus)	Qe - (Surplus)
Pe + (Price below equilibrium)	Qe - (Shortage)	Qe + (Shortage)

Figure: Suggested diagram: A standard supply and demand curve graph with the equilibrium price (P_e) and equilibrium quantity (Q_e) clearly marked where the two curves intersect.

The Equilibrium Price and Quantity

The equilibrium price is the price at which the market clears – there is neither a surplus nor a shortage. The equilibrium quantity is the quantity bought and sold at this equilibrium price.

Changes in factors other than price (such as changes in consumer income, tastes, or the cost of production) can shift the supply and demand curves, leading to a new equilibrium price and quantity.