Having analyzed supply and demand separately, we now combine them to see how they determine the quantity of a good sold in a market and its price.
Equilibrium a situation in which the market price has reached the level at which quantity supplied equals quantity demanded.
Equilibrium price the price that balances quantity supplied and quantity demanded.
Equilibrium quantity the quantity supplied and the quantity demanded at the equilibrium price.
The market supply curve and market demand curve together. Notice that there is one point at which the supply and demand curves intersect. This point is called the market’s equilibrium. The price at this intersection is called equilibrium price, and the quantity is called the equilibrium quantity. In one situation the equilibrium price is $ 2.00 per cone and the equilibrium quantity is 7 ice cream cones.
The dictionary defines the word equilibrium as a situation in which various forces are in balance and this also describes a market’s equilibrium. At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell. The equilibrium price is sometimes called the market clearing price because, at this price, everyone in the market has been satisfied: Buyers have bought all they want to buy, and sellers have sold all they want to sell.
The actions of buyers and sellers naturally move market toward the equilibrium of supply and demand. To see why, consider what happens when the market price is not equal to the equilibrium price.
Suppose first that the market price is above the equilibrium price. At a price of $ 2.50 per cone, the quantity of the good supplied (10 cones) exceeds the quantity demanded (4 cones).
Surplus a situation in which quantity supplied is greater than quantity demanded.
Shortage a situation in which quantity demanded is greater than quantity supplied.
There is a surplus of the good: Suppliers are unable to sell all they want at the going price. A surplus is sometimes called a situation of excess supply. When there is a surplus in the ice cream market, sellers of ice creams find their freezers increasingly full of ice cream they would like to sell but cannot. They respond to the surplus by cutting their prices. Falling price, in turn, increase the quantity demanded and decrease the quantity supplied. Prices continue to fall until the market reaches the equilibrium
Suppose now that the market price is below the equilibrium price. In this case, the price is $ 1.50 per cone, and the quantity of the good demanded exceeds the quantity supplied. There is a shortage of the good: Demanders are unable to buy all they want at the going price. A shortage is sometimes called a situation of excess demand. When a shortage occurs in the ice cream market, buyers have to wait in long lines for a chance to buy one of the few cones available. With too many buyers chasing too few goods, sellers can respond to the shortage by raising their prices without losing sales. As the price rises, the quantity demanded falls, the quantity supplied rises, and the market once again moves toward the equilibrium.
Thus, the activities of the many buyers and sellers automatically push the market price toward the equilibrium price. Once the market reaches its equilibrium all buyers and sellers are satisfied, and there is no upward or downward pressure on the price. How quickly equilibrium is reached varies from market to market depending on how quickly prices adjust. In most free markets, surpluses and shortages are only temporary because prices eventually move toward their equilibrium levels. Indeed, this phenomenon is so pervasive that it is called the law of supply and demand: The price of any adjusts to bring the quantity supplied and quantity demanded for that good in to balance.
Three steps to analyzing changes in equilibrium
So far, we have seen how supply and demand together determines a market’s equilibrium which in turn determines the price of the good and the amount of the good that buyers purchase and sellers produce. Of course, the equilibrium price and quantity depend on the position of the supply and demand curves. When some event shifts, the equilibrium in the market changes, resulting in a new price and a new quantity exchanged between buyers and sellers.
When analyzing how some event affects the equilibrium in a market, we proceed in three steps. First, we decide whether the event shifts the supply curve, the demand curve, or in some cases, both curves. Second, we decide whether the curve shifts to the right or to the left. Third, we use the supply and demand diagram to compare the initial and the new equilibrium, which shows how the shift affects the equilibrium price and quantity.