Market Equilibrium

UNDERSTANDING MARKET EQUILIBRIUM

A simplified version of market equilibrium for teachers.

In Economics, the term equilibrium means a state of balance or equality. Market equilibrium is therefore a condition where quantity demanded is equal to quantity supplied, that is, the point at which the quantity that suppliers are willing to produce exactly equals the quantity that consumers are willing to purchase. The price at which demand and supply meet is called the equilibrium price or the market clearing price and the quantity is referred to as the equilibrium quantity.

In the graph above, the demand and supply curves intersect to determine the equilibrium price and quantity. The equilibrium price is $6.00 per pound and the quantity demanded of coffee is 25 million tonnes.

With an upward sloping supply curve and a downward sloping demand curve, there can only be one point of intersection. This means that there can only be one equilibrium price in the market for coffee. Any other price will create a state of disequilibrium in the market. This will force the invisible hands to come into play in order to restore equilibrium.

At any price above the equilibrium price of $6.00, quantity supplied will be greater than quantity demanded, creating a surplus or glut on the market.

A surplus will cause the market price to fall. Why? Take for example the coffee producers who have excess inventory. What will they do? They will most likely put them up for sale at lower prices. At a lower price, the consumers will demand more of the product and the producers supply less coffee (law of demand and supply) until an equilibrium is reached. A surplus places a downward pressure on price.

At any price below the equilibrium price of $6.00, quantity demanded will be greater than quantity supplied, creating a shortage on the market.

A shortage will cause the market price to rise. Why? When there is a shortage, coffee producers face an increased demand for the limited supply of their product. Since they have a profit motive, they will respond by increasing the price per pound of coffee, causing consumers to reduce their demand for coffee until an equilibrium is reached. Remember, at a higher price, consumers' quantity demanded for coffee will fall and suppliers' quantity supplied of coffee will increase (law of demand and supply). Therefore, a shortage places an upward pressure on price in order to bring back equilibrium.