Demand, Supply and Price

Market Equilibrium

A market is in equilibrium if at the market price, the quantity demanded of a good or service is equal to the quantity supplied. The price at which these two quantities are identical is called the equilibrium price or market clearing price.

The market equilibrium is also called competitive equilibrium because in a perfectly competitive market, both buyers and sellers are price takers, the price will go down until it is equal to the magical costs, thus, each firm makes a profit of zero. Here’s why:

• In a perfectly competitive market with no barriers to entry, market forces will incentivize sellers to come in and produce more.
• As number of firms increases, the market price decreases due to excessive supply by the producers. 
• Firms must lower prices to sell their stock, this decreases profits until they reach zero. 
• New firms are discouraged to enter the market. 

Surplus, Shortage and Equilibrium

It is clear that markets don’t arrive at an equilibrium price instantly, instead, the process requires many trials and errors. As a result, the market may experience a surplus when the quantity supplied is greater than the quantity demanded or a shortage, the result of the quantity demanded exceeds the quantity supplied.

What happens next after a shortage or a surplus?

When there is a surplus, the price tends to fall until the surplus is sold and equilibrium is reached. Producers try to cut the amount of supply to align with customer demand.

Elsewhere, when a shortage occurs, producers will raise prices and increase the quantity supplied in an attempt to balance the quantity supplied and the quantity demanded.

In real life context, the equilibrium price is not constant and can be replaced with a new price due to various impactful factors including:

• Causes of change of demand: income, consumer taste, consumer expectations, market size, substitutes, and complements.

• Causes of change of supply: input costs, productivity, technology, government action, producer expectations, and number of producers.

Price system

When many producers supply the same kinds of products or services, there exists competitive pricing. It occurs when producers sell products at lower prices to lure customers away from rival producers, while still making profits by selling more units.

In a market economy, the price system has four characteristics:

• It is neutral.

• It is market-driven.

• It is flexible.

• It is efficient.

Price Floors and Ceilings

Both price floors and ceilings are examples of government-imposed price controls, which alter the natural market equilibrium. While these interventions are implemented to achieve certain economic or social objectives, these often lead to certain inefficiencies.

Price floors

Price floors are minimum prices set by the government to prevent prices from falling below a certain level. Price floors only become an issue if they are set above the equilibrium price as consumers might not afford to buy that many goods at the higher price.

An example is the minimum wage, where the government ensures workers receive a minimum hourly pay. While it protects workers’ earnings, it can lead to surpluses (e.g., unemployment), as employers may hire fewer workers at higher wages.

Price ceilings

In contrast, price ceilings are maximum prices set by the government to prevent prices from rising above a set level. Price ceilings are only an issue if they are set below the equilibrium price, consumers will demand more due to cheaper product prices, leading to excess demand or supply shortage.

Rent control is a common example, aimed at making housing more affordable. However, it often results in shortages (e.g., fewer rental units available) as landlords may reduce supply or stop maintaining properties due to lower profit incentives.

References

Core Econ n.d., Market equilibrium, Core Econ, available at <https://www.core-econ.org/the-economy/v1/book/text/leibniz-08-04-02.html>.

Econ Port n.d., Price Floors and Ceilings, Econ Port, available at <https://www.econport.org/content/handbook/Equilibrium/Price-Controls.html>.

Mirjam, S.S and Sean, M 2020, Market Equilibrium, Inomics, available at <https://inomics.com/terms/market-equilibrium-1431109>.

Quickonomics 2024, Market Equilibrium, Quickonomics, available at <https://quickonomics.com/terms/market-equilibrium/>.

Tejvan, P 2019, Market equilibrium, Economics Help, available at <https://www.economicshelp.org/microessays/equilibrium/market-equilibrium/>.