How to Calculate Market Equilibrium

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  • 0:05 Supply and Demand
  • 0:39 Market Equilibrium
  • 4:55 Surplus and Shortage
  • 7:59 Lesson Summary
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Lesson Transcript
Instructor: Jon Nash

Jon has taught Economics and Finance and has an MBA in Finance

Supply and demand is an important part of macroeconomics. In this lesson, you'll learn how to calculate the equilibrium price and quantity in a market at the intersection of the supply and demand curves.

Supply and Demand

We're talking about supply and demand, and how they interact to create the market equilibrium. The demand curve illustrates the quantities of a good or service that buyers are willing and able to buy at every price. While the supply curve, on the other hand, illustrates the quantities that sellers are willing and able to sell at every price. So, let's look at an example first from the supply perspective and then from the demand side.

A business will produce more supply if consumers will pay more for a product.
Market Supply Schedule Graph

Market Equilibrium

I want you to imagine that right in front of you are two hats. One hat is blue, while the other hat is green. Both of these hats fit you perfectly. The blue hat represents the business owners, which we call suppliers. The green hat, on the other hand, represents the consumer who demands products and services. In order to understand market equilibrium, you have to be willing to wear one hat at a time, which means you're either wearing the hat of a supplier or a consumer. Then you can step back and see both sides of the market at the same time and understand how it works, and why it makes sense.

Now imagine that your next-door neighbor Mandy bakes cakes for a living, and the name of her business is Mandy's Cake Walk. So, put on your supplier hat as you think about this. Here's the market supply schedule for basic round cakes.

Because Mandy is in business to earn a profit, she, and every other cake business in the economy, wants to sell cakes for a high price - as high as possible. And the cake suppliers are willing and able to sell more and more and more cakes the higher the price. As you can see, suppliers want high prices, and more cakes.

Now it's time to take off your supplier's hat and put on your consumer's hat. Let's look at it from the other perspective. Here's the market demand schedule for cakes. When the price of cakes is $30, then all the consumers in the economy would be willing and able to buy 50,000 cakes. When the price goes down to $25 though, they buy 100,000. And when it drops to $20, they're willing to buy 125,000 cakes per week. They'd even buy 175,000 cakes a week if the price were as low as $15.

Market equilibrium is achieved when both buyer and seller agree on a common price.
Market Equilibrum Chart

So now we have a market - we have buyers and we have sellers. A market is where buyers and sellers meet in order to exchange, and a transaction will only take place if the price is right for both of them. Let's bring the buyers and sellers together in this market and see what the price of cakes will turn out to be given the demand that consumers have right now and the quantity that suppliers are currently willing to sell.

When the demand and supply curves are combined, at the intersection of demand and supply, we can find the market equilibrium, which is the only price where the quantity demanded equals the quantity supplied. It's the exact price at which buyers are willing to buy a product or service and sellers are willing to sell it.

Notice that in this case, the two curves intersect at a price of $20 per cake. At this price the quantity demanded and quantity supplied are totally equal. This means the market for cake is in equilibrium. Unless the demand curve shifts, or the supply curve shifts, the price of cakes should not change.

Okay, so we've talked about cakes. Let's talk about another example. The following table shows the schedule of supply and demand for coffee, per month.

Supply and Demand of Coffee

By looking for the price in which demand and supply are exactly the same, we can locate the market equilibrium price. In this case, the equilibrium price is $1.25 per pound, because that's the price at which the quantity demanded (700) is equal to the quantity supplied (also 700). As you can see, we can clearly illustrate all this information using supply and demand curves that intersect at a market equilibrium price of $1.25 per pound.

When an excess of a product exists, it is called a surplus.
Surplus Graph

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