Market Equilibrium from a Microeconomics Perspective

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  • 0:01 Definition of Market…
  • 1:08 Equilibrium on a…
  • 3:20 Equilibrium Changes -…
  • 6:13 Lesson Summary
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Lesson Transcript
Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

Learn about the definition of market equilibrium. Learn how to identify the equilibrium point on a supply and demand graph and discover what causes this point to change in our everyday lives.

Definition of Market Equilibrium

Have you ever witnessed or been a part of a tug-of-war challenge? The idea is two teams challenge each other in a test of strength to see who can move the rope and the other team across a certain boundary. If the two teams are fairly equally matched, there is often a moment in time where the flag in the middle and rope hardly move. The forces on each end of the rope cancel each other out. In physics, this is known as a state of equilibrium. In microeconomics, the concept is very similar.

Market equilibrium is the state in which market supply and market demand balance each other, resulting in stable prices. It can also be said another way, which is when the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers.

Generally, when there is too much supply for goods or services, the price goes down, which results in higher demand. The balancing effect of supply and demand results in a state of equilibrium. As you can see from the graph, the equilibrium price is P0, right where demand and supply intersect:

Supply and demand graph
supply and demand graph

Equilibrium on a Supply and Demand Graph

In a competitive economy where there are many buyers and sellers, supply and demand will constantly adjust and change to market conditions. Ultimately, though, as you can see from the graph, the market equilibrium price, P, and the equilibrium quantity, Q, are determined by where the demand curve and supply curve intersect (please see the video beginning at 01:34 for this illustration).

Now, as we go back to the original graph we looked at, we notice the areas shaded A and B. Sometimes the price of a good or other outside factors can result in short-term situations where the current market price is not at the equilibrium intersection. This leads to surpluses and shortages, which are explored in greater detail in other lessons, but a brief mention of the two is worthwhile now.

The area above the equilibrium price that is shaded and labeled B, is an area of excess supply or surplus. An example of this would be when an auto manufacturer was willing to produce 20,000 vehicles at the current price of $15,000, but buyers were only willing to buy 10,000 new cars at that price. The result is a 5,000-vehicle surplus. Most likely, the auto manufacturer will have to discount the remaining vehicles down to the price where supply and demand intersect.

Just the opposite can happen if buyers demand more than a seller is willing or able to produce. The area below the equilibrium price, labeled A, is a point when there is excess demand or a shortage of a good. At that point, the seller can either demand higher prices or produce more to meet demand; either choice will push the market closer to the equilibrium point. A real-world example you may see quite often is when a new hot smartphone or computer tablet hits the market.

Now that we have a basic understanding of the equilibrium and how it looks on a graph, let's look at a few examples of when equilibrium can actually change.

Equilibrium Changes - Shifts in Supply & Demand

We all know that prices and demand for products continually change year after year and even sometimes daily. Gas, milk, televisions, shoes, clothing are just a few products we can all relate with. A change in the equilibrium price for these products may occur for a dozen reasons, but they ultimately all are a result of the supply or demand curve shifting.

What causes the demand or supply curve to shift and a new equilibrium price to be set? Let's review quickly a few of those shift factors. Changes in consumers' income, the prices of other goods, and changes in tastes and preferences for products can all shift demand. On the supply side, you may remember that advancements in technology, changes in the cost of production materials, and changes in taxes, weather, or expectations about the future can all affect supply. When any of these things happen and either the supply or demand curve shifts, a new equilibrium is born.

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