[1.1.3c] Market equilibrium

Market Equilibrium

A market brings together buyers and sellers to determine price and quantity. When the quantity demanded by consumers exactly equals the quantity supplied by producers at a given price, the market is in equilibrium. The equilibrium price (P*) is where the market clears; the equilibrium quantity (Q*) is the amount bought and sold at that price.

The Supply and Demand Diagram

Equilibrium is found at the intersection of the supply and demand curves. The diagram below shows supply (S) and demand (D) crossing at equilibrium point E, with excess demand and excess supply regions annotated.

Quantity (Q) Price (P) D S E P* Q* Pₗ Excess demand Pʰ Excess supply

Excess Demand and Excess Supply

Excess demand occurs when price is set below equilibrium. Consumers want more than producers will supply.

Excess demand = Quantity demanded − Quantity supplied (when Qd > Qs)

Market forces remove the shortage: unsatisfied buyers bid up the price. As price rises, Qd falls and Qs rises until the market returns to P*.

Excess supply occurs when price is set above equilibrium. Producers want to sell more than consumers will buy — unsold stock accumulates.

Excess supply = Quantity supplied − Quantity demanded (when Qs > Qd)

Market forces remove the surplus: producers cut prices to sell excess stock. As price falls, Qd rises and Qs falls until equilibrium is restored.

How Shifts Affect Equilibrium

Demand shifts right → excess demand at old price → price rises → new equilibrium: higher P*, higher Q*. Example: heatwave boosts demand for ice cream.

Demand shifts left → excess supply at old price → price falls → new equilibrium: lower P*, lower Q*. Example: health scare reduces demand for red meat.

Supply shifts right → excess supply at old price → price falls → new equilibrium: lower P*, higher Q*. Example: improved harvest technology increases wheat supply.

Supply shifts left → excess demand at old price → price rises → new equilibrium: higher P*, lower Q*. Example: drought reduces cocoa supply.

 Key Takeaways

  • Equilibrium is where Qd = Qs — the market clears at P* and Q*.
  • Excess demand (shortage): price below equilibrium; market forces push price up.
  • Excess supply (surplus): price above equilibrium; market forces push price down.
  • A rightward demand shift raises both P* and Q*; a leftward shift lowers both.
  • A rightward supply shift lowers P* but raises Q*; a leftward shift raises P* but lowers Q*.
g) Equilibrium price and quantity and how they are determined. h) The use of diagrams to show: • how shifts in supply and demand affect equilibrium price and quantity in real-world situations • excess demand • excess supply. i) Define, calculate and draw excess demand and excess supply. j) The use of market forces to remove excess supply or excess demand.