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Market Equilibrium
Introduction
Equilibrium
in economics refers to a situation in which the forces of that determines the
behavior of some variable are in balance and therefore exert no pressure on the
variable to change. Market equilibrium occurs when the quantity of a commodity
demanded in the market per unit of time equals the quantity of the goods
supplied to the market over that particular period (Tewari, 2008). This means
that when a market is at equilibrium, there is no tendency for any price change
since there is a stable price provided by the existing market conditions.
The
concept of market equilibrium
Equilibrium
in the market is defined to as the state of equality which shows that there is
a balance between supply and demand. In the diagram below, the two curves
intersect at Price =6 and Quantity =20, that is the equilibrium price is 6 and
equilibrium quantity is 20. At any price above 6, the supply of the commodity
exceeds the quantity demanded while at any price below 6, the demand for the
quantity exceeds supply. Any change in the demand or supply will shift the
demand or the supply curves (Hirshleifer et.al 2005).
Surplus
and shortage
Surplus
in the market is created when the market price is above the equilibrium price
and these results into higher quantity supplied than quantity demanded. For
example, if the price of a product is lowered, the quantity demanded will
increase until an equilibrium level is reached. In this case, surplus leads to
low prices of the product (Tewari, 2008). On the other hand, if the market
price is below the equilibrium price leading to higher demand for the product
than the supply of the product then a shortage will be experienced. For
example, if the price of a product is high, the quantity demanded will reduce
until equilibrium is reached. In this case, the shortage leads to an increase
in price. If a surplus exists in the market, the price of products must fall so
as to entice additional quantity demanded and lower the quantity supplied until
a level is reached when the surplus is eliminated (Hirshleifer et.al 2005).
The
existence of a shortage in the market leads to an increase in price so as to
entice the additional supply hence reducing quantity demanded until a level at
which shortage is eliminated (Snyder and Nicholson, 2008). For example, from the figure above, if price
=8 than quantity supplied will be 30 and quantity demanded will be 10. This
will indicate that quantity supplied is grater than the quantity demanded
leading to a surplus in the market. Therefore, the price will drop because of
the surplus. If the price is 4, then the
quantity supplied will be 10 and the quantity demanded will be 30. As a result,
the quantity supplied is less than the quantity supplied leading to a shortage
in the market. Therefore, the price of the product will rise due to the
shortage in the market.
Stable
and unstable equilibrium
A
stable equilibrium is said to exist when economic forces tend to push the
market towards the equilibrium (Tewari, 2008). This implies that any divergence
from the equilibrium position sets up forces which tend to restore the
equilibrium. The equilibrium at price P* is stable because the establishment of
a disequilibrium price sets up economic forces which tend to restore equilibrium.
In the case of an unstable equilibrium, any divergence from the equilibrium
position sets up forces which tend to push the prices further (Snyder and Nicholson,
2008).
The
case of unstable equilibrium
Price
of commodity
The
above diagram illustrates the market for a commodity X which has an abnormal
demand curve that slopes upwards from left to right. Commodity x could be a
giffen good or good of ostentation. Pe and Qe represents the equilibrium price
and quantity respectively. The equilibrium is, however, an unstable one. To
demonstrate this, suppose a disequilibrium price P*is established. This leads
to a situation of excess demand given by (Q2-Q1). In this case, however, the
price is pushed further from the original equilibrium price Pe. Consider an
alternative disequilibrium price P2. In this situation there is an excess
supply given by (Q4-Q30 which will also tend to push the price even further downwards
from the original equilibrium price Pe (Tewari, 2008).
Price
controls
Government
regulations may in one way or the other create a surplus or shortage in the
market. For example, price ceiling leads to a shortage while price floor leads
to a surplus. Price ceiling or the maximum price controls are imposed below the
equilibrium price since the government considers that the price as determined
by the forces of demand and supply to be too high (Hirshleifer et.al 2005). Minimum price controls or price floor are
imposed above the equilibrium price since the government considers that the
price as determined by the forces of demand and supply to be too low. They are
usually geared to protecting producers from low prices and thereby encouraging
certain lines of production.
The
effects of price ceiling on market
If
the government considers the maximum price Pe as determined by the market
forces of demand and supply is too high, especially for low income consumers,
it then decides to fix a disequilibrium price such as P max such that the price
has to be legally reduced from Pe to P max. The maximum price can therefore
benefit low income consumers and can be used as one of the several
non-inflationary measures aimed at dealing with the negative effects of
inflation (Snyder and Nicholson, 2008). If the government imposes a maximum
price control given by P max there will be a shortage of the commodity given by
(Q2-Q1).
Effects
of price floor on the market
The
minimum price as determined by the forces of demand and supply is Pe which is
considered too low by the government which then fixes a minimum price P min above
equilibrium price (Tewari, 2008). The minimum price is designed to ensure that
prices for certain products do not fall when the market forces change to create
unfavorable conditions for the product. Order Your Market Equilibrium Essay Now
Changes in equilibrium quantity and price
Equilibrium quantity and price are determined
by forces of market demand and supply. Therefore, a change in the supply of
goods will lead to a change in the quantity demanded as well as the price of
the goods (Hirshleifer et.al 2005). It is highly unlikely that the change in
the demand and supply will perfectly offset one another so that equilibrium
remains the same. The following examples are based on the Ceteris Paribus:
If
an exporter wishes to export oranges from Florida to Asia, he or she will
increase the demand of oranges in Florida. This increase in demand will then
create shortage which will then lead to an increase in the equilibrium price and
quantity.
If
an importer wishes to import oranges from Mexico to Florida, he or she will
lead to an increase in supply of oranges in Florida. This increase in supply
will then create surplus which will then lead to a reduction in the equilibrium
quantity and price.
Movement from one market equilibrium to another
The changes in the equilibrium
quantity and price do not happen instantaneously. The shifts in demand and
supply curve are responsible for these movements (Hirshleifer et.al 2005). An outward
shift of demand for example leads to a short term rise in the price of goods
and a corresponding fall in supply. Higher price act as an incentive to
suppliers to raise the output and this causes a movement up the short term
supply curve towards the equilibrium point.
Importance of the price elasticity of demand
The price elasticity of demand
highly influences the shifts in supply on equilibrium quantity and price. An
outward shift in supply leads to an increase in the equilibrium quantity and
price with only a very small change affecting the market price. An inelastic demand of a product will have
more effect on the price of the commodity (Tewari, 2008). This is indicated by
the sharp fall in the price with a small increase in equilibrium quantity
level.
Summary
Excess demand in the market is
referred to as the seller’s market because competition among buyers will force
up the price due to the existing shortage. Excess supply on the other hand is
referred to as the buyer’s market since suppliers may be obliged to lower their
output in order to dispose of their output, a situation which is favorable to
buyers (Snyder and Nicholson, 2008). In this research paper, it is clearly
evident that the equilibrium quantity and price will change when there is a
shift in both the demand and supply curve. Ceteris paribus, a decrease in
demand will lead to a fall in price and decrease in quantity supplied. An
outward shift in the demand curve will lead to a surplus at the original equilibrium
price and suppliers will have to lower their prices to get rid of their stock.
The fall in price will lead to a decrease in the quantity supplied and an
increase in the quantity demanded so that new equilibrium is established. Ceteris
paribus, a fall in supply will raise the price and lead to a reduction in the
quantity demanded (Hirshleifer et.al 2005).
References
N.
Gregory Mankiw, (2008). Principles of economics. Cengage Learning
D.
D. Tewari, (2003). Principles of Microeconomics. New Age International
Hirshleifer.J,
Glazer.A, Hirshleifer.D.A, (2005). Price theory and applications: decisions,
markets, and information. Cambridge University Press
Nicholson.W,
Snyder.C, (2008). Microeconomic theory: basic principles and extensions. Cengage
Learning
Weigel.
W, (2008). Economics of the law: a primer. Routledge
