Equilibrium Equilibrium is a state of balance. Market equilibrium is when the quantity demanded is equal to quantity supplied. There is no tendency for change at equilibrium. The markets naturally tend towards equilibrium.
Equilibrium The equilibrium point is where the two graphs meet. At this point, Qd = Qs. QE represents the quantity demanded and supplied at equilibrium. PE represents the price at equilibrium. The market will operate at equilibrium. However, if something shifts the demand or supply curves, the equilibrium P and Q will change.
Equilibrium The market wants to operate at equilibrium. It’s similar to an atom that gives or receives electrons to become balanced. That’s what the market does, supply and demand will adjust and try to find equilibrium naturally. The market will always move itself to equilibrium, ceteris paribus.
Surplus and Shortage Sometimes the price for an item isn’t at equilibrium. Either sellers have mistakenly put too high a price or too low a price onto a product. The price system will adjust itself to get back to equilibrium on it its own. The price, Qs and Qd all act as signals to consumers and producers until the market finds the correct price.
Surplus and Shortage Let’s say the market price is set above equilibrium:
Surplus and Shortage If price is above equilibrium price, Qs will be higher than Qd. That means there will be lots of stuff left on the shelf because people don’t want to buy the product for that high of a price. This is called a surplus. A surplus is a situation of excess supply in a market (Qd < Qs).
Surplus and Shortage As suppliers begin to incur losses because they are producing more items than are selling, they will start lowering prices (sale!) If the price is lower, more people will buy the product, so there is an increase in Qd If the price is lower, producers will respond by supplying less (decrease Qs)
Surplus and Shortage This will go on, little by little, until equilibrium is reached and Qd = Qs
Surplus and Shortage The opposite will occur when price is less than equilibrium price:
Surplus and Shortage If the price is set below equilibrium, Qd>Qs (demand is higher than supply), this is called a shortage. A shortage is a situation of too little supply in a market (Qd > Qs) If the market was to stay here, buyers will being to outbid each other to get the product (think of Tickle-Me Elmo).
Surplus and Shortage As the price goes up, producers will increase production (increase Qs) As the price goes up, buyers will decrease their quantity demanded (decrease Qd)
Surplus and Shortage This will go on, little by little, until equilibrium is reached:
Prices as Signals This shows that prices—the monetary value of a product as established by supply and demand—is a signal that helps us make our economic decisions.
Prices as Signals Advantages: Prices in a competitive market economy are neutral because they favor neither the producer nor the consumer. Prices in a market economy are flexible. This allows the price system to absorb unexpected shocks and accommodate change. Prices have no cost of administration. Prices are familiar to us all, allowing decisions to be made quickly and easily.
Price as Signal How would we distribute and allocate goods and services without prices? Rationing—a system under which an agency such as government decides everyone’s “fair” share Lottery? Anarchy?
Rationing Rationing is the most used allocation system that does not use prices Problems with rationing: Fairness—who deserves how much? High administrative cost Diminishing incentive—people do not have as much motivation to work or produce