Price Determination » Market Equilibrium

Where buyers and sellers agree

Buyers want low prices. Sellers want high prices. Yet in a working market, there is usually one price at which both sides are happy to trade. At that price, the quantity buyers want to buy is exactly the quantity sellers want to sell.

In The Price Mechanism you saw how prices steer resources. This lesson shows the price that demand and supply settle on.

Key terms:

• Market equilibrium: a situation in which demand equals supply, so there is no tendency for the price or the quantity to change.
• Equilibrium price: the price at which quantity demanded equals quantity supplied.
• Equilibrium quantity: the quantity bought and sold at the equilibrium price.

What does equilibrium mean?

Equilibrium means a state of balance. Think of a seesaw with two children of the same weight: nothing moves.

In a market, demand and supply are in balance when demand equals supply. Nobody has a reason to change what they are doing, so the price stays where it is. We say there is no tendency to change.

Each market has one equilibrium price and one equilibrium quantity at any moment.

Finding equilibrium from a schedule

You can find equilibrium from a demand and supply schedule. Here is the made-up market for reusable water bottles in the country of Tolmar.

Price per bottle ($)	Quantity demanded (thousands a month)	Quantity supplied (thousands a month)
2	100	20
4	80	40
6	60	60
8	40	80
10	20	100

Follow these steps.

1. Look down the demand column and the supply column.
2. Find the row where the two numbers are the same.
3. Read the price from that row. That is the equilibrium price.
4. Read the quantity from that row. That is the equilibrium quantity.

Here both columns show 60 at a price of $6. So the equilibrium price is $6 and the equilibrium quantity is 60 thousand bottles a month.

At every other price the two columns show different numbers, so the market is not in balance there. What happens at those prices is the topic of Disequilibrium: Shortages and Surpluses.

Drawing equilibrium on a diagram

A diagram shows the same information with curves. In the exam, follow these steps.

1. Draw the axes. Label the vertical axis Price and the horizontal axis Quantity.
2. Draw a downward sloping line from the top left. Label it D for demand.
3. Draw an upward sloping line from the bottom left. Label it S for supply.
4. Mark the point where the two curves cross. This is the equilibrium point.
5. Draw a dotted line from the crossing point across to the price axis. Label it P. This is the equilibrium price.
6. Draw a dotted line from the crossing point down to the quantity axis. Label it Q. This is the equilibrium quantity.

The crossing point is the only place where demand and supply give the same quantity at the same price. That is why it is equilibrium.

Reading the diagram

Suppose the Tolmar diagram has its curves crossing at a price of $6 and a quantity of 60 thousand. Then P is $6 and Q is 60 thousand.

• Go from the crossing point across to read the price.
• Go from the crossing point down to read the quantity.
• Both curves pass through the same point, so the quantity demanded equals the quantity supplied there.

Look back at the schedule. The 60 and 60 in the $6 row are the crossing point of the two curves. The schedule and the diagram tell the same story.

Exam-style question

Rice boxes are sold from street stalls in the made-up town of Dalmoor. The table shows the daily market for rice boxes.

Price per box ($)	Quantity demanded	Quantity supplied
3	400	100
4	340	190
5	280	280
6	220	370
7	160	460

(a) Define market equilibrium. [2 marks]

(b) Identify the equilibrium price and the equilibrium quantity. [2 marks]

(c) Describe how you would show this equilibrium on a demand and supply diagram. [4 marks]