Market Equilibrium

Market Equilibrium:

When all firms and all consumers can either sell or buy what they desire, the market is in equilibrium, or supply equals demand. In a free market (i.e. unregulated) it is the price that will adjust so that such equilibrium is attained. If the market price is too low initially, there will be consumers who will be unable to find goods to buy at the market place; in the quantities they wished to buy (there is an excess demand). Consumers will in this case be rationed. This could be done by the government who will issue coupons to each citizen in equal amounts (or based on age or size of the household etc.), or it can be a more spontaneous rationing via queuing (“served on a first-come-first-basis”). Firms sometimes put out waiting lists for, for example, new cars, but this is very similar to standing in line. Hospitals also have waiting lines which are managed due to the assessed need of care etc.

If the market price is too high, firms will find that they cannot sell everything that they produce and they accumulate (unplanned) inventories (there is an excess supply). Since it is costly to carry inventories firms normally choose to reduce production, i.e. to decrease the quantity supplied. Alternatively, firms start to lower prices to get rid of the unwanted inventories.

In the next period they are wiser and they choose both a lower price and a lower quantity.

The market equilibrium price in our beer market can be computed as:

QD = QS

70 – 2.p = 20 + 3.p
5. p = 50
p = 50/5 = 10

and the equilibrium quantity is: 70 – 2.10 = 50. Note that if we’re dealing with aggregate (market) demand and supply curves, the quantities may be thousands or even million liters per period (depending on the length of the period we consider).

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