At the equilibrium point, the market determines prices and quantities for consumers and producers. Consumers and producers agree on price and quantity. Why agree? At that point, consumers obtain the quantity of goods at the price they are willing and able to pay. And, producers offer quantities at prices where they are willing and able to accept.
When the market reaches equilibrium, there is no tendency to change. If there is disequilibrium, the market mechanism will force demand and supply towards a new equilibrium.
Two conditions of disequilibrium:
- Excess demand (shortage) – the quantity supplied is less than the quantity demanded.
- Excess supply(surplus) – the quantity supplied is greater than the quantity demanded
When there is excess demand, the price will tend to rise. Producers will increase supply and slowly raise the price. Consumers will also reduce the quantity demanded because of the higher price.
Meanwhile, when there is excess supply, the price will tend to fall. Producers reduce supply and reduce the price. Meanwhile, consumers increase demand because the price is lower.
How do you find the market equilibrium?
The easiest way to determine equilibrium is to look at supply and demand curves. Equilibrium occurs at the point of intersection of the two curves.
If you don’t have a curve, you can calculate market equilibrium from the supply and demand functions. You can determine it by equating the demand function and the supply function.
Determine market equilibrium from the equation of supply and demand functions
Say, we have a product’s demand function: QD = 24 – 2P. Meanwhile, the supply function for the product is: QS = – 14+ 8P
You calculate the equilibrium point by equating the two equations: QD = QS –> 24 – 2P = – 14+ 8P
- Price = (24 + 14) / (2 + 8) = 3.8
- Quantity = 24 – 2 * 3.8 = 16.4 or QS = – 14+ 8 * 3.8 = 16.4
What happens when the market experiences disequilibrium
The market mechanism will work when there is disequilibrium and will drive demand and supply towards a new equilibrium.
Disequilibrium occurs if:
- Prices are above equilibrium prices
- Price is below the equilibrium price
When the market price is above equilibrium, the quantity supplied is greater than the quantity demanded. That results in excess supply (surplus). In this situation, prices will tend to fall.
Excess supply creates pressure on producers. The market is not enough to absorb their output. They will then reduce output and reduce prices to attract more demand.
On the other hand, lower prices make consumers buy more. That drives the quantity demanded to increase.
The process continues until the quantity demanded is equal to the quantity supplied and a new equilibrium is reached.
The other disequilibrium condition occurs when the product price is below equilibrium. The quantity demanded exceeds the quantity supplied, or in other words, there is excess demand. The market experiences a scarcity of goods due to high demand.
Producers see opportunities to generate more revenue by increasing output. They are gradually also raising prices because of strong demand. Higher output causes increased market supply.
At the same time, because the price becomes higher, consumers reduce demand. And the process continues, until reaching a new equilibrium, i.e., when the quantity supplied is the same as quantity demanded.