Determination of Equilibrium Price and Quantity

Equilibrium means a state of no change. Evidently, at the equilibrium price, both buyers and sellers are in a state of no change. Technically, at this price, the quantity demanded by the buyers is equal to the quantity supplied by the sellers. Both market forces of demand and supply operate in harmony at the equilibrium price.

The equilibrium price is the price where the quantity demanded is equal to the quantity supplied. That quantity is known as the equilibrium quantity.

Graphically, this is represented by the intersection of the demand and supply curve. Further, it is also known as the market clearing price. The determination of the market price is the central theme of microeconomics. That is why the microeconomic theory is also known as price theory.

Equilibrium means a state of no change. Evidently, at the equilibrium price, both buyers and sellers are in a state of no change. Technically, at this price, the quantity demanded by the buyers is equal to the quantity supplied by the sellers. Both market forces of demand and supply operate in harmony at the equilibrium price.

Graphically, this is represented by the intersection of the demand and supply curve. Further, it is also known as the market clearing price. The determination of the market price is the central theme of microeconomics. That is why the microeconomic theory is also known as price theory.

Process of Finding Equilibrium:

To determine the equilibrium price and quantity, we must analyze both the demand and supply curves.

Step 1: Identifying the Demand and Supply Functions

The demand curve can be expressed as a function:

Qd = f(P)

where Qd is the quantity demanded and $P$ is the price.

Similarly, the supply curve is expressed as:

Qs = g(P)

where Qs​ is the quantity supplied.

At equilibrium, the quantity demanded equals the quantity supplied, so:

Qd = Qs

​Step 2: Setting Quantity Demanded Equal to Quantity Supplied

Set the demand function equal to the supply function to solve for the equilibrium price. For example, if the demand function is:

Qd = 100 − 2P

And the supply function is:

Qs = 3P

Set these two equal to each other:

100 − 2P = 3P

Step 3: Solving for Equilibrium Price

Now solve for the price ($P$):

100 =5P

$$P=20$$

So, the equilibrium price is 20.

Step 4: Solving for Equilibrium Quantity

Substitute the equilibrium price back into either the demand or supply equation to solve for the equilibrium quantity. Using the demand equation:

Qd = 100 − 2(20) = 100 − 40 = 60

Thus, the equilibrium quantity is 60 units.

Effects of Changes in Demand and Supply

The equilibrium price and quantity are not fixed; they change when there is a shift in either the demand or the supply curve.

Increase in Demand

If demand increases due to factors such as higher consumer income or changes in preferences, the demand curve shifts to the right. This results in a higher equilibrium price and quantity.

Example:

• If more consumers want to buy a good (shift in demand to the right), the equilibrium price will rise, and producers will supply more to meet the increased demand.

Decrease in Demand

If demand decreases (due to factors such as falling income or changes in preferences), the demand curve shifts to the left. This results in a lower equilibrium price and quantity.

Example:

• If consumers no longer desire a good, the equilibrium price falls, and producers may reduce the quantity supplied.

Increase in Supply

If supply increases (due to factors such as technological improvements or lower production costs), the supply curve shifts to the right. This results in a lower equilibrium price and a higher equilibrium quantity.

Example:

• If a new technology reduces the cost of producing a good, the supply curve shifts rightward, leading to a lower price and higher quantity.

Decrease in Supply

If supply decreases (due to factors such as higher production costs or natural disasters), the supply curve shifts to the left. This results in a higher equilibrium price and a lower equilibrium quantity.

Example:

• If a natural disaster disrupts the production of a good, the supply decreases, leading to higher prices and lower quantities available.

Role of Price Mechanism in Reaching Equilibrium

The price mechanism plays a crucial role in reaching equilibrium. If there is a surplus (where supply exceeds demand), producers will lower prices to encourage consumers to buy more. Conversely, if there is a shortage (where demand exceeds supply), consumers will compete to buy the good, causing prices to rise. This process continues until the market reaches equilibrium.

• Surplus: If the price is above equilibrium, supply exceeds demand, and producers reduce the price.
• Shortage: If the price is below equilibrium, demand exceeds supply, and prices rise as consumers compete for the limited supply.