Supply and Demand Equilibrium
Supply and Demand Equilibrium
The demand curve shows the quantity of a good or service that buyers are willing and able to purchase at each price. It slopes downward, indicating an inverse (negative) relationship between price and quantity demanded.
The supply curve shows the quantity of a good or service that producers are willing and able to offer for sale at each price. It slopes upward, indicating a positive relationship between price and quantity supplied.
The demand curve and the supply curve will intersect at only one point, where the quantity demanded is equal to the quantity supplied. This intersection point is called equilibrium. It represents the price and quantity that exchanges will take place in a free market.
Equilibrium is a point where no forces exist that will cause any changes in the market. Once the equilibrium point is reached, the market will stay at that point unless something else changes. For supply and demand, such a change would be a change in a determinant of supply or a determinant of demand, causing the supply curve or the demand curve to shift.
At any price other than the equilibrium price, the quantity supplied and the quantity demanded are not equal.
If the price is above the equilibrium price, the quantity supplied is greater than the quantity demanded, and the result is called a surplus.
If the price is below the equilibrium price, the quantity demanded is greater than the quantity supplied, and the result is called a shortage.
The surplus and shortage situations can be seen as resulting from the fact that the supply curve slopes upward while the demand curve slopes downward. If the price rises above the price where the quantity supplied is equal to the quantity demanded, purchasers would want to purchase a lower quantity while suppliers would want to supply a higher quantity. If the price falls below the price where the quantity supplied is equal to the quantity demanded, purchasers would want to purchase a higher quantity while suppliers would want to supply a lower quantity. The law of supply and the law of demand make this true.
Surpluses and shortages represent situations of disequilibrium. Disequilibrium is not sustainable as long as the price is free to adjust. Market forces will move the situation back to an equilibrium condition.
If a surplus exists, suppliers will have an increase in unsold inventory. The suppliers will lower their prices and reduce the quantity being made available for sale in order to reduce the unsold inventory. Lower prices and decreased production will be more profitable than unsold inventory.
If a shortage exists, producers will see that inventories are depleted and consumer demand is not being met. Suppliers will see this unmet demand as a source of potential profits. The suppliers will raise their prices and increase the quantity being made available for sale in order to take advantage of the consumer demand.
One more thing about a shortage: Many people try to equate the concept of shortage with the concept of scarcity. Actually, in economics, these terms are unrelated. A shortage is a situation in which the quantity demanded is greater than the quantity supplied. Scarcity refers to the fact that human wants are infinite while resources are limited (more would be wanted at a price of zero than would be available).
In equilibrium, the price and quantity exchanged in a free market will not change unless one of the determinants of supply or demand changes. But what would be the result of such a change?
Continue with a discussion of changes in supply and demand equilibrium