In the third episode of the Economic Lowdown Video Series, economic education specialist Scott Wolla explains the concept of equilibrium. Viewers will get a refresher on the laws of supply and demand before they learn about market equilibrium – the point at which there is no shortage or surplus of a good or service.
• Listen to the audio version of this episode.
Hi, I'm Scott Wolla, and today I'm talking about market equilibrium.
In a market economy like the United States, the choices that individual consumers and producers make every day determine how society’s scarce resources will be used.
Consumer and producer choices determine what and how much will be produced, and at what price.
These choices create the market forces of supply and demand.
Let’s review the basics of supply and demand, and then we will discuss market equilibrium.
Law of Demand: Quantity demanded is the amount of a good that buyers are willing and able to purchase at a particular price.
Many things determine demand, but only price can determine the quantity demanded of a specific good.
The law of demand states that—other things being equal—when the price of a good rises, the quantity demanded of that good falls.
The reverse is also true—when the price of a good falls, the quantity demanded of that good rises.
Economists refer to the relationship between price and quantity demanded as the law of demand.
The combination of the quantities people are willing and able to buy of a good or service at various prices constitutes a demand schedule. When the demand schedule is graphed, the demand curve is downward sloping.
Law of Supply
Now, we need to look at the other side of the market and examine the sellers or producers.
The quantity supplied of any good or service is the amount of a good that sellers are willing and able to sell at a particular price.
Many factors affect supply, but only price can determine the quantity supplied.
When the price of a good rises, the quantity supplied of that good will increase.
The reverse is also true: if the price of a good decreases, the quantity supplied of that good will decrease.
Economists refer to the relationship between price and the quantity supplied as the law of supply.
The combination of the quantities producers are willing to produce and sell at various prices constitutes a supply schedule.
When the supply schedule is graphed, the supply curve is upward sloping.
So, is it supply or demand that determines the market price?
The answer is “both.”
Like the two blades of a scissors, supply and demand work together to determine price.
When you combine the supply and demand curves, there is a point where they intersect—this point is called the market equilibrium.
The price at this intersection is the equilibrium price, and the quantity is the equilibrium quantity.
At the equilibrium price, there is no shortage or surplus. The quantity of the good that buyers are willing to buy equals the quantity that sellers are willing to sell.
Buyers can buy the quantity they want to buy at the market price, and sellers can sell the quantity they want to sell at the market price.
So, is equilibrium a constant, unchanging point? No.
Markets do have a natural tendency to settle at the equilibrium price, but the price may bounce around a bit in the process.
Think of a deep bowl with steep sides. Now, put a marble in the bowl and turn the bowl in circles.
The marble in the bowl will roll around the sides of the bowl, but as it rolls, gravity will pull it toward the bottom.
As you slow the turning motion, the marble will drop to the bottom.
In a similar way, prices also roll around as the forces of supply and demand change, but they tend toward, and eventually settle at, equilibrium.
Imagine a market in transition, where the demand for widgets has suddenly decreased, but market price has not yet settled to the new equilibrium.
Suppliers will continue to respond to the market price—which is now too high—while consumers have decreased the quantity they demand.
This means that suppliers will produce a greater quantity than consumers are willing to purchase, resulting in a surplus.
The surplus puts downward pressure on the market price, which causes it to drop back toward the equilibrium price.
Now, imagine the demand for widgets has increased, but the market price has not yet risen to the new, higher equilibrium price.
Suppliers will continue to respond to the market price—which is now too low—while consumers have increased the quantity they demand.
This means that sellers will supply a smaller quantity of goods than buyers are willing to purchase, resulting in a shortage.
Buyers will respond by bidding up the price, and before you know it, the price is rising toward the equilibrium point.
Well, that’s all the time we have for today. Be sure to listen to Episode 8 of our audio podcast series to learn even more about market equilibrium.
Thanks for watching.