Introduction
It is undoubtedly one of the most crucial aspects of economics as it means the call passed by the market about the “right” price of the products or services offered is the equilibrium price concept. At the price called the equilibrium price, the quantity of a product demanded by consumers is equal to the quantity supplied by the producers.
In other words, what the market "self-corrects" to is its price. At this juncture there could not be both shortage as well as surplus. This is because at this price the buyer can obtain his desired quantity and sellers can also sell all their produce at the price – thus both buyers and sellers are satisfied.
From food to apparel, housing to serving up bits, the concept just seems to be as ubiquitous as every other market in the real world. Knowing about equilibrium is important in predicting how prices will move and what the markets will do.
Understanding Demand and Supply in Price Determination
But, before understanding the determination of the equilibrium price, it is important to know the two forces that determines the price of the equilibrium: demand and supply.
Demand refers to the amount demanded of a product at different prices by the consumers. Typically, in a given market, if the price is low, then the demand is high and if price is high, then the demand is low. This results in demand curve sloping down.
On the other hand, supply means the readiness of producers to supply a product at various prices. A rise in price encourages producers to supply more goods as they can make a greater profit. This gives rise to an upward sloping supply curve.
Both of these forces are constantly at play in the market. Consumers attempt to purchase it at a lower cost, producers to sell it to consumers at a higher cost. The equilibrium price is where these opposing forces are in balance.
Without knowing the meaning of supply and demand one cannot understand the free market process of price formation.
Finding Equilibrium Price step by step
Most people use their understanding of the supply and demand schedule, or graph, to understand how to find the equilibrium price.
First economists record a number of different prices for a product or service, then record the quantity demanded and quantity supplied! Typically, this information is in tabular format.
This information is then shown in a graph. As per the law of supply, the curve of supply is upward and the curve of demand is downward from left to right. The point(s) where the graphs of the two curves intersect each other are referred to as equilibrium points.
Here the price and quantity is at equilibrium. This means equilibrium situation with no excess of pressure on the price of the commodity.
Setting the price above the equilibrium will result in the excess of supply, thus a surplus occurs. Sellers would have to sell it at a lower price otherwise you would not have buyers. When the price is lower than the equilibrium price, then the demand will be greater than the supply, the result of which will be a shortage. In this situation, prices are tending to increase.
This is a natural adjustment mechanism which will take place until the market is rebalanced again.
Mathematical Method of Finding Equilibrium Price
Graphical & Mathematical approach to Explain the Method of Determination of Equilibrium Price.
Normally, demand and supply can be represented in the form of equations also. For example:
Demand: Qd = a – bP
Supply: Qs = c + dP
At equilibrium the quantity demanded and equilibrium quantity supplied happen to be the same. So we set:
Qd = Qs
a – bP = c + dP
This equation can be solved and would determine the equilibrium price (P). Once we have P we substitute it into either equation to obtain the equilibrium quantity.
The calculation of this is a rather good strategy because it is not estimated, but to be a high level of accuracy, especially in the sphere of economics and business analysis.
For instance if demand is Qd = 100 – 2P and supply is Qs = 20 + 3P then by setting Qd = Qs gives:
100 – 2P = 20 + 3P
The price which is final output after finding answer will be the Equilibrium price. The methodology is pure algebraic; and it is used quite common in a real economic or academic models.
Real World Examples of Equilibrium Price
However, some real-life examples are worth considering in order to have a better understanding on how to find the equilibrium price.
Let's look in the food market at what's sold for rice? The higher the price, the lower the sales probability and the unsold stocks on the side of suppliers. Prices will be cut so as to get rid of the surplus. They may bid higher than it is supplied when the price is too low leading to shortage and then the prices will settle to higher.
Concerning houses, as a rule, the price of housing will only vary in accordance with the principle of demand and supply. Since demand for housing exceeds supply in the city, housing prices have been steadily rising until equilibrium is attained.
The price of a subscription in the digital market is reliant on demand and the rivalry amongst business, such as streaming services. If there becomes an over-abundance of services, prices might even level off at a point that would at least allow users to pay and business to break a profit.
As can be seen by these examples, the equilibrium price is not an abstract, theoretical concept but a real one which affects people's day-to-day lives economically.
Factors That Can Shift Equilibrium Price
1) Change in Supply 2) Change in Demand
Equilibrium price is not always a constant price. May shift/slide when the demand changes and when the supply changes.
When quantity of a product demanded increases due to population increase, addition in income levels and/or changes in preferences, the demand curve shifts to the right. This usually results in an increase of the level of prices.
If this happens due to a change in prices (fall in economic conditions), or if tastes or preferences change (i.e. a fall in demand for the good), then a different set of sellers may find themselves competing for a different set of buyers.
From the supply side, these factors like production costs, technological changes and others can change the supply curve. A fall in costs due to new technology will make supply more, which will lead to a fall in the equilibrium price, e.g.
Government policies such as taxes, and subsidies, also impact on equilibrium. What you are doing really is increasing the costs and therefore the prices through taxes and decreasing them through subsidies.
Also, there may be short term changes in equilibrium as a result of external shocks and changes in supply and demand (natural disasters, global shocks etc.).
Importance of knowledge of the Equilibrium Price
Knowledge of how to obtain an equilibrium price is of importance to consumers and companies.
For consumers, it can be a method to comprehending the factors to consider that can result in cost adjustments and how a shortage or oversupply impacts a market. This also assists the people to make their purchases as per the market conditions.
After determining the equilibrium point, it can be useful for businesses to make pricing decisions. In particular, companies can have the confidence that it's pricing is a price that helps them slightly increase their profit, yet is also competitive in the market.
The concept of this widely used way of thinking is also transferred to the formulation of policies by governments. It helps in getting insights into Market equilibrium and effect of it in formulating minimum wage law, price control etc.
They will apply equilibrium analysis in overall economic performance, inflation and unemployment analysis.
Finally: The notion of equilibrium price is a simple one that helps in comprehending the functioning of the market in an efficient manner.
Final Thought
In that way knowledge of the equilibrium price is helpful in understanding the natural balancing force prevailing in the market which makes out the price between the demand and supply. The concept illustrates how prices are price in a competitive environment either graphically or by mathematical equations.
But balance isn't just an academic notion — it is typically the way of action that effects food, home and more. Its information can help any business, individual or policy maker make a choice on what action to take and what choices to make based on the economy at that point in time. This is a continuously changing market and the cuts-off point to where the buyers and sellers get stability is the equilibrium point.
FAQs
What is equilibrium price?
It is the price at which the quantity demanded equals the quantity supplied in a market.
How do you find equilibrium price on a graph?
It is found at the point where the supply and demand curves intersect.
What happens when price is above equilibrium?
There is a surplus because supply exceeds demand, causing prices to fall.
What happens when price is below equilibrium?
There is a shortage because demand exceeds supply, causing prices to rise.
Can equilibrium price change?
Yes, it changes when demand or supply shifts due to economic factors.
What causes demand to increase?
Factors like higher income, population growth, and changing preferences increase demand.
How does supply affect equilibrium price?
An increase in supply usually lowers equilibrium price, while a decrease raises it.
Is equilibrium price always stable?
It is stable only until market conditions change.
Why is equilibrium price important?
It helps explain how markets allocate resources efficiently.
Do governments control equilibrium price?
Governments can influence prices through taxes, subsidies, and price controls, but market forces usually determine equilibrium.
