Market equilibrium is the state of product or service market at which the intentions of producers and consumers, regarding the quantity and price of the product or service, match. At market equilibrium point, consumers collectively purchase the exact quantity of goods or services being supplied by producers and both the parties also agree on a single price per unit. We use the word equilibrium because the market always tends to revert back to matched price and quantity after any price or quantity distrubances on either producers' or consumers' side.
Market equilibrium is represented by the point of intersection of supply and demand curves of a market. The price and quantity prevailing at market equilibrium point are known as equilibrium price and equilibrium quantity respectively. At any price above or below equilibrium price, the quantity supplied doesn't equal the quantity demanded. This creates forces that tend to push the market back to its equilibrium state as explained in the following example. But before we move to the example, it is important to note that equilibrium point is not static and anything that shifts supply or demand curves will also shift the market equilibrium point.
Consider the following supply and demand schedules of a hypotetical product market:
When we plot the above schedules in a single Catesian coordinate system and fit trend lines to the scattered points, we obtain intersecting supply and demand curves as shown below:
The equilibrium point of the market is the point at which the supply curves cross each other. We have equilibrium price and quantity of $3.0 and 210 units respectively.
At any price above $3.0, the quantity supplied exceeds the quantity demanded. This results in unsold inventories and forces producers to offer reduced price. The reduction in price is accompanied by reduction in quantity supplied on the producers' side and increase in quantity demanded on consumers' side. In other words, both producers and consumers move down towards the equilibrium point along supply and demand curves respectively.
At any price below $3.0, the quantity supplied falls short of quantity demanded. This causes shortage and consumers' start to bid higher prices. The increase in price motivates the producers to supply more quantity but also causes the consumers to reduce the quantity demanded. Thus both producers and consumers move upwards along their respective curves towards the equilibrium point.
Written by Irfanullah Jan