Market Equilibrium and Price Equilibrium

Market equilibrium and equilibrium price; both economic terms relate to each other.

One helps you to understand the other

A market equilibrium is a market situation where demand and supply become exactly equal to a product or a service. You can find neither surplus nor shortage in the market.

An equilibrium price is the price of a product or service at market equilibrium. In an ideal textbook situation, the market does not tend to have shortage or surplus. When a price is too high- fewer consumers shall purchase- you will see a surplus. If the price is too low – more consumers shall buy- you will see a shortage.

A standard model of supply and demand assumes a competitive market without any monopolistic actors. When supply increases for a product or service, the price level shall decrease resulting in more demand for it.  If its supply decreases price rises causing less demand. Such variations in supply and demand balance themselves at some point where supply and demand become equal for a product/service.

Various factors affecting the market, change demand and supply, causing shifts in demand and supply curves. The point where supply and demand curves cross each other depicts equilibrium price, as illustrated in the diagram below.

A good manager, especially in production or retail sector actively monitors the variations in demand of his/her customers and try to synchronize supply accordingly to capture maximum possible revenue.

To better understand the concepts of market equilibrium and equilibrium price we will observe how dynamic nature of supply or demand affects them. Let’s assume demand D0 remains constant throughout the scenarios.

Example of Price and Market Equilibrium

Here is a graphical representation to understand it visually. Suppose there is a product in a market. The consumer's behavior tends to get product/service at least price possible, so to do so they bid down the market price. As the market price decreases, the quantity demanded increases eventually, and the quantity supplied by the producer decreases till the moment, quantity demanded becomes equal to the quantity supplied, at that point the surplus diminished, and market equilibrium is set.

An increase in supply with constant demand decreases the equilibrium price and increases the equilibrium quantity. In the same way, a decrease in supply with constant demand raises the equilibrium price and decreases the equilibrium quantity. The dynamics of supply and demand changes Market Equilibrium and Equilibrium Price. Equilibrium price can be momentous or comparably longer at period depending upon market dynamics.

Figure (1) shows the initial state of equilibrium for a market at the point where supply curve S1 intersects demand D0. At that point, the price P1 is for the quantity Q1

Figure (2) explains the situation when an increase in supply from producer shifts supply curve from S1 to S2

Figure (3) an increase in quantity supplied by producer from Q1 to Q2 at equilibrium price P1

Figure (4) Quantity supplied by a producer at P1 is greater than quantity demanded by a consumer, a surplus is created.

Figure (5) the surplus enables consumers to bid down the market price of the product/service. As the market price decreases from P1 to P2, quantity demanded increases along D0.  The Qs decreases along the supply curve S1. The quantity demanded to continue increasing along D0 while the quantity demanded to continue decreasing along S2 till the moment whole surplus is diminished. Quantity supplied becomes equal to quantity demanded thus establishing new Market Equilibrium and a new Equilibrium price for the product.

Good managers are sensitive about market dynamics

Various competitive managerial positions in public or private business organizations demand such managers, who can, not only asses current demand but can also anticipate future customers’ demands for products/services. Of course, there are several statistical tools to assess current or estimate future demand and well-qualified managers do use them, while many of them still use intuitive approach. It means they decide about product/service supply level based on their experience. In both cases, good managers have to keep an eye on variations in customers’ demand.

For example:

1.    This simple case explains how mismanagement regarding maintaining supply versus demand, can take a business far from its business objectives. A pharmaceutical company tries to maintain production level according to demand. The production manager if the supply surpasses demand, the company will have to bear extra storage and spoilage costs. Better synchronizing production can minimize costs according to demand. Medicines have specific product life. The longtime surplus can expire their recommended usage time. It is better to produce them fresh and replenish market as per their demand. Otherwise, a surplus leads to a strong reduction in price which is a direct loss of dollars. But there are several other losses which a company faces when it has to store quantity which is not demanded in the market. No firm would continue with a production manager who does not know when to stop producing.

2.    Suppose you are a manager of an underwriting company. It gets a new contract from a newly established corporation which legally binds it to sell its Initial Public Offering (IPOs) or shares to the public. It ensures the corporation that in case of under-subscription of shares, it will purchase the remaining shares itself. The corporation offers 100,000 shares. You are required to set the price of corporate IPOs/shares according to the market equilibrium. If you sell IPOs/shares above the equilibrium price, the shares will become over-valued. Let’s assume you get purchase request only for 50,000 shares. What will you do with the rest stock? The company will have to purchase the remaining lot and most probably fired. The golden principle on investment is cited as, “Purchase shares when they are cheap, sell them when they get costly.” (Warren Buffett) On the other hand, if you set IPOs price less than equilibrium level and receive more demand than quantity supplied, you will put the IPOs into undervalued condition besides damaging goodwill of the underwriting company. Your job would be at risk in either of the situations.

In simple words, your core job as managers is to handle supply and demand issues effectively, especially if you are managing production departments, running medium to small sized businesses or underwriting businesses for your corporate clients. You can do this properly best by keeping yourself continuously updated by the variations in demand.

Law of Supply and Demand

Is law of Demand a Law?

Origin of Supply and Demand Model

Supply and Demand Lesson

Why Demand Curve Slopes Downwards?

When Demand Curve Slopes Upwards?

Elasticity Definition

Price Elasticity

Price Elasticity of Demand

Measurement of Demand Elasticity

Point Elasticity of Demand

Income Elasticity of Demand

Applications of Income Elasticity of Demand

Cross Price Elasticity of Demand

Supply Curve and Elasticities

Perfect Price Elasticity of Supply

Relative Elasticities and In-elasticity of Supply

Exceptions to Demand and Supply