In this lesson summary review and remind yourself of the key terms and graphs used in the analysis of markets. Topics include how to use a market model to predict how price and quantity change in a market when demand changes, supply changes, or both supply and demand change.
In a competitive market, demand for and supply of a good or service determine the equilibrium price.
Equilibrium
MARKETS: Equilibrium is achieved at the price at which quantities demanded and supplied are equal. We can represent a market in equilibrium in a graph by showing the combined price and quantity at which the supply and demand curves intersect.
For example, imagine that sellers of squirrel repellant are willing to sell units of squirrel repellant at a price of per can. If buyers are willing to buy units of squirrel repellent at that price, this market would be in equilibrium at the price of and at the quantity of cans.
Disequilibrium
Whenever markets experience imbalances—creating disequilibrium prices, surpluses, and shortages—market forces drive prices toward equilibrium.
A surplus exists when the price is above equilibrium, which encourages sellers to lower their prices to eliminate the surplus.
A shortage will exist at any price below equilibrium, which leads to the price of the good increasing.
For example, imagine the price of dragon repellent is currently per can. People only want to buy cans of dragon repellent, but the sellers are willing to sell cans at that price. This creates a surplus because there are unsold units. Sellers will lower their prices to attract buyers for their unsold cans of dragon repellant.
Changes in equilibrium
Changes in the determinants of supply and/or demand result in a new equilibrium price and quantity. When there is a change in supply or demand, the old price will no longer be an equilibrium. Instead, there will be a shortage or surplus, and price will subsequently adjust until there is a new equilibrium.
For example, suppose there is a sudden invasion of aggressive unicorns. There will be more people who want to buy unicorn repellent at all possible prices, causing demand to increase. At the original price, there will be a shortage of unicorn repellant, signaling sellers to increase the price until the quantity supplied and quantity demanded are once again equal.
We can summarize the changes in equilibrium with the following table:
| Change | Change in | Change in |
|---|
| Supply increases (shifts right) | P | Q |
| Supply decreases (shifts left) | P | Q |
| Demand increases (shifts right) | P | Q |
| Demand decreases (shifts left) | P | Q |
| Demand Increases, Supply increases | P (indeterminate) | Q |
| Demand Increases, Supply decreases | P | Q (indeterminate) |
| Demand decreases, Supply increases | P | Q (indeterminate) |
| Demand decreases, Supply decreases | P (indeterminate) | Q |
Key Terms
| Term | Definition |
|---|
| market | an interaction of buyers and sellers where goods, services, or resources are exchanged |
| shortage | when the quantity demanded of a good, service, or resource is greater than the quantity supplied |
| surplus | when the quantity supplied of a good, service, or resource is greater than the quantity demanded |
| equilibrium | in a market setting, an equilibrium occurs when price has adjusted until quantity supplied is equal to quantity demanded |
| disequilibrium | in a market setting, disequilibrium occurs when quantity supplied is not equal to the quantity demanded; when a market is experiencing a disequilibrium, there will be either a shortage or a surplus. |
| equilibrium price | the price in a market at which the quantity demanded and the quantity supplied of a good are equal to one another; this is also called the “market clearing price.” |
| equilibrium quantity | the quantity that will be sold and purchased at the equilibrium price |
Key Graphical Models - The market model
Consider the market for giant shiny salamander stickers, given in Figure . Currently, the equilibrium price of these stickers is , and the equilibrium quantity is .
Changes in Supply
Suppose the price of glitter, which is used to make giant shiny salamander stickers, increases so that it now costs the seller more per sticker to produce them. This will cause the supply of this good to decrease. To see the impact a decrease in supply will have on the equilibrium price and quantity, grab the interactive supply curve and shift it to the left until the price is higher at every level of output (the new supply curve should start at ).
What change did you notice? If you adjusted the graph correctly, you should see the equilibrium price increases to , and the equilibrium quantity in this market decreases to stickers.
Now instead, suppose someone invents a new way to produce shiny salamander stickers so there is less waste and fewer resources are needed to produce them. This would result in an increase in the supply of shiny salamander stickers. To see the impact an increase in supply will have on the equilibrium price and quantity, grab the interactive supply curve and drag it to the right so that at every quantity the price is lower (the new supply curve should start at ).
How did you do? If you adjusted the graph correctly, you should see the equilibrium price decreases to and equilibrium quantity increases to stickers.
Changes in demand
Suppose a famous, trendsetting actress starts wearing giant shiny salamander stickers, which makes them instantly the must-have accessory. This would cause the demand for this good to increase. To see the impact on equilibrium price and quantity in the market from an increase in demand, grab the demand curve Figure and shift it to the right to represent an increase in demand.
Changes in both demand and supply
When both supply and demand change at the same time, the impact on equilibrium price and quantity cannot be determined for certain without knowing which changed by a greater amount.
Suppose shiny salamander stickers fall out of popularity, and therefore the demand for them decreases. At the same time, the price of glitter goes up, which leads to a decrease in supply.
On the one hand, the decrease in demand should make price decrease and quantity demanded decrease.On the other hand, the decrease in supply should also make price increase and quantity demanded decrease. That means we know for certain that the quantity of giant shiny salamander stickers will decrease. But what will happen to price?
In Figure 3, we see a decrease in supply and a decrease in demand. The effect on quantity is easy to determine (quantity will definitely decrease). On the other hand, it is hard to tell if the equilibrium price has increased, decreased, or stays the same. Because we cannot say which of these has happened with certainty, we say that the price change is indeterminate or ambiguous.
Of course, when modeling changes in a graph it is possible to see changes in both equilibrium price and quantity when shifting both demand and supply (depending on how much each curve shifts). In the interactive graph below, move both demand and supply in different directions. Each time, move the equilibrium point to the new intersection of demand and supply. Try to create new equilibria at which:
- Price is higher and quantity is higher
- Price is higher and quantity is lower
- Price is lower and quantity is higher
- Price is lower and quantity is lower
Common Misperceptions
- When showing an equilibrium price and quantity, it is important to clearly label these on the appropriate axis, not just the interior of the graph. Remember that the point on either axis represents the market price and the market quantity, not a point in the middle of the graph.
- When both supply and demand change at the same time, we will not be able to make a statement about what happens to both price and quantity, one of these will be uncertain.
Discussion Questions
- When both supply and demand increase at the same time, why can't we tell what will happen to the equilibrium price?
- Can you think of an example of a good in your own life for which there was a shortage?
- What happened to the price of that good?
- Using a correctly labeled graph, show the impact on equilibrium price and quantity in the market for pumpkin spiced lattes if the cost of producing them increases.
An increase in the cost of production causes a decrease in supply, and increase in equilibrium price, and a decrease in equilibrium quantity, as in Figure .
FAQs
An increase in demand, all other things unchanged, will cause the equilibrium price to rise; quantity supplied will increase. A decrease in demand will cause the equilibrium price to fall; quantity supplied will decrease.
What is the concept of market equilibrium and disequilibrium? ›
Equilibrium and disequilibrium are distinct situations in economics. Equilibrium refers to perfect competition, a theoretical market structure in which all suppliers are equal, and overall supply and demand are equal. Conversely, disequilibrium describes a market with an imbalance of supply and demand.
How do you analyze changes in equilibrium? ›
First, we decide whether the event shifts the supply curve, the demand curve, or in some cases both curves. Second, we decide whether the curve shifts to the right or to the left. Third, we use the supply-and-demand diagram to examine how the shift affects the equilibrium price and quantity.
What is the market equilibrium in high school economics? ›
MARKETS: Equilibrium is achieved at the price at which quantities demanded and supplied are equal. We can represent a market in equilibrium in a graph by showing the combined price and quantity at which the supply and demand curves intersect.
What are the three steps to analyzing changes in equilibrium? ›
To determine the effects of any event, 1) Decide whether event shifts S curve, D curve, or both or just move along curve. 2) Decide in which direction the curve shifts. 3) Use supply-demand diagram to see how the shift changes the equilibrium P and Q.
How do you move from disequilibrium to equilibrium? ›
Disequilibrium is generally resolved by the market entering into a new state of equilibrium. For instance, people are incentivized to start producing more overpriced goods, increasing the supply to meet demand and lowering the price back to its equilibrium.
What two things happen when the market is in disequilibrium? ›
Disequilibrium refers to an imbalance between the quantity demanded and the quantity supplied, at a particular price. If the product is underpriced, it will cause a shortage (excess demand) and this will push up price, encouraging further supply until equilibrium is reached).
What is an example of a market disequilibrium in economics? ›
Disequilibrium refers to a situation in which demand does not equal supply. For example, the demand for a good might be 6, and the supply might be 10. The excess supply is 4. One possibility is that the excess supply causes the price of the good to fall, raising demand and reducing supply, and equilibrium results.
What is the best explanation of market equilibrium? ›
Market equilibrium is a market state where the supply in the market is equal to the demand in the market. The equilibrium price is the price of a good or service when the supply of it is equal to the demand for it in the market.
What are the three reasons for a change in equilibrium? ›
The reason behind the change in equilibrium:
- Change in temperature.
- Change in pressure.
- Changing concentrations.
- Effect of catalyst.
When we stress the equilibrium, the chemical reaction is no longer at equilibrium, and the reaction starts to move back toward equilibrium in such a way as to decrease the stress. The formal statement is called Le Chatelier's principle: If an equilibrium is stressed, then the reaction shifts to reduce the stress.
What are the factors that affect market equilibrium? ›
Excess demand or supply, changes in either or both demand and supply, competitive factors and strategic factors are the give main factors that affects the market equilibrium.
What is a real life example of market equilibrium? ›
When there is a surplus in the ice-cream market, for instance, sellers of ice cream find their freezers increasingly full of ice cream they would like to sell but cannot. They respond to the surplus by cutting their prices. Prices continue to fall until the market reaches the equilibrium.
What is the difference between equilibrium and disequilibrium? ›
The main difference between equilibrium and disequilibrium in economics is that equilibrium refers to a situation in which a market or economy is operating efficiently, while disequilibrium refers to a situation in which a market or economy is not operating efficiently.
What two conditions can lead to disequilibrium in a free market? ›
What are the two causes of a disequilibrium market? The two causes of disequilibrium occurring in a market are: Shortages: when quantity demanded exceeds quantity supplied. Surpluses: when quantity supplied exceeds quantity demanded.
What happens to a market in equilibrium when there is an increase in demand? ›
When demand increases, the market is no longer at equilibrium. The quantity demand exceeds the quantity supplied, leading to a shortage and increase in prices. This would cause an upward movement along the supply curve. Hence, both equilibrium price and quantity increase.
What happens to the equilibrium price when the demand curve shifts right? ›
And, when a demand curve shifts rightwards, both price and quantity rise. As a result, the equilibrium price will rise, but equilibrium quantity cannot be determined as it depends on the magnitude of shifts of the demand and supply curves.
What happens if changes in demand cause significant changes in equilibrium price? ›
If changes in demand cause significant changes in equilibrium price, then supply must be quite inelastic. positive, and therefore X is a normal good. We would expect the income elasticity of demand for steak to be positive, and that for hamburger to be negative.
What happens to equilibrium price and quantity when demand increases and supply decreases? ›
If the increase in demand is more than the decrease in supply, the equilibrium quantity increases. If the increase in demand is less than the decrease in supply, the equilibrium quantity decreases. In both cases, equilibrium price increases.
