For understanding how the thing works in the market system first, we have to have a general understanding of demand and supply. In this system buyer who is a demander interacts with the seller who is the supplier and the point where their interest matched the equilibrium gets settled. Market equilibrium is the point where buyer demands of products meet with supplier will to produce at a specific price.
Market Equilibrium Price and Quantity:
According to the law of demand, as the prices increases, the demand decreases, and according to the law of supply, as the prices increase, the supply increases, so the price and quantity at which demand and supply interact this price and quantity is the market equilibrium price and quantity. It is the price where the buyer demand is fulfilled by the supplier completely.
If we take a hypothetical example in which we check at the different prices how many cartons of milk the buyer wants to purchase and how many suppliers want to supply at that price. We can see it through the table and graph only at $11 the buyer’s demand meets with supplier willingness to produce. Therefore, $11 is the equilibrium price and 11 cartons of milk are the equilibrium quantity. At this equilibrium price, there is no surplus and shortage and this state is called Market Equilibrium.
|Price of a milk carton||Quantity demanded per month||Quantity supplied per month|
Change in Equilibrium:
Once the market is in equilibrium it will remain in equilibrium or rest until or unless there is a change in demand or change in supply. The demand in the market may change due to a number of reasons such as a change in buyer’s taste, increase or decrease in numbers od demanders, the income of buyers, price of related goods. Similarly, supply might be changed due to a number of factors like taxes, technology, change in prices of resources, increase, or decreases in the number of sellers.
Now we will see six different cases that how a change in one or both factors i.e. demand and supply affects the equilibrium price and quantity.
- Change in Demand and Constant Supply: Consider the case in which demand in the market increases but the supply remains the same. It results in a shift of demand curve to the right and the supply curve remains in the same position. The interaction of these two curves will be at a higher price and quantity which results in the shift of equilibrium to a new price and quantity. On the other hand, if the demand decreases, the demand curve shifts to left, and the supply curve remain the same then they meet at a lower price and quantity and shifts the equilibrium at a low price and quantity.
- Change in Supply and Constant Demand: Now consider the supply in the market increase and demand remains the same. The result of the increase in supply, the supply curve shifts to right. Now the new supply curve and previous demand curve meet at a lower price and higher quantity due to this equilibrium also shifts to new price and quantity. However, if the supply decreases the supply curves shift towards the left. Therefore, the equilibrium shifts to higher prices and lower quantity.
- Increase in Demand & Increase in Supply: If the supply and demand both increase at the same time in the market so both curves shifts toward the right. As we know through previous cases when supply increase prices increase but when demand increases prices decrease. So if the increase in the supply is greater than an increase in the demand than the equilibrium price would go up. But if the increase in demand is greater than an increase in supply than equilibrium price would go down. However, quantity always increases when supply and demand increase so, in this case, the increase in the equilibrium quantity is more than that happens in separate cases.
- Decrease in Demand & Decrease in Supply: If supply and demand both decrease at the same time than both curves will shift to left. If we see the cases separately decrease in demand happens when price increase and decreases in supply occur when prices decrease. So if the decrease in demand is greater than a decrease in supply than the equilibrium price would go down and if the decrease in supply is greater than the decrease in demand than equilibrium price would go up. In the case of a quantity which always decreased in both cases so the equilibrium quantity would also be decreased.
- Increase in Demand & Decrease in Supply: When demand increases demand curve shifts to right and hence the price increases and quantity demanded increases. But when supply decreases supply curve shifts to left and hence price increases and quantity supplied decreases. So in the combined cases as the effect on price is the same so equilibrium price would be increased but more than in separate cases. However, the effect on quantity is different in both cases so increases and decreases in equilibrium quantity depend on the relative movement of curves. If the increase in demand would be more than the equilibrium quantity will increase but if the decrease in supply would be more than the equilibrium quantity will decrease.
- Decrease in Demand & Increase in Supply: When demand decreases demand curve shifts to left and hence the equilibrium price and quantity decreases. But when supply increases supply curve shifts to right and hence price decreases and quantity supplied increases. So in the combined cases as the effect on price is the same so the equilibrium price would be decreased but more than in separate cases. However, the effect on quantity is different in both cases so increases and decreases in equilibrium quantity depend on the relative movement of curves. If the decrease in demand would be more than the equilibrium quantity will decrease but if the increase in supply would be more than the equilibrium quantity will increase.