definition of market equilibrium and disequilibrium

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Interaction of Demand and Supply (Cambridge AS & A‑Level Economics – Topic 2.4)

Learning Objective

Students will be able to:

  • Define market equilibrium and disequilibrium (ceteris paribus).
  • Identify the five demand‑side and five supply‑side determinants that shift curves.
  • Distinguish movements along a curve from shifts of a curve.
  • Explain the welfare implications – consumer surplus (CS) and producer surplus (PS).
  • Analyse the role of elasticities, the time‑frame (short‑run vs. long‑run) and price‑adjustment speed.
  • Evaluate the model’s limitations and link it to common government interventions (price ceilings/floors, taxes, subsidies).

Key Concepts

  • Demand curve: Quantity of a good that consumers are willing and able to buy at each price, ceteris paribus (all other determinants held constant).
  • Supply curve: Quantity of a good that producers are willing and able to sell at each price, ceteris paribus.
  • Market mechanism: The process by which the interaction of demand and supply determines the market price and quantity.

Determinants that Shift Curves (required syllabus list)

Demand determinants (shift D)Supply determinants (shift S)
  • Income (normal vs. inferior goods)
  • Prices of related goods (substitutes & complements)
  • Tastes & preferences
  • Expectations of future price or income
  • Number of buyers
  • Input (factor) prices
  • Technology & productivity
  • Expectations of future price
  • Number of sellers
  • Taxes, subsidies & regulations

Movements vs. Shifts – Quick Reference

What changes?Resulting change in the diagramTypical cause
Own‑price of the good Movement along the same curve (point moves up or down) Price change, all other determinants unchanged
Any other determinant (income, technology, taxes, etc.) Whole curve shifts left (decrease) or right (increase) Change in a non‑price factor

Diagram convention: label the vertical axis “Price (P)”, the horizontal axis “Quantity (Q)”, the equilibrium point as P* and Q*, and shade CS and PS with clear hatching.

Market Equilibrium

Definition (ceteris paribus): The market is in equilibrium when the quantity demanded equals the quantity supplied at a particular price, so there is no tendency for the price to change.

Mathematically:

$$ Q_D(P^{*}) = Q_S(P^{*}) $$

where P* = equilibrium price and Q* = equilibrium quantity.

  • The market “clears”: every unit producers are willing to sell is bought by consumers.
  • There is neither excess supply (surplus) nor excess demand (shortage).

Disequilibrium

Definition (ceteris paribus): Disequilibrium occurs when, at the prevailing market price, Q_D ≠ Q_S. This creates a pressure for the price to move toward equilibrium.

Types of Disequilibrium

  1. Surplus (excess supply): Q_S > Q_D at the current price → downward pressure on price.
  2. Shortage (excess demand): Q_D > Q_S at the current price → upward pressure on price.

Adjustment Process

  • Surplus → price falls → quantity demanded rises and quantity supplied falls until Q_D = Q_S.
  • Shortage → price rises → quantity demanded falls and quantity supplied rises until Q_D = Q_S.

Welfare Interpretation – Consumer & Producer Surplus

  • Consumer surplus (CS):
    $$ CS = \int_{0}^{Q^{*}} \big[ P_D(Q) - P^{*} \big] \, dQ $$
    The monetary difference between what buyers are willing to pay (the demand curve) and what they actually pay (the market price).
  • Producer surplus (PS):
    $$ PS = \int_{0}^{Q^{*}} \big[ P^{*} - P_S(Q) \big] \, dQ $$
    The monetary difference between the market price received and the minimum price at which producers are willing to supply (the supply curve).

Both CS and PS represent net benefits (welfare) to buyers and sellers respectively. In equilibrium the sum CS + PS is maximised (ignoring externalities).

Elasticities and Their Relevance to Equilibrium

ElasticityFormulaInterpretation (Cambridge convention)
Price elasticity of demand (PED) $$\varepsilon_{D}^{P}= \frac{\% \Delta Q_D}{\% \Delta P} \; (<0)$$ |ε| > 1 = elastic; |ε| < 1 = inelastic; |ε| = 1 = unit‑elastic.
Income elasticity of demand (YED) $$\varepsilon_{D}^{Y}= \frac{\% \Delta Q_D}{\% \Delta Y}$$ Positive for normal goods, negative for inferior goods.
Cross‑price elasticity of demand (XED) $$\varepsilon_{D}^{X}= \frac{\% \Delta Q_{D_x}}{\% \Delta P_y}$$ Positive for substitutes, negative for complements.
Price elasticity of supply (PES) $$\varepsilon_{S}^{P}= \frac{\% \Delta Q_S}{\% \Delta P}$$ More elastic in the long‑run because firms can vary all inputs.

Why Elasticities Matter

  • They determine the magnitude of CS and PS changes when price moves (e.g., after a tax).
  • They affect the speed of the adjustment process – a high PES means quantity supplied can respond quickly to price changes.
  • They are crucial for analysing tax incidence:
    • If demand is relatively inelastic and supply relatively elastic, consumers bear most of the tax burden.
    • If supply is relatively inelastic and demand relatively elastic, producers bear most of the burden.

Numeric Example – Tax Incidence

Assume a market for “widgets” with the following linear functions (prices in £, quantities in units):

  • Demand: P_D = 100 – 0.5Q → PED = –0.5 (inelastic)
  • Supply: P_S = 20 + 0.25Q → PES = 0.25 (elastic)

Government imposes a £10 per‑unit tax on producers. Supply shifts upward by £10:

$$P_S^{\text{new}} = 20 + 0.25Q + 10 = 30 + 0.25Q$$

Equilibrium before tax:

$$100 - 0.5Q = 20 + 0.25Q \;\Rightarrow\; Q^{*}=112\;\text{units},\; P^{*}=44\text{£}$$

Equilibrium after tax:

$$100 - 0.5Q = 30 + 0.25Q \;\Rightarrow\; Q^{t}=93\;\text{units},\; P^{t}_{\text{buyers}}=53.5\text{£},\; P^{t}_{\text{sellers}}=43.5\text{£}$$

Incidence:

  • Buyers pay £9.5 of the £10 tax (53.5 – 44) → 95 % of burden.
  • Producers receive £0.5 less than before (43.5 – 44) → 5 % of burden.

Because demand is inelastic and supply relatively elastic, the tax falls mainly on consumers – a classic AO2/3 point.

Time‑frame – Short‑run vs. Long‑run

  • Short‑run: At least one factor of production is fixed; supply is relatively inelastic. Example – a bakery cannot instantly increase oven capacity, so a rise in wheat price leads to a steep upward shift of the short‑run supply curve.
  • Long‑run: All inputs can be varied; supply becomes more elastic. Example – the same bakery can invest in new ovens and hire extra staff; the long‑run supply curve is flatter, allowing quantity to adjust with a smaller price change.

Consequently, price adjustments are larger in the short‑run and smaller (but more quantity‑intensive) in the long‑run.

Link to Government Intervention (Topic 3)

Understanding the equilibrium model provides a benchmark for analysing the welfare effects of:

  • Price ceiling (e.g., rent control): sets a maximum price P_c below P* → creates a shortage, reduces CS for landlords, may generate dead‑weight loss.
  • Price floor (e.g., minimum wage): sets a minimum price P_f above P* → creates a surplus, reduces CS for employers, may cause unemployment.
  • Tax: shifts supply upward (or demand downward) → reduces both CS and PS, creates dead‑weight loss; incidence depends on PED & PES.
  • Subsidy: shifts supply downward (or demand upward) → increases CS and PS, may cause over‑production and a dead‑weight loss.

Critical Evaluation (AO3)

The simple equilibrium model rests on strong assumptions: perfect competition, full information, no externalities, and instant adjustment. In reality:

  • Markets may feature monopoly or oligopoly power, distorting price away from the competitive equilibrium.
  • Information asymmetries can prevent buyers or sellers from responding fully to price signals.
  • External costs (pollution) or benefits (education) mean that the market‑determined equilibrium is not socially optimal.
  • Adjustment can be slow or incomplete if factors are sticky (e.g., wages, contracts), leading to prolonged disequilibrium.

Students should discuss how government intervention can correct (or sometimes worsen) these failures, weighing efficiency gains against potential market‑distorting side‑effects.

Summary Table – Market Conditions

Condition Relationship between Q_D and Q_S Pressure on price Typical outcome
Equilibrium Q_D = Q_S No pressure – price stable at P* Market clears; CS + PS maximised (absent externalities)
Surplus (excess supply) Q_S > Q_D Downward pressure Price falls toward P*; quantity contracts
Shortage (excess demand) Q_D > Q_S Upward pressure Price rises toward P*; quantity expands

Key Take‑aways

  • Equilibrium = intersection of demand and supply (ceteris paribus); labelled P* and Q*.
  • Disequilibrium creates a surplus or shortage, generating price pressure that moves the market back toward equilibrium.
  • Only a change in the good’s own price causes a movement along a curve; any other determinant causes a whole‑curve shift.
  • Consumer surplus and producer surplus measure the net welfare benefits of a market outcome.
  • Elasticities determine how large surplus changes are and who bears the burden of taxes or subsidies.
  • Short‑run supply is relatively inelastic; long‑run supply is more elastic, affecting the speed and magnitude of adjustment.
  • The equilibrium model provides a benchmark for evaluating price controls, taxes, and subsidies, but its assumptions limit its applicability to real‑world markets.

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