Definition of market equilibrium

Published by Patrick Mutisya · 14 days ago

Cambridge IGCSE Economics 0455 – Allocation of Resources: Price Determination

Allocation of Resources – Price Determination

Objective

Define market equilibrium and understand how it is reached through the interaction of supply and demand.

Key Concepts

  • Demand: The quantity of a good or service that consumers are willing and able to purchase at various prices, ceteris paribus.

  • Supply: The quantity of a good or service that producers are willing and able to sell at various prices, ceteris paribus.

  • Market Price: The price at which a good is bought and sold in a market.

  • Market Quantity: The quantity of a good that is bought and sold at the market price.

Definition of Market Equilibrium

Market equilibrium occurs when the quantity demanded equals the quantity supplied at a particular price. At this point there is no tendency for the price to change because the amount that buyers want to purchase exactly matches the amount that sellers want to sell.

Mathematically, equilibrium is expressed as:

\$Qd = Qs\$

where \$Qd\$ is the quantity demanded and \$Qs\$ is the quantity supplied.

How Equilibrium is Reached

  1. At a price above equilibrium, the quantity supplied exceeds the quantity demanded, creating a surplus.

  2. Producers respond to the surplus by lowering the price to clear excess stock.

  3. At a price below equilibrium, the quantity demanded exceeds the quantity supplied, creating a shortage.

  4. Consumers compete for the limited goods, pushing the price up.

  5. These adjustments continue until \$Qd = Qs\$, i.e., the market reaches equilibrium.

Characteristics of Equilibrium

FeatureExplanation
Stable priceThe price tends to remain constant unless an external factor shifts supply or demand.
Efficient allocationResources are allocated where they are most valued; no excess or unmet demand.
No surplus or shortageQuantity supplied equals quantity demanded.

Diagrammatic Representation

Suggested diagram: Standard demand and supply curves intersecting at the equilibrium point (E). Label the axes (Price on the vertical axis, Quantity on the horizontal axis), the demand curve (D), the supply curve (S), the equilibrium price (Pe) and equilibrium quantity (Qe). Indicate surplus above Pe and shortage below Pe.

Factors that Shift Equilibrium

Any change that alters either the demand curve or the supply curve will move the equilibrium price and quantity.

  • Demand Shifters: consumer income, tastes, price of related goods, expectations, number of buyers.

  • Supply Shifters: input prices, technology, expectations, number of sellers, taxes/subsidies.

Example Calculation

Suppose the demand equation is \$Qd = 120 - 2P\$ and the supply equation is \$Qs = 20 + 3P\$, where \$P\$ is price.

Set \$Qd = Qs\$ to find equilibrium:

\$120 - 2P = 20 + 3P\$

\$100 = 5P\$

\$P_e = 20\$

Substitute \$Pe\$ back into either equation to find \$Qe\$:

\$Q_e = 20 + 3(20) = 80\$

Thus, the equilibrium price is \$£20\$ and the equilibrium quantity is 80 units.