Determining a Competitive Equilibrium
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Excess demand in a market is a price/quantity combination in which
consumers demand a greater quantity of a good than producers supply.
Excess supply in a market is a price/quantity combination in which
producers supply a greater quantity of a good than consumers demand.
A competitive equilibrium exists when the market finds a price/quantity
combination from which there is no incentive to move.
To understand the idea of
competitive equilibrium, examine
this example in which there is a case of
excess demand. At a price of $1.50
per loaf, consumers demand seven
loaves, but producers want to supply
only four loaves. The unsatisfied
consumers then bid against each other,
much like an auction, for the scarce
loaves of bread.
The case of excess supply uses the
same process but works in the opposite
direction.
At a price of $3 per loaf, seven loaves
are supplied, but only three are
demanded. Producers have to drop
their prices until enough buyers want
to purchase what is offered. Some
producers may drop out of the market
altogether as the price falls.
When there is either excess demand or
excess supply, a bidding process takes
place in the market. Consumers or
producers will leave or enter the
market at different points. The bidding
process drives the price to a point that
equilibrates demand and supply. In
this example, the equilibrium price is
$2.10 per loaf with five loaves
demanded and supplied. This
combination is the competitive
equilibrium.
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1170.doc –rev 11/07/2006