MARKET EQUILIBRIUM
PRICE NOTES
DETERMINING PRICES IN A FREE MARKET
SYSTEM
Assuming
that competition exists,
prices are determined in a market
system through the interaction of
buyers (those who are willing and
able to purchase goods) and
sellers (those who are willing and
able to produce or sell goods).
 This
means that without government
intervention, the “invisible hand” of the
marketplace coordinates the quantities
that consumers are willing and able to
purchase (demand) and that producers
are willing and able to sell (supply) at
various prices at a particular point in
time.
When
the market matches up the
two sides (supply and demand) of
the market, a market price is
determined. The market price is
that price at which all that is
supplied is demanded.
EQUILIBRIUM IN THE MARKETPLACE
Equilibrium in the
Marketplace
P
The Pe =
2$
The Qe =
10 units
At the market price, what is the relationship of
QS
=
QD?
S
3
Because this relationship exists, the market is said to
be in balance at the market price.
2
1
D
5
10
15
Q
Therefore, the market price is also called the
equilibrium price (Pe) and the quantity at the
market price is called the
equilibrium quantity (Qe).
The market price and quantity (Pe and Qe) are found
ONLY at the intersection of the supply and demand
curves.
DISEQUILIBRIUM IN THE MARKETPLACE
Disequilibrium in the
Marketplace
If the seller(s) decide to raise the price of the good
above the market price (Pe) from $2 to $3,
S
P
3
___P above Pe:
5
QD 15
QS n/a S n/a D
2
D
1
5
10
15
Q
At the new higher price: QD
Therefore, SURPLUS exists.
<
QS
The market is in disequilibrium (out of balance)
because a SURPLUS exists. When this occurs,
sellers will ____ P, then QD ____ and QS _____
until QD ____ QS. Because of the laws of
SUPPLY and DEMAND, the market always seeks
equilibrium. In this case, P will ____ until Pe is
reached. QS - QD = the size or amount of the
SURPLUS which = 10 .

DISEQUILIBRIUM IN THE MARKETPLACE
Disequilibrium in the
Marketplace
P
If the seller(s) decide to lower the price of the good
below the market price (Pe) from $2 to $1,
S
3
__P below Pe:
15 QD
5 QS n/a S n/a D
2
1
D
5
10
15
Q
At the new lower price: QD > QS
Therefore, SHORTAGE exists.
The market is in disequilibrium (out of balance) because a SHORTAGE exists. When this
occurs, sellers will ____ P and then QD ______ and QS __ ___ until QD = QS. In this
case, P will ____ until Pe is reached. QD - QS = size or amount of the SHORTAGE
which = 10 .
HOW THE MARKET PRICE IS CHANGED
If the seller raises or lowers the price above/below the market price equilibrium (Pe), the
result will be a SHORTAGE or SURPLUS . This is because the change in price
simply causes movement along the demand and supply curves. This movement changes only the
QD and the QS , thus causing QD and QS to no longer be in balance.
For the market price to change, there must be a new intersection of supply and demand; thus,
the market price changes ONLY if there has been a change in SUPPLY or DEMAND
DETERMINANTS . Such
resulting from a change in NON - PRICE
changes will cause a SHIFT in the supply and/or demand curves, resulting in a new
intersection and therefore, a new Pe and a new Qe .
Effects of changes in supply and demand
on the market price
Increase in Demand
Decrease in Demand
P
____D_____Pe_____Qe
S
D2
D
Increase in Supply
S
____D_____Pe_____Qe
D2 D
Decrease in Supply
P
____S_____Pe_____Qe
P
S
S2
D
P
____S_____Pe_____Qe
S2 S
D
GOVERNMENT INTERVENTIONS IN THE
MARKET PLACE
Sometimes government intervenes in the operation of the
FREE
MARKET
because the people have asked the government to do something
about prices that are “ TOO LOW” or “ TOO HIGH ”. The government
takes action in these instances to place legal barriers on the market place that
will not allow
PRICE to fall below a certain price or to
RISE
above
a certain price. These legal barriers are identified and defined below:


PRICE
may not fall.
FLOOR : legal minimum price below which the price of a good
PRICE
not rise.
CEILING : legal maximum price above which the price may

Price Ceiling
Price Floor
To be effective, a minimum price must be To be effective, a maximum price must be
placed ABOVE the Pe (equilibrium price). placed BELOW the Pe (equilibrium price).
Such a minimum price will create a
SURPLUS .
Such a maximum price will create a
SHORTAGE .
Effect of a price floor/support:
P
S
D
Effect of a price ceiling:
P
S
D