Page 67 - 6727

Economic Theory

The equilibrium price is the only price where the plans of consumers
and the plans of producers agree – that is, where the amount of the product
consumers want to buy (quantity demanded) is equal to the amount
producers want to sell (quantity supplied). This common quantity is called

the equilibrium quantity. At any other price, the quantity demanded does
not equal the quantity supplied, so the market is not in equilibrium at that

price. Market equilibrium requires that there be neither excess demand
nor excess supply, and hence, the market will be cleared.
The word “equilibrium” means “balance.” If a market is at its
equilibrium price and quantity, then it has no reason to move away from

that point. However, if a market is not at equilibrium, then economic
pressures arise to move the market toward the equilibrium price and the
equilibrium quantity.

At any above-equilibrium price, the quantity supplied exceeds the
quantity demanded. We call this an excess supply or a surplus. So, if the
price is above the equilibrium level, incentives built into the structure of
demand and supply will create pressures for the price to fall toward the

equilibrium.
When the price is below equilibrium, there is excess demand, or a
shortage – that is, at the given price the quantity demanded, which has

been stimulated by the lower price, now exceeds the quantity supplied,
which had been depressed by the lower price.
Finding the precise quantity that clears the market at a specific price
will require a little math. At equilibrium, the quantity demanded (Qd) must

equal the quantity supplied (Qs) = Q. Further, the demand price (Pd) must
equal the supply price (Ps) = P.

The demand and supply price equations are:
Demand Price: Pd = 40 – 2Qd.
Supply Price: Ps = 0 + 1,75Qs.
But, at the market-clearing equilibrium (but only at the market-

clearing equilibrium), we know that the demand price and the supply price
is the same: Pd = Ps = P, so the subscripts on P can be eliminated. Further,
at the market-clearing equilibrium Qd = Qs = Q, so the subscripts on Q can

also be removed. Now the demand and supply functions are represented by
two equations, one for demand and one for supply, with two unknowns, P
and Q. Algebra is used to solve this system of two equations in two
unknowns for the point where the demand and supply functions intersect.

This point of intersection is the market-clearing equilibrium.

67