Market Equilibrium

Definition

Market equilibrium is the point where the quantity of a good or service demanded by consumers equals the quantity supplied by producers, resulting in a stable market price. This balance reflects the interaction of supply and demand, and any changes in external factors can disrupt this equilibrium, leading to fluctuations in price and quantity.

5 Must Know Facts For Your Next Test

1. Market equilibrium is achieved at the intersection of the supply and demand curves on a graph, where both curves meet.
2. When there is a surplus, where supply exceeds demand, prices tend to decrease until equilibrium is restored.
3. Conversely, when there is a shortage, where demand exceeds supply, prices usually increase until the market reaches equilibrium again.
4. Externalities, such as positive or negative impacts on third parties not reflected in market prices, can shift supply and demand curves, affecting market equilibrium.
5. Market equilibrium does not always mean that all goods are sold; it simply indicates the price and quantity at which the market is stable.

Review Questions

• How does an externality affect market equilibrium?
  • An externality can significantly impact market equilibrium by shifting either the supply or demand curve. For instance, a negative externality, like pollution, increases production costs for suppliers, leading to a decrease in supply. This shift causes the equilibrium price to rise and quantity sold to drop, resulting in potential market failure if not addressed through regulation or taxation.
• In what ways can changes in factor demand affect market equilibrium?
  • Changes in factor demand directly influence production capabilities and costs. For example, if there's an increase in demand for labor in a certain industry, firms may pay higher wages to attract workers. This increased cost can lead to a decrease in supply of goods produced, causing a leftward shift in the supply curve. As a result, market equilibrium will adjust with higher prices and lower quantities sold.
• Evaluate the long-term implications of persistent market disequilibrium on consumer and producer surplus.
  • Persistent market disequilibrium can severely affect both consumer and producer surplus over time. For consumers, continual price increases due to sustained shortages can erode purchasing power and satisfaction, reducing overall consumer surplus. Similarly, producers may struggle with fluctuating prices and uncertainty in demand, impacting their profitability and willingness to invest. Over time, this instability can lead to inefficient markets where resources are misallocated, ultimately harming economic growth.

Related terms

Supply and Demand:

The fundamental economic model that describes how the quantity of a good or service changes based on its price, reflecting consumer behavior and producer decisions.

Consumer Surplus:

The difference between what consumers are willing to pay for a good or service and what they actually pay, representing the benefit to consumers from participating in the market.

Producer Surplus:

The difference between what producers are willing to accept for a good or service and what they actually receive, representing the benefit to producers from participating in the market.