Equilibrium Price

Definition

Equilibrium price is the price at which the quantity of a good demanded by consumers equals the quantity supplied by producers. It represents a state of balance in the market, where there is neither a surplus nor a shortage of goods, leading to stable prices. This price is crucial in understanding how supply and demand interact in markets, as it helps determine how resources are allocated efficiently.

5 Must Know Facts For Your Next Test

1. Equilibrium price is determined by the intersection of the supply and demand curves on a graph.
2. When the market price is above the equilibrium price, a surplus occurs, leading suppliers to lower prices to attract buyers.
3. Conversely, if the market price is below the equilibrium price, a shortage arises, prompting suppliers to raise prices due to high demand.
4. Changes in factors like consumer preferences, production costs, or external events can shift supply and demand curves, leading to a new equilibrium price.
5. Equilibrium price plays a critical role in signaling to producers and consumers about where resources should be allocated within the economy.

Review Questions

• How does a change in demand affect the equilibrium price of a good?
  • A change in demand directly affects the equilibrium price by shifting the demand curve either to the right (increase in demand) or to the left (decrease in demand). When demand increases, at any given price, more consumers want to buy the product. This can lead to a higher equilibrium price as suppliers respond to increased demand by raising prices. Conversely, if demand decreases, it can lead to lower equilibrium prices as suppliers reduce prices to clear excess inventory.
• What impact does a surplus have on the equilibrium price and how do markets respond?
  • A surplus occurs when the quantity supplied exceeds the quantity demanded at a given price. This excess supply puts downward pressure on the equilibrium price because sellers will lower prices to encourage sales and reduce their inventories. As prices fall, more consumers may enter the market, increasing demand until a new equilibrium is established where supply equals demand.
• Evaluate how external factors such as government regulations or natural disasters can disrupt market equilibrium and alter equilibrium prices.
  • External factors like government regulations can impose price ceilings or floors, disrupting the natural balance between supply and demand. For instance, a price ceiling may prevent prices from rising above a certain level during high demand periods, leading to shortages. Similarly, natural disasters can suddenly reduce supply by damaging production facilities or transportation networks. This shift can create immediate shortages, pushing prices higher until new equilibrium levels are reached as markets adjust to altered conditions.

Related terms

Supply: The total amount of a good or service that producers are willing and able to sell at various prices.

Demand: The total quantity of a good or service that consumers are willing and able to purchase at different price levels.

Market Equilibrium: A situation in which market forces are balanced, leading to no inherent tendency for price change; this occurs at the equilibrium price.