The Supply and Demand (equilibrium)
Equilibrium is defined to the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves. In words, equilibrium exists when the sellers are willing to sell goods and services equal to the amount that buyers are willing to buy.
The market price of goods are determined by both the supply and demand for it. In 1890, English economist Alfred Marshall published his work, Principles of Economics, which was one of the earlier writings on how both supply and demand interacted to determine price. Today, the supply-demand model is one of the fundamental concepts of economics. The price level of a good essentially is determined by the point at which quantity supplied equals quantity demanded. To illustrate, consider the following case in which the supply and demand curves are plotted on the same graph.
Equilibrium: What Happens to Price When There Is a Surplus or a Shortage?
What did the middlemen do when the price was $ 5.00 and there was a surplus of apples? He lowered the price of apple. What did the middlemen do when the price was $2.5 and there was a shortage of apple? He raised the price. The behavior of the middlemen can be summarized this way: If a surplus exists, middlemen lower the price of apple ; if a shortage exists, middlemen raise the price of apple. This is how the middlemen moved the apple market into equilibrium.
Not all markets have middlemen. (When was the last time you saw an middlemen in the grocery store?) But many markets act as if an middle men were calling out higher and lower prices until equilibrium price is reached. In many real-world middlemen-less markets, prices fall when there is a surplus and rise when there is a shortage. Why?
WHY DOES PRICE OF GOODS FALL WHEN THERE IS A SURPLUS?
In the below table , there is a surplus of (150 Qs -50 Qd = 100) at a price of $15 and the Quantity supplied (150 units) is greater than quantity demanded (50 units). Suppliers will not be able to sell all they had hoped to sell at $15. As a result, their inventories will grow beyond the level they hold in preparation for demand changes. Then the sellers want to reduce their inventories by lowering prices to clear-off their inventories, some will cut back on production and others will do a little of both by reducing price and cutting back production . As shown in the picture, there is a tendency for price and output to fall until equilibrium is achieved.
WHY DOES PRICE OF GOODS INCREASES WHEN THERE IS A SHORTAGE?
In below table , there is a shortage of goods (150-50 =100 units) at a price of $5 and Quantity demanded (Qd) (150 units) is greater than quantity supplied (Qs) (50 units), buyers will not be able to buy all they had hoped to buy at $5. Some buyers will bid up the price to get sellers to sell to them instead of selling goods to other buyers. Some sellers, seeing buyers more demand for the goods, sellers will realize that they can raise the price of the goods that they have for sale. Hence the higher prices will also make the sellers to add (production) output. Thus, there is a tendency for price and output to rise until equilibrium is achieved.
The same information can be shown with a graph. On the graph, the equilibrium price and quantity are indicated by the intersection of the supply and demand curves.
By observing the below table it can be understood that the price of $3.00 is the equilibrium price and the quantity of 70 is the equilibrium quantity. At any other price, sellers would want to sell a different quantity than buyers want to buy.