Market Equilibrium
With our understanding of demand and supply, we can now show how the decisions of buyers of corn interact with the decisions of sellers to determine the equilibrium price and quantity of corn. In the table in Figure 3.6 , columns 1 and 2 repeat the market supply of corn (from the table in Figure 3.5 ), and columns 2 and 3 repeat the market demand for corn (from the table in Figure 3.3 ). We assume this is a competitive market so that neither buyers nor sellers can set the price. Equilibrium Price and Quantity We are looking for the equilibrium price and equilibrium quantity. The equilibrium price (or marketclearing price ) is the price where the intentions of buyers and sellers match. It is the price where quantity demanded equals quantity supplied. The table in Figure 3.6 reveals that at $3, and only at that price , the number of bushels of corn that sellers wish to sell (7000) is identical to the number consumers want to buy (also 7000). At $3 and 7000 bushels of corn, there is neither a shortage nor a surplus of corn. So 7000 bushels of corn is the equilibrium quantity : the quantity demanded and quantity supplied at the equilibrium price in a competitive market. Graphically, the equilibrium price is indicated by the intersection of the supply curve and the demand curve in Figure 3.6 (Key Graph). (The horizontal axis now measures both quantity demanded and quantity supplied.) With neither a shortage nor a surplus at $3, the market is in equilibrium, meaning “in balance” or “at rest.” Competition among buyers and among sellers drives the price to the equilibrium price; once there, it remains unless it is subsequently disturbed by changes in demand or supply (shifts of the curves). To better understand the uniqueness of the equilibrium price, let’s consider other prices. At any above-equilibrium price, quantity supplied exceeds quantity demanded. For example, at the $4 price, sellers will offer 10,000 bushels of corn, but buyers will purchase only 4000. The $4 price encourages sellers to offer lots of corn but discourages many consumers from buying it. The result is a surplus (or excess supply ) of 6000 bushels. If corn sellers produced them all, they would find themselves with 6000 unsold bushels of corn. Surpluses drive prices down. Even if the $4 price existed temporarily, it could not persist. The large surplus would prompt competing sellers to lower the price to encourage buyers to take the surplus off their hands. As the price fell, the incentive to produce corn would decline and the incentive for consumers to buy corn would increase. As shown in Figure 3.6 , the market would move to its equilibrium at $3. Any price below the $3 equilibrium price would create a shortage; quantity demanded would exceed quantity supplied. Consider a $2 price, for example. We see both from column 2 of the table and from the demand curve in Figure 3.6 that quantity demanded exceeds quantity supplied at that price. The result is a shortage (or excess demand ) of 7000 bushels of corn. The $2 price discourages sellers from devoting resources to corn and encourages consumers to desire more bushels than are available. The $2 price cannot persist as the equilibrium price. Many consumers who want to buy corn at this price will not obtain it. They will express a willingness to pay more than $2 to get corn. Competition among these buyers will drive up the price, eventually to the $3 equilibrium level. Unless disrupted by changes of supply or demand, this $3 price of corn will continue to prevail.
References
