Lesson objective

At the end of this lesson, you will be able to:

• Define market equilibrium
• Show the equilibrium price and the equilibrium quantity from the graph.
• Outline the graph of market equilibrium.
• Explain the concept of excess demand and excess supply in the market.

Brainstorming Question

Think of the situation in your local market and enumerate the goods that are expensive and cheap in the market, and explain the reasons for price differences

Key Terms and Concepts

In the preceding sections, we discussed both consumers’ demand for goods in a market and firms’ supply of goods independently. Demand and supply curves indicate how much consumers demand and how much producers supply at different prices, respectively. However, they do not directly determine the actual price of a product in general. Now, we turn to the important question: how do the forces of demand and supply work together to determine market prices? We explain how these forces lead to “equilibrium” and how the “equilibrium price” is established.

The Concept of Equilibrium

The term “equilibrium” refers to a state of balance. In the physical world, when two opposing forces acting on an object are balanced such that the object remains stationary, it is said to be in equilibrium. Similarly, in economics, an economic system is in equilibrium when its key variables show no tendency to change, with no external forces acting on them to alter their values. For example, after reaching equilibrium, a consumer has no intention of reallocating their money or income. Likewise, a firm is in equilibrium when it has no tendency to adjust its output level, either upward or downward. The tendency towards equilibrium price is known as the “market mechanism,” and the resulting balance between supply and demand is termed “market equilibrium.”

In real-world economic activities, perfect equilibrium may never actually be realized. The central idea of equilibrium analysis in economics is that economies tend towards equilibrium when no external forces disrupt them.

Market Equilibrium

In the context of price determination, market equilibrium occurs when the quantity demanded of a commodity equals the quantity supplied. It signifies the balance between the opposing forces of demand and supply.

Equilibrium Price

The price at which the quantity demanded of a commodity equals the quantity supplied is known as the “equilibrium price.” This price is determined by the forces of demand and supply in a given market. At equilibrium price, the amount consumers wish to buy matches the amount producers are willing to sell.

Equilibrium Quantity

Equilibrium quantity is the quantity of a commodity that is bought and sold at the equilibrium price. It represents the amount consumers are willing to buy at the equilibrium price, which matches exactly what producers are willing to supply.

Illustration of Market Equilibrium

To understand how the forces of demand and supply operate in a market to determine equilibrium price and quantity, consider an imaginary market with numerous buyers and sellers of a commodity, such as oranges. Table 4.5 illustrates the demand and supply schedule for oranges at various prices in this hypothetical market.

Price (Birr per kg)	Demand (kg)	Supply (kg)	Trend
5	1000	200	Excess demand
10	800	400	Excess demand
15	600	600	Equilibrium
20	800	800	Excess supply
25	200	1000	Excess supply

In the above market demand schedule, there is one price at which market demand equals market supply. This price is Birr 15 per kg because, at this price, the quantity demanded equals the quantity supplied, specifically 600 kg of oranges. Therefore, the equilibrium price is determined to be Birr 15 per kg. It is the price at which the maximum number of buyers and sellers find satisfaction. Thus, as long as market demand and supply remain unchanged, the price will neither tend to rise nor fall below this equilibrium price. Any change in the equilibrium quantity will result in either excess demand or excess supply in the market.

Case of Excess Demand

Excess demand for a commodity occurs when consumers want to buy more than what producers are willing to supply. If, at a given price, demand exceeds supply, competition among buyers will drive the price up to the point where demand equals supply. For example, suppose the current price of oranges in the market is Birr 10 per kg. At this price, demand for oranges is 800 kg while supply is only 400 kg, resulting in an excess demand of 400 kg (800 – 400). This shortage will lead to competition among buyers, driving the price up until it reaches the equilibrium price of Birr 15 per kg, where demand equals supply (600 kg of oranges).

Case of Excess Supply

Excess supply of a commodity occurs when producers are willing to supply more than what consumers want to buy. If, at a given price, the quantity supplied exceeds the quantity demanded, competition among sellers will push the price down until supply matches demand. For instance, suppose the price of oranges is Birr 20 per kg. At this price, the demand is 400 kg while the supply is 800 kg, resulting in an excess supply of 400 kg. In response, sellers will compete to sell their oranges by lowering the price until it reaches Birr 15 per kg, the equilibrium price where demand equals supply (600 kg of oranges).

Graphical Presentation of Market Equilibrium

The determination of equilibrium price and quantity can be illustrated graphically using market demand and supply curves. Figure 4.5 depicts the market equilibrium.

Figure 4.5 depicts the market’s equilibrium

The graph shows the market demand curve (DD) and the market supply curve (SS). The equilibrium point E is where these curves intersect. At this point:

• The equilibrium price is Birr 15.
• The equilibrium quantity is 600 kg.

In summary, the equilibrium price of a commodity graphically is where the demand and supply curves intersect. The graph also illustrates situations of excess demand and surplus supply.