Chapter 11 – Market Equilibrium

Equilibrium Price

Equilibrium price the price at which there is no tendency to change because planned (or desired or
ex ante) purchases (i.e. demand) are equal to planned sales (i.e. supply).

Buyers and sellers come together in a market. A price (sometimes called the market price) is struck
and goods or services are exchanged.

Different Situations in Market Equilibrium

 Demand is greater than supply and there is therefore excess demand (i.e., too much
demand in relation to supply) in the market. There will be a shortage of products on the
market.
 Supply is greater than demand and therefore there will be excess supply. There will be a
surplus of products on the market.
 There is only one price where demand equals supply. This price is known as the equilibrium
price.
o This is the only price where the demand of buyers equals the supply of sellers in the
market. It is also known as the market-clearing price because all the products supplied
to the market are bought or cleared from the market, but no buyers are left frustrated
in their wishes to buy goods.

CHANGES IN THE DEMAND AND SUPPLY

A change in price would lead to a change in quantity demanded or supplied, shown by a movement
along the demand or supply curve.

A change in any other variable, such as income or the costs of production, would lead to an increase or
decrease in demand or supply and therefore a shift in the demand or supply curve.

THE EFFECTS OF CHANGES IN DEMAND AND SUPPLY ON EQUILIBRIUM PRICE AND

QUANTITY

An increase in demand
shifts the demand
curve to the right, and
raises price and
output.

A decrease in demand
shifts the demand
curve to the left, and
reduces price and
output.
 An increase in supply
shifts the supply curve
to the right, which
reduces price and
increases output.

A decrease in supply
shifts the supply curve
to the left, which
raises price but
reduces output.

Market clearing
Equilibrium price is also called market clearing price because at this price the exact quantity that
producers take to market will be bought by consumers, and there will be nothing ‘left over’. This is
efficient because there is neither an excess of supply and wasted output, nor a shortage – the
market clears efficiently. This is a central feature of the price mechanism, and one of its significant
benefits.

Free market forces - forces in free

markets that act to reduce
prices when there is excess supply
and raise prices when
there is excess demand.
CONSUMER SURPLUS

Consumer surplus, the difference between how much buyers are prepared to pay for a good and
what they actually pay.

PRODUCER SURPLUS

Producer surplus, the difference between the market price which firms receive and the price at
which they are prepared to supply.

CHANGES IN CONSUMER AND PRODUCER SURPLUS DUE TO A CHANGE IN DEMAND AND SUPPLY

The amounts of consumer and producer surplus will change if either demand or supply change.
Changing consumer surplus and Producer Surplus due to a rise in demand

Producer Surplus

In Figure 5 demand increases. For suppliers, an increase in demand

results in higher equilibrium output and higher prices. Suppliers will
experience an increase in producer surplus from FGJ to FKM.

Consumer Surplus

For consumers, the increase in demand shows that they are

prepared to pay a higher price for the same quantity bought.
They place a greater value on the good. So, their consumer
surplus also increases from JGH to MKL
Changing consumer surplus and Producer Surplus due to a rise in Supply

Producer Surplus

If the supply increases, shown by a shift to the right in the supply curve. For
suppliers, an increase in supply results in higher equilibrium output but
lower prices. Suppliers will experience an increase in producer surplus
from JKH to FGM,

Consumer Surplus

For consumers, the increase in supply will lead to an increase in quantity

bought. So, their consumer surplus also increases from HKL to MGL.

*On the other hand, if there is a fall in supply, shown by a shift to the left in the supply curve,
consumer and producer surplus will both fall.