Market equilibrium and equilibrium price

The basis of the market mechanism is the interaction of supply and demand. By bringing these concepts together, we can find out how the interaction of household decisions about buying a product and manufacturers’ decisions about selling it determines the price of a product and the amount that is actually bought and sold in the market.

According to the law of demand, the impulse of the behavior of the consumer (buyer) is set by the supply price (at which the producer offers his goods), which then faces the demand price (which the consumer is able and willing to pay).

Usually, a compromise is reached in the form of the “market price” of the commodity, at which it is actually sold and bought. The market price is also called the “equilibrium price”, because it is at the level when the seller is still willing to sell (at a lower price, the sale is unprofitable), and the buyer already agrees to buy (at a higher price, buying is unprofitable).

If you combine the downward demand curve (DD) and the upward supply curve (SS) on the same chart (Fig. 8.7.), the intersection point of the curves (E) shows that here demand is equal to supply and market equilibrium has been achieved. The coordinates of point E are the equilibrium price OF PE and the equilibrium volume of the QE commodity.

If the price of P1 deviates in favor of demand (point B) and turns out to be below the equilibrium price, then a deficit will arise (line AB on the chart), at which the amount of demand will exceed the amount of supply. The state of deficit will cause a reduction in inventories, increased competition between buyers for purchased goods, which will increase their willingness to pay a higher price. In this situation, manufacturers will begin to raise the price of goods.

Consequently, excess demand exerts upward pressure on the price, and it will grow until it is established at the equilibrium level (PE). It follows from this that whenever they want to please consumers and set a lower price, this leads to shortages, ruin of producers, to a shadow market.

If the price (P2), deviating in favor of sellers (point M), is higher than the equilibrium price, then competition between producers will increase, due to the inflow of capital from other areas, there will be an expansion of the production of goods, and as a result, the volume of supply will exceed the volume of demand. This situation will cause difficulties with the sale of goods and an increase in inventories (on the chart the CM line), which will put downward pressure on the price. This will lead to a decrease in the price to equilibrium and to a reduction in the amount of supply, and as a result – to a weakening of the competition of commodity producers.