A market equilibrium happens when the supply of a good is equal to the demand for it. Market equilibrium is a phenomenon where the supply of a product meets the demand. Equilibrium entails balance. The price at which the quantity supplied and demanded are equal is known as the equilibrium price or market clearing price, and the quantity that corresponds to that price is known as the equilibrium quantity. A market has no motivation to stray from its equilibrium price and quantity if it is there. Economic pressures, however, start to build up when a market is out of balance and push it in the direction of the equilibrium price and quantity. Due to its description of the distribution of commodities and services in a market with perfect competition, the market equilibrium is also known as the competitive equilibrium. Each firm will experience a loss in a competitive market where buyers and sellers are price takers since the equilibrium price will be equal to marginal costs.
Market Equilibrium is a phenomenon that rarely happens since it’s considered a standard that the economy aspires to reach. However, a general equilibrium can be reached when the prices are almost near the index. An index is a level or price range to be reached. This calculated price is the actual equilibrium price based on the demand and supply function. But mostly, there is only a partial equilibrium in the market. Since there are monopolistic markets, sometimes equilibrium can also be faked to make a profit. For example, say a product is sold only by a single company. They can manipulate the supply to increase the price they sell.
Now, there is the quantity factor and the price factor. When the quantity produced is more, prices decrease. When the quantity produced is less, the prices decrease. Thus the quantity and the prices are inversely proportional.
There are seven types of market equilibrium. They are economic equilibrium, competitive equilibrium, general equilibrium, underemployment equilibrium, Lindahl equilibrium, and intertemporal equilibrium. Economic equilibrium is the condition in which economic forces, such as supply and demand, are balanced, and the levels of macroeconomic variables do not fluctuate. General equilibrium factors in a balance that is reached on the macroeconomic level. Underemployment equilibrium factors in the unemployment that the economy faces when it achieves general equilibrium Lindahl equilibrium is a quasi-market equilibrium for the sole benefit of the general population. But it is harder to achieve in theory. Intertemporal equilibrium refers to the volatility of prices below and above the equilibrium levels.
Changes in supply and demand are the primary factor that affects equilibrium. A change in supply occurs when a market’s suppliers start to provide either fewer or more of a certain item or service. Because of this, the amount offered to consumers changes. A change in demand describes how consumers desire more or less of a certain product, resulting in a shift in the quantity demanded. Change in parameters of either supply or demand creates a change in prices affecting the market equilibrium if achieved.
An example of equilibrium is the price of masks during and after the initial stages of the pandemic. There was a scarcity of masks during the early onset of the covid-19 pandemic. The prices of masks went up to 319%, according to data from the Organisation for Economic Co-operation and Development. But the prices reduced to original levels when the supply met the demand.
What is Market Equilibrium?
Market Equilibrium is a state of the market when the supply and demand balance with each other. The consumers would get goods at a price they are willing to pay, and the suppliers would also get a price at which they are willing to sell when market equilibrium is achieved. Adam Smith, the father of economics, had the opinion that in a free market, prices tend to gravitate toward the equilibrium price. The quantity supplied equals the number of goods demanded when a market is in equilibrium. The equilibrium can change when there is new competition in the market or a replacement product, or new technological improvements take place.
Prices typically oscillate near the equilibrium levels. Market forces will encourage sellers to enter and increase production if the price increases excessively. More bidders will place higher bids if the price is too low. These actions maintain the relative equilibrium level over time.
Disequilibrium is the opposite of equilibrium. An imbalance between the quantity supplied and the quantity required at a specific price is referred to as disequilibrium. Underpriced goods will lead to shortages or excess demand, which will drive up prices and encourage more supply until equilibrium is attained.
How does Market Equilibrium work?
Supply and demand are equal in a market where equilibrium is reached. But this phenomenon is highly theoretical since there is a rare chance for the market to reach such an equilibrium. The market can only hope to achieve an almost equilibrium or reach around the equilibrium price. A product’s supply rises as producers produce more of it to offer on the market, which leads to a decline in demand. This means that there aren’t many buyers in the market to buy the excess supply. Producers decide to decrease the price so that people can buy at a lower price. Therefore, his whole thing means that when the supply increases, prices decrease.
When there is too much of something in the market, people won’t bother buying it if it’s not a necessity good. On the other hand, if the demand is more and the supply is less, then the prices can increase as well. For example, precious metals, have high demand, but low supply, hence the prices are more too. When both demand and supply are plotted on a graph, there might be a point where these two curves, i.e., the demand and the supply curve, intersect. It is said that at this point the prices of both demand and supply are in equilibrium.
The below steps underline how market equilibrium is achieved.
- The supply and demand of a product or service start to move towards a central point. For example, the demand for mango becomes ten in a market when the supply is ten.
- The prices start to reach a central point as well with the supply and demand. For example, the price of mangoes starts to stay between Rs.100 and 105.
- Finally, equilibrium is reached and the product or service gets a desirable price in multiple viewpoints. For example, Rs.102.50 for the mangoes. This is called an equilibrium price and it is considered desirable for both the sellers and consumers.
Economics and authorities analyze market equilibrium. Market equilibrium is an important price point, and it could be an indicator of the economy. Economists and governments should closely analyze economic indicators to ensure they take the needed action, if required, to address any shortcomings in the economy. The authorities can make the most of the situation if reaching the equilibrium price is indicative of a positive aspect and is spotted on time.
What are the two types of Market Equilibrium?
There are two main types of equilibrium based on the factors involved.
1. Partial Equilibrium
Partial equilibrium is achieved when there is an equilibrium between any two factors while the other components remain constant. Components are often dependent on each other in an economy. But partial equilibrium neglects that fact to reach equilibrium. Partial equilibrium is a microeconomic phenomenon and it has no impact on macroeconomic levels.
An example of partial equilibrium is a balance that is achieved within a certain sector. Let us take the example of the FMCG sector to understand this. It is considered partial equilibrium when the FMCG sector achieves equilibrium while the rest of the market remains disequilibrium.
Partial equilibrium is an important concept as it can help you understand the situation of an economy at a microeconomic level. Partial equilibrium is often achieved by certain sectors of companies alone. This helps you figure out what the sector is doing right and analysis helps economists make the most out of the equilibrium.
The main difference between partial and general equilibrium is that partial equilibrium cannot be used at a macroeconomic level. Partial equilibrium is ineffective at a macroeconomic level as it never takes into account external factors and focuses solely on two or more variables.
2. General Equilibrium
General equilibrium is a balance achieved by involving multiple factors. General equilibrium is a phenomenon when the whole economy achieves a balance in terms of supply and demand. General equilibrium is a macroeconomic phenomenon. All industries and sectors are taken into consideration when it comes to general equilibrium. General equilibrium considers the independency of all market components.
The only example of general equilibrium is the whole economy achieving equilibrium. The supply and demand of the products and services would be ideal and equal when general equilibrium is achieved. There won’t be any surplus or shortage of goods and services. But general equilibrium is a rare phenomenon. Prices always tend to fluctuate near the equilibrium points. Economists believe that the close the price is to the equilibrium, the better the state of supply and demand.
General equilibrium is an important parameter because it gauges the economy is a macro level. General equilibrium is more realistic since it is not blind-sighted toward the interdependency of different components. General equilibrium becomes more important since the equilibrium of an isolated sector is often inadequate to gauge the current market situation.
The critical difference between general equilibrium and partial equilibrium is practicability. General equilibrium is more pragmatic since the whole economy is considered. General and practical equilibrium are used to study different economic theories as well.
What are the five factors affecting Market Equilibrium?
The five factors that affect the market equilibrium are excess demand, excess supply, changes in demand and supply, competitive factors, and strategic factors. The introduction of any of the five factors will fluctuate the price and affect the equilibrium.
The factors play a role even when there is no equilibrium price reached as market equilibrium is a rare phenomenon.
1. Excess Demand
Excess demand is a phenomenon that occurs when there is more demand for a product than its supply. The market price during excess demand is less than the equilibrium price. The price will increase in the direction of its new equilibrium when there is excess demand. Excess demand is also called a shortage. One of the two elements of market disequilibrium is the shortage when there is excess demand. Oversupply is the opposite circumstance of excess demand.
Excess demand affects the market equilibrium’s price factors. Price increases are pushed by excessive demand. There is a greater demand for things that are less readily available. Purchasers are enticed to decrease demand by price rises. They think the price is too high and beyond their pricing range. As a result, market demand progressively declines.
2. Excess Supply
Excess supply is the circumstance in which a price exceeds its equilibrium price. The occurrence of excess supply occurs when manufacturers or suppliers deliver a greater number of goods than anticipated. The demand for the good or service would be lower when compared to the supply in an excess supply situation. Excess supply
Excess supply affects market equilibrium as it would result in a significant rise in stock and fierce competition among merchants to sell their own inventories. Therefore, to sell more inventory, suppliers would begin to reduce prices to move the surplus stock. This decline in price manipulates the market supply and market demand, which correspondingly reduces and increases.
3. Changes in both demand and supply
Changes in demand and supply are a state where the current demand and supply levels are disrupted. Supply and demand are interrelated and change due to changes in the corresponding factors most of the time. But supply and demand can change without the pressure of the other factor as well. Supply could be curbed during a raw material shortage which drives up the demand. Such a situation will cause changes in both demand and supply components.
Changes in demand and supply bring about changes in equilibrium prices. The prices could go up if the supply is reduced and the demand is increased. The market equilibrium is disturbed and the market price moves further away from the equilibrium price. The market price may attain its nearness to the equilibrium price when supply and demand changes are rectified or it could move to a different equilibrium.
4. Competitive factors
Competitive factors deal with how companies that provide comparable goods or services affect one another. Consumers may opt for a different company (a competitor) for two main reasons – quantity or price. The consumer may opt for a competitor if the competitor is able to give a better service than what is already available. The consumer may also choose a competitor if they are able to provide services at a better price. Companies always try to bring a balance between price and quality to stay competitive.
Competitive factors affect the market equilibrium as they can change prices. The companies may be forced to bring down the prices to attract customers when they are unable to cope with the new competition. The equilibrium price changes when companies change their product or service prices.
5. Strategic factors
Closely related to the competition factor mentioned above, strategies can also influence prices. But it can either be from a competitor or from within their company. For instance, if there is a change in management or there is any expansion within the company, it can affect the prices.
This means that every decision made within a company as well as circumstances that are external to the market can play a role in affecting the market equilibrium. A small change made in the price of one of the companies can even disrupt the equilibrium.
What are examples of Market Equilibrium in the stock market?
The market is in equilibrium when the curves representing supply and demand coincide. Both the quantity supplied and the quantity required are equal at this point. The quantity reached during market equilibrium is the equilibrium quantity, and the matching price is the equilibrium price.
An example of equilibrium in the stock market is the performance of the FMCG sector in India during the pandemic period. The pandemic shook the supply and demand balance for most industries but FMCG remained strong. This equilibrium of FMCG during the first phase of the pandemic is underlined by the performance of the Nifty FMCG index. Nifty FMCG is an index that measures the performance of the FMCG sector. The FMCG index continued to see a steady rise of about 15% from March to June of 2022. The rate of rise during this period matches the equilibrium levels it had before.
Another example of market equilibrium in the stock market is the low-volume periods of a stock. The share price of a company will remain somewhat constant during a period of a lower number of trades, creating an equilibrium. The trades are considered factors that influence the equilibrium and when their number is lower, the price is more steady. But the price will start to drop or rise and move away from equilibrium once there are more trades as supply and demand levels are disturbed.
How do supply and demand relate to Market Equilibrium?
Supply and demand are two factors that affect the price of a product in the market. Supply is the quantity of a commodity that businesses, producers, workers, lenders, or other economic agents are willing and able to offer to the market or to a specific person. Demand is the amount of a good that buyers are ready and willing to buy at different prices at a particular time. Supply and demand work together to give a product or service a price. The price increases when there is excess demand and/or lesser supply. The price decreases when the supply is higher and/or the demand is lower. Supply and demand is the foremost determinant of market equilibrium.
- Market equilibrium is reached when the supply and demand reach a balance. The number of products in the market and the number of products needed by the customer should remain the same for a supply and demand balance.
- The market equilibrium is disoriented when there is an excess of lower supply. Excess supply results in a price drop while lower supply results in price rise.
- The market equilibrium changes when the demand goes up or high. The prices will increase when demand increases and the prices will drop when the demand drops.
How can we calculate Market Equilibrium?
Market equilibrium is calculated by calculating the equilibrium price and then comparing it with the current market price. The intersection of a product’s cost and demand, which results in a price compromise, is known as the equilibrium price. Customers who buy the goods and businesses that supply them are in balance at the equilibrium price. The equilibrium price can be calculated using the formula-
Qs = x + yP
Qs = the quantity supplied
X = quantity
P = price
Follow the below steps to understand how to calculate the equilibrium price.
- Finding the supply line – Use the formula Qs = x + yP to find the supply line first.
As an example, let us consider the demand for a product is 100 and the price is Rs.1 each. Then, Qs = 100 + 1P.
- Finding the quantity – Use the equation Qd = x + yP to find the quantity.
For example, the equation is Qd = 400 + 5P if the supply of the product is 400, priced at Rs.4 each.
- Equate supply and demand: Equate both supply and demand to find the equilibrium price.
That means Qs = Qd
Qs = 100 + 1P and Qd = 400 + 5P
100 + 1P = 400 + 5P
Using the basic rules of algebra, the answer becomes Rs. -0.75 = P
A negative equilibrium price signified that the demand is higher than the quantity supplied. By finding the equilibrium price, the company will be able to find the shortage of products in the market.
What are the advantages of Market Equilibrium in the stock market?
Market Equilibrium can be considered a standard that every company aspires to reach. Therefore, this figure of equilibrium can also be used by investors and stock market traders as a benchmark to evaluate the different companies and their prices and growth. In the stock market, the stock prices and their fluctuations are directly related to the fluctuations in the market equilibrium. That is, when the demand decreases, prices decrease as well. And so do the stock prices. This happens and vice versa as well.
The biggest advantage of market equilibrium in the stock market is that it helps lower the volatility of the market. Volatility is defined as the degree of possible price fluctuations in the market. Higher volatility entails higher risk. A state of equilibrium in the stock market means there is a lesser risk because the supply and demand are in a state of balance. But achieving such a balance is rare in the case of stock markets.
Market equilibrium helps attract more investors to the stock market as well. Price fluctuations keep some investors away from the stock market. The price fluctuations are kept at a minimum when there is a market equilibrium. Stability in the stock market could attract more conservative investors to invest in the stock market. At the same time, more investments could derail the equilibrium as well making it a rare feat to achieve.
What are the disadvantages of Market Equilibrium in the stock market?
The most critical disadvantage of market equilibrium in the stock market is that it is impossible to achieve. The stock market is driven by supply and demand. Supply and demand dynamics change with every trade unless there is a sell for every but. This achieving a similar balance is not possible as the market is driven by profits. Investors always look at the stock market with the aim to get more profits making it even more impossible.
Market equilibrium in the stock market would also create a low-growth environment. The stock market helps the economy grow when there is a price increase in general. Market equilibrium, if achieved, prohibits price increases, nullifying the growth potentials.
What is an Equilibrium price?
The equilibrium price is the price at which products or goods can be sold that does not create any excess supply.
The point of equilibrium on a graph of supply and demand for a product is where the supply and demand curves intersect. At this moment, the quantity and price of the product are agreed upon by both consumers and producers. The market for that product will no longer have equilibrium quantity or equilibrium pricing if either the quantity or the cost change.