Market equilibrium

The essentials

A market is in equilibrium when market demand equals market supply. The price at which this happens is the equilibrium price and the quantity bought and sold is the equilibrium quantity. At this point the plans of buyers and sellers match.

Key points

• Excess demand: at a price below equilibrium, quantity demanded exceeds quantity supplied. Competition among buyers pushes price up.
• Excess supply: at a price above equilibrium, quantity supplied exceeds quantity demanded. Sellers cut price.
• Increase in demand only: equilibrium price and quantity both rise. Decrease in demand: both fall.
• Increase in supply only: price falls, quantity rises. Decrease in supply: price rises, quantity falls.
• Both increase: quantity rises; price may rise, fall or stay the same depending on which shift is larger. If the shifts are equal, price is unchanged.
• Demand rises, supply falls: price rises; quantity may go either way.
• Free entry and exit with identical firms: in the long run price equals the minimum AC of a firm. A rise in demand then only increases quantity (through new firms entering), and price stays at minimum AC.
• With linear curves qd = a − bp and qs = c + dp, equilibrium price p* = (a − c) ÷ (b + d).

Exam tips

• In equation questions, set qd = qs, solve for p, then put p back into either equation for q.
• For double shifts, state what is certain first, then explain what is uncertain.

Common mistakes

• Saying excess demand lowers price. Excess demand raises price.
• Assuming price always rises when demand rises, even under free entry and exit in the long run.