Equilibrium of Demand and Supply

Equilibrium 

Generally equilibrium is a state in which various forces are in balance. In economics equilibrium is a situation in which the market price reaches the level at which quantity demanded of a commodity equals to its quantity supplied. In other words, equilibrium is the point of intersection between the downward sloping demand curve and the upward sloping supply curve at which both are in balance. This balancing point of intersection is the point of market’s equilibrium. The price that balances the quantity supplied and quantity demanded is the equilibrium price and the quantity supplied and demanded at the equilibrium price is the equilibrium quantity.

The equilibrium price is sometimes called market-clearing price because every one in the market are satisfied. Consumers purchase all they want to buy and sellers sell all they want to sell. The concept of equilibrium between quantity supplied and demanded can also be explained by the following schedule.

Demand and Supply Schedule

Px	Dx	Sx	Balance
5	2	4	D<S
4	3	3	D=S
3	4	2	D>S

In the schedule, at per unit price $5, $4 and $3, quantities demanded of good-X are 2, 3 & 4 units and quantities supplied are 4, 3 & 2 units. At price $5, supply of good-X exceeds its demand and at price $3, demand for good-X exceeds its supply. So, the market is not in equilibrium at the prices $5 and $3 but it is in equilibrium at price $4 because the quantity demanded balances the quantity supplied. Hence, the equilibrium price is $4 and the equilibrium quantity is 3 units of good-X. In order to show the determination of equilibrium price and quantity, the schedule can be plotted in a diagrammatical form as;

The equilibrium situation of market is shown in the above diagram. In the diagram, X-axis measures quantity demanded and supplied of good-X and Y axis measures its per unit price. DD and SS are the demand and supply curves which intersect each other at point E. The point of intersection E is the equilibrium point and its corresponding price $4 and quantity 3 units are the equilibrium price and quantity respectively. The price $5 is higher price than the equilibrium price Rs. 4. At this price the buyers are ready to buy only 2 units of good-X whereas the sellers are willing to sell 4 units. It shows that the supply is excess than demand by ‘AB’ but no one is buying more than 2 units at that prevailing price. So the sellers reduce the supply of ice-cream by lowering the price. However, the buyers respond the fall in price by increasing demand. This process goes on till the quantity demanded equals to quantity supplied.

Similarly, at $3 per unit price, which is lower than the equilibrium price, the buyers are willing to buy 4 units of good-X whereas sellers are ready to sell only 2 cones of it. The demand is excess than supply by ‘CD’ but the buyers are not not getting the amount of goods that they are ready to buy at that prevailing price. The sellers respond the greater demand of buyers by increasing the price and quantity. Due to an increase in the price, the buyers cut down demand for goods from 4 units to 3 units. This process continues till the point of intersection reached. This is how equilibrium is attained in a market and the equilibrium price and quantity both are is determined simultaneously.

2- Change in Equilibrium

So far, we have seen how market forces demand and supply together attain equilibrium and how equilibrium price and quantity are determined by the interaction between the buyers and the sellers or producers in a free market. In fact, the equilibrium price and quantity depend on the position of demand and supply curves. When there is a change in any one of determinants of demand or supply or both of them, it occurs a shift in any one of the curves or both. The equilibrium in market gets changed, resulting in a new equilibrium price and quantity. The change in equilibrium is mainly caused by three reasons. They are, a change in demand, a change in supply and a change in the both demand and supply which are described separately as given below.

2.1- A Change in Demand

One of the reasons to change in equilibrium is a change in demand. When there is a change in any factor that influences demand, the demand for a commodity also changes. Consequently, there is a shift in demand curve either to the right or to the left from the initial point of equilibrium with the constant supply curve. This shift in demand curve will determine the new equilibrium price and quantity. Thus, a change in demand causes a change in equilibrium. The change in equilibrium has been explained under the following headings.

2.1.1-Increase in demand with constant supply

When there is an increase in demand due to change in other factors with constant supply, the demand curve shifts to the right. This shift in demand curve breaks the initial equilibrium and establishes a new equilibrium with a higher price and quantity. So the increase in demand with constant supply causes to rise in both the price and quantity. The increase in demand with constant supply has been shown in the following diagram as;

In the above diagram, E is the initial point of equilibrium at which P1 and Q1 are the equilibrium price and quantity of umbrellas. Now let’s suppose that there is a change in weather. It has been raining heavily for last three days . There is still no signs to clear out the clouds and stop the rain. This leads to increase in demand for umbrella and the demand curve shifts upward. This new demand curve D1D1 intersects SS supply curve at the point E1 which is the new point of equilibrium between the quantity of umbrellas demanded and supplied. This point of equilibrium causes an increase in both the price and quantity of umbrellas  from OP1 to OP2 and OQ1 to OQ2 respectively. Now the new equilibrium price and quantity of umbrellas are OP2 and OQ2.

2.1.2- Decrease in demand with constant Supply

When the demand for a commodity decreases due to the change in other factors that influence demand, the demand curve shifts to the left. This shift in demand curve breaks the initial equilibrium and attains a new point of equilibrium causing a fall in both the price and the quantity. So the decrease in demand for a commodity with constant supply, causes to fall in the price and the quantity demanded and supplied of a commodity. The decrease in demand with its constant supply and its effect on the price and quantity of a commodity has been shown in the diagram below.

In the above diagram E is the initial point of equilibrium at which P2 and Q2 are the equilibrium price and quantity of umbrellas. Now let’s suppose that there is a change in weather. It has completely stopped raining . Now the sky is clear and there is no signs to rain again. This leads to decrease in demand for umbrellas   and the demand curve shifts to backward from DD to D1D1. This new demand curve D1D1 intersects SS supply curve at E1 which is the new point of equilibrium between the quantity of umbrellas demanded and supplied. This point of equilibrium shows a fall in both the price and quantity of umbrellas  from OP2 to OP1 and OQ2 to OQ1 respectively. Now the new equilibrium price and quantity of umbrellas are OP1 and OQ1.

2.2-A Change in Supply

A change in supply also causes change in equilibrium position and it also results in change in the price and quantity of a commodity demanded and supplied. When there is a change in supply due to the change in other factors that influence supply, the supply curve shifts either to the right or to the left from from the initial point of equilibrium. With a constant demand curve, a forward shift in supply curve causes a fall in equilibrium price and rise in equilibrium quantity. On the other hand, a backward shift in supply curve causes a rise in equilibrium price and fall in equilibrium quantity. The change in supply and its effect on the equilibrium price and quantity has been explained under the following headings

2.2.1-Increase in Supply with constant demand

When there is an increase in the quantity supplied due to change in other factors with constant demand, the supply curve shifts forward. This shift in supply curve breaks the initial equilibrium and establishes a new equilibrium with a fall in equilibrium price and rise in quantity demanded and supplied. Suppose that , due to the availability of sufficient raw materials as inputs for producing umbrellas, their production cost decreases. It gives rise to the production of umbrellas. The demand curve does not change because the input cost and its availability does not directly affect the demand for umbrellas . It’d rather affected by the condition of weather. When the inputs used to produce umbrellas are easily available at a cheaper price, the cost of production of umbrellas falls and a large number of umbrella can be produced and supplied. Therefore, the supply curve shifts to the right from the initial equilibrium. Consequently, there is a change in equilibrium leading to fall in the equilibrium price and increase in the equilibrium quantity. The shift in supply curve and change in equilibrium have been illustrated in the following diagram.

In the above diagram, demand and supply of umbrellas and its prices are measured along X and Y axis respectively. The downward sloping DD curve is the demand curve and the upward sloping SS curve is the initial supply curve. The point E is the initial point of equilibrium. Lets suppose that there is the availability of sufficient raw material for producing umbrellas. Consequently, the production cost of umbrellas falls and its production increases. Hence, the supply of umbrellas increases and with this the supply curve shifts to the right from SS to S1S1 and the new point of equilibrium E1 establishes. This change in equilibrium causes a fall in equilibrium price from OP2 to OP1 and a rise in equilibrium quantity from OQ1 to OQ2. In this way a change in supply brings changes in equilibrium condition as well as in equilibrium price and quantity.

2.2.2- Decrease in supply with constant demand

With a decrease in supply due to change in other affecting factors, supply curve shifts backward. This shift in supply curve disturbs the initial equilibrium and establishes a new point of equilibrium. At the new point of equilibrium, the equilibrium price rises and the equilibrium quantity declines. Suppose that an unavailability of sufficient raw materials for producing umbrellas, drives up cost of production. It reduces the number of umbrellas that produced and supplied at any given price. The demand curve does not change because the input cost and its unavailability does not directly affect the demand for umbrellas. It’d rather affected by the condition of weather. Therefore, the supply curve shifts backward from the initial equilibrium. This leads to rise in the equilibrium price and decrease in the equilibrium quantity. The shift in supply curve and its effect on the equilibrium price and quantity is illustrated in the following diagram.

In the above diagram, demand and supply of umbrellas and its prices are measured along X and Y axis respectively. The downward sloping DD curve is the demand curve and the upward sloping SS curve is the initial supply curve. The point E is the initial point of equilibrium. Lets suppose that there is an unavailability of sufficient raw material for producing umbrellas. Consequently, the production cost of umbrellas rises and its production decreases. Hence, the supply of umbrellas decreases and with this the supply curve shifts to backward from SS to S1S1 and the new point of equilibrium E1 establishes. This change in equilibrium causes a rise in equilibrium price from OP1 to OP2 and a fall in equilibrium quantity from OQ2 to OQ1. In this way a change in supply brings changes in equilibrium condition as well as in equilibrium price and quantity.

3- Simultaneous shift in demand and supply curve

Sometimes it also happened that the supply and demand curve both simultaneously shift to the same or an opposite direction due to a change in their determinants at the same time period. In such a case, a change in the equilibrium price and quantity occurs differently.

The change in equilibrium price and quantity that occurs due to change in the determinants of demand and supply at the same time is stated in the table below.

Shift in Demand and Supply 1-If demand and supply curves shift forward simultaneously, 2-If demand and supply shift backward simultaneously, 3-If demand curve shifts forward and supply curve shifts backward simultaneously, 4-If demand curve shifts backward and supply curve shifts forward simultaneously,

Effect on price and quantity 1-Price ambiguous but quantity increases. 2-Price ambiguous but quantity decreases. 3- Price increases but quantity is ambiguous. 4-Price decreases but quantity is ambiguous.