Market Equilibrium Price

In this note we bring the forces of supply and demand together

to consider the determination of equilibrium prices.
The Concept of Market Equilibrium

Equilibrium means a state of equality or a state of balance

between market demand and supply. Without a shift in
demand and/or supply there will be no change in market price.
In the diagram above, the quantity demanded and supplied at
price P1 are equal. At any price above P1, supply exceeds
demand and at a price below P1, demand exceeds supply. In
other words, prices where demand and supply are out of balance
are termed points of disequilibrium.
Changes in the conditions of demand or supply will shift the
demand or supply curves. This will cause changes in the
equilibrium price and quantity in the market.
Demand and supply schedules can be represented in a table. The
example below provides an illustration of the concept of
equilibrium. The weekly demand and supply schedules for T-
shirts (in thousands) in a city are shown in the next table:

Price per 8 7 6 5 4 3 2 1
unit (£)
Demand 6 8 10 12 14 16 18 20
(000s)
Supply (000s)18 16 14 12 10 8 6 4
New Demand 10 12 14 16 18 20 22 24
(000s)
New Supply 26 24 22 20 18 16 14 12
(000s)

1. The equilibrium price is £5 where demand and supply are

equal at 12,000 units
2. If the current market price was £3 – there would be excess
demand for 8,000 units
3. If the current market price was £8 – there would be excess
supply of 12,000 units
 4. A change in fashion causes the demand for T-shirts to rise
by 4,000 at each price. The next row of the table shows the
higher level of demand. Assuming that the supply schedule
remains unchanged, the new equilibrium price is £6 per tee
shirt with an equilibrium quantity of 14,000 units
5. The entry of new producers into the market causes a rise in
supply of 8,000 T-shirts at each price. The new equilibrium
price becomes £4 with 18,000 units bought and sold
Changes in Market Demand and Equilibrium Price

The demand curve may shift to the right (increase) for several
reasons:
1. A rise in the price of a substitute or a fall in the price of a
complement
2. An increase in consumers’ income or their wealth
 3. Changing consumer tastes and preferences in favour of the
product
4. A fall in interest rates (i.e. borrowing rates on bank loans or
mortgage interest rates)
5. A general rise in consumer confidence and optimism
The outward shift in the demand curve causes a movement
(expansion) along the supply curve and a rise in the equilibrium
price and quantity. Firms in the market will sell more at a
higher price and therefore receive more in total revenue.
The reverse effects will occur when there is an inward shift of
demand. A shift in the demand curve does not cause a shift in
the supply curve! Demand and supply factors are assumed to be
independent of each other although some economists claim this
assumption is no longer valid!
Changes in Market Supply and Equilibrium Price

���� The supply curve may shift outwards if there is

1. A fall in the costs of production (e.g. a fall in labour or raw
material costs)
2. A government subsidy to producers that reduces their costs
for each unit supplied
3. Favourable climatic conditions causing higher than
expected yields for agricultural commodities
4. A fall in the price of a substitute in production
5. An improvement in production technology leading to
higher productivity and efficiency in the production process
and lower costs for businesses
 6. The entry of new suppliers (firms) into the market which
leads to an increase in total market supply available to
consumers
The outward shift of the supply curve increases the supply
available in the market at each price and with a given demand
curve, there is a fall in the market equilibrium price from P1 to
P3 and a rise in the quantity of output bought and sold from Q1
to Q3. The shift in supply causes an expansion along the demand
curve.
Important note for the exams:
A shift in the supply curve does not cause a shift in the demand
curve. Instead we move along (up or down) the demand curve to
the new equilibrium position.
A fall in supply might also be caused by the exit of firms from
an industry perhaps because they are not making a sufficiently
high rate of return by operating in a particular market.
The equilibrium price and quantity in a market will change when
there shifts in both market supply and demand. Two examples of
this are shown in the next diagram:
In the left-hand diagram above, we see an inward shift of supply
(caused perhaps by rising costs or a decision by producers to cut
back on output at each price level) together with a fall (inward
shift) in demand (perhaps the result of a decline in consumer
confidence and incomes). Both factors lead to a fall in quantity
traded, but the rise in costs forces up the market price.
The second example on the right shows a rise in demand from
D1 to D3 but a much bigger increase in supply from S1 to S2.
The net result is a fall in equilibrium price (from P1 to P3) and
an increase in the equilibrium quantity traded in the market.
Moving from one market equilibrium to another
Changes in equilibrium prices and quantities do not happen
instantaneously! The shifts in supply and demand outlined in
the diagrams in previous pages are reflective of changes in
conditions in the market. So an outward shift of demand
(depending upon supply conditions) leads to a short term rise in
price and a fall in available stocks. The higher price then acts as
an incentive for suppliers to raise their output (termed as an
expansion of supply) causing a movement up the short term
supply curve towards the new equilibrium point.
We tend to use these diagrams to illustrate movements in market
prices and quantities – this is known as comparative static
analysis. The reality in most markets and industries is much
more complex. For a start, many firms have imperfect
knowledge about their demand curves – they do not know
precisely how demand reacts to changes in price or the true level
of demand at each and every price level. Likewise, constructing
accurate supply curves requires detailed information on
production costs and these may not be available.
The importance of price elasticity of demand
The price elasticity of demand will influence the effects of shifts
in supply on the equilibrium price and quantity in a market. This
is illustrated in the next two diagrams. In the left hand diagram
below we have drawn a highly elastic demand curve. We see an
outward shift of supply – which leads to a large rise in
equilibrium price and quantity and only a relatively small
change in the market price. In the right hand diagram, a similar
increase in supply is drawn together with an inelastic demand
curve. Here the effect is more on the price. There is a sharp fall
in the price and only a relatively small expansion in the
equilibrium quantity.
 Author: Geoff Riley, Eton College, September 2006

Equilibrium

Equilibrium is a term relating to a 'state of rest', a situation

where there is no tendency to change. In economics, equilibrium
is an important concept. Equilibrium analysis enables us to look
at what factors might bring about change and what the possible
consequences of those changes might be. Remember, that
models are used in economics to help us to analyse and
understand how things in reality might work. Equilibrium
analysis is one aspect of that process in that we can look at cause
and effect and assess the possible impact of such changes.
For the purposes of this resource we are going to look at market
equilibrium. Market equilibrium occurs where the amount
consumers wish to purchase at a particular price is the same as
the amount producers are willing to offer for sale at that price. It
is the point at which there is no incentive for producers or
consumers to change their behaviour. Graphically, the
equilibrium price and output are found where the demand curve
intersects (crosses) the supply curve.

Mathematically, what we are looking to find is the point where

the quantity demanded (Qd) is equal to the quantity supplied
(Qs). Let's take our example from above:
Assume the demand is Qd = 150 - 5P and that supply is given
by Qs = 90 + 10P. What we now have is a task that involves
understanding how to do simultaneous equations.
In equilibrium we know that Qs = Qd. Remember that Qs = 90 +
10P and that Qd = 150 - 5P. Given that we know that an
equation means that whatever is on the left hand side must be
the same as that on the right hand side we can re-write our
simultaneous equation as follows:
90 + 10P = 150 - 5P
We can now go about collecting all the like terms onto each side
(by doing the same to both sides) and solving the equation to
find P. Explanation 1 shows the long route and Explanation 2
the route you might normally see in a textbook.
Explanation 1

(90 - 90) + (10P + 5P) = (150 - 90) - (5P + 5P)

We have added 5P to both sides and taken away 90 from
both sides. This gives us:
15P = 60
Now divide both sides by 15 to get P on its own.
15P / 15 = 60 / 15
The 15P term will now cancel down. How many times does 15
go into 15P? Once.
60 / 15 = 4
P=4
Explanation 2

10P + 5P = 150 - 90
15P = 60
P=4
We now know the equilibrium price is 4 so we can substitute
this into the equations to get the Qd and Qs.
Qd = 150 - 5P
Qd = 150 - 5(4)
Qd = 150 - 20
Qd = 130
Doing the same thing to the supply:
Qs = 90 + 10P
Qs = 90 + 10(4)
Qs = 90 + 40
Qs = 130
So, the equilibrium price is 4 and the equilibrium quantity
bought and sold is 130.
Other examples of where this technique might be used include
finding equilibrium national income in a two sector economy
(for example, if just consumption and investment are
considered), in IS/LM analysis, in finding the break even point,
in prodcution calculations and many other areas.
Sometimes, you will also see demand and supply equations
written differently; don't panic. The principles are exactly the
same. Take the examples below:
P = 900 - 0.5Q and P = 300 + 0.25Q
Which is the equation for the demand curve and which for the
supply curve?
Remember, the relationship between demand and price is
inverse so the negative sign in the first equation tells you it is the
equation for the demand curve. There is a positive relationship,
however, between price and quantity supplied. The + sign thus
tells you that the second equation is the one for the supply curve.
Let's take these equations and find the equilibrium:
In equilibrium, the same price equates the demand and supply,
so:
900 - 0.5Q = 300 + 0.25Q (Collect all the like terms together)
900 - 300 = 0.25Q + 0.5Q
600 = 0.75Q
Q = 800
If the equilibrium quantity (Q) = 800 then we can now find the
equilibrium price through substituting Q into the two equations:
P = 900 - 0.5 (800)
P = 900 - 400
P = 500
For supply (as a check)
P = 300 + 0.25 (800)
P = 300 + 200
P = 500
Some examples to work through:

1.Q = 3P + 2, Qs = 2 - P
2.3P + 7Q = 10, 4P - Q = 3
3.5P + 10Q = 10, 2P - Q = 1
4.2P + Q = 7, 3P + Q = 10
5.5P + 3Y = 7, 4P - 5Y = 3
6.4P + 6Q = -13, 3P - 5Q = 14
7.6P + 3Q = 1, 4P - 2Q = 2
8.3P + 5Q = 12, 6P - 4Q = 3
9.6P + 3Q = 2P + Q = 1
10. 2P + Q = 7, 4P + Q = 11
11. 5P + 7Q = 12, 6P - 3Q = 3
12. 2P + 3Z = 2, 6P - 12Z = 13

Linear Regression Trendline

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A Linear Regression Trendline is a straight line drawn
through a chart of a security’s prices using the least squares
method, and it is used to forecast future trends.
A Linear Regression trendline uses the least squares method to
plot a straight line through prices so as to minimize the distances
between the prices and the resulting trendline.A Linear
Regression trendline is simply a trendline drawn between two
points using the least squares fit method. The trendline is
displayed in the exact middle of the prices. If you think of this
trendline as the “equilibrium” price, any move above or below
the trendline indicates overzealous buyers or sellers.

A Linear Regression trendline shows where equilibrium exists.

Raff Regression Channels show the range prices can be
expected to deviate from a Linear Regression trendline.