Equilibrium
The equilibrium price is where the quantity demanded equals the quantity supplied. At any higher price there is a surplus: sellers want to sell more than buyers want to buy, which pushes the price down. At any lower price there is a shortage, which pushes the price up. Competitive markets move toward equilibrium without anyone planning it.
Worked example: finding equilibrium
Suppose, for a town's weekly fresh-fish market:
- Demand: Qd = 100 − 2P
- Supply: Qs = 20 + 3P
(P in dollars, Q in kilos.) Set Qd = Qs: 100 − 2P = 20 + 3P, so 80 = 5P and P = 16. Substitute: Qd = 100 − 32 = 68, and Qs = 20 + 48 = 68. Equilibrium is P = 16, Q = 68.
Now a health report boosts demand so that Qd = 120 − 2P. Then 120 − 2P = 20 + 3P gives 100 = 5P, so P = 20 and Q = 20 + 60 = 80. A rightward demand shift raised both price and quantity.
Predicting shifts
Keep a four-way rule in mind:
- Demand increases: price up, quantity up.
- Demand decreases: price down, quantity down.
- Supply increases: price down, quantity up.
- Supply decreases: price up, quantity down.
If both curves shift, you can usually predict one of price or quantity, but the other depends on which shift is larger.
Price controls
A price ceiling is a legal maximum price. If it is set below equilibrium, it binds and creates a shortage. Using our fish market with a ceiling of 10: Qd = 100 − 20 = 80 and Qs = 20 + 30 = 50, a shortage of 30 kilos. Rent control is a common real-world example, and it can lead to queues, lower quality and black markets.
A price floor is a legal minimum price. If set above equilibrium it binds and creates a surplus. With a floor of 20: Qd = 100 − 40 = 60 and Qs = 20 + 60 = 80, a surplus of 20 kilos. Agricultural support prices and minimum wages are examples.
Key point: a ceiling set above equilibrium, or a floor set below it, does nothing, because the market price is already within the limit. Always check whether the control is binding before predicting anything.