What is Equilibrium Price and Quantity?
Equilibrium refers to a state of balance that comes about because there is equality in all forces.
Economic equilibrium refers to those situations where all market forces that are being considered, like demand and supply, are equal.
To further understand this, consider the case of two friends who are deciding how to spend their holiday. One of them wants to go out for dinner while the other wants to go for a movie. They begin their discussion at a place where none of them is ready to compromise-only watching the movie is unacceptable to the first friend, and only going out for dinner is unacceptable to the other. However, with persistent conversations, figuring out schedules, making a few adjustments, they finally come to a plan that works for both of them-they decide to order food and watch a movie while having dinner. Or they agree to watch the movie first and then have dinner. In either case, they have reached what we will call an equilibrium-a place of balance that both agree with.
Similarly, bargaining is also a form of reaching an equilibrium. Suppose a tomato vendor was charging you ₹100 per kg, but you thought it was too much and quoted a price of ₹70. Since this was too low for the vendor, he then agreed to give you the tomatoes for ₹90, to which you responded with a price of ₹80. Finally, after several rounds of offers, both of you agreed to settle on ₹85. In this case, then, ₹85 becomes your equilibrium or point of balance.
The same is the case with the economic market. The equilibrium is achieved when the ‘bargain’ between the supply side and the demand side reaches a place of balance. It is that point where both sides are ready to agree.
Technically speaking, at each price, the suppliers in the market are willing to supply a different quantity, and this quantity increases with an increase in price. The consumers, too, are willing to buy a different quantity of the good at different prices, and this quantity decreases with an increase in price. There is only one point at which these two quantities coincide, and this is the place of equilibrium. This quantity is called the equilibrium quantity, and the price at which this quantity exists is called the equilibrium price.
How to Find Equilibrium Price and Quantity?
In a Tabular Form
In some cases, you may be given the quantity demanded and the quantity supplied at different prices in a tabular form as follows:
In such a case, the first step is to find the row where the demand and supply values are equal. This common value mentioned for both demand and supply will be the equilibrium quantity, which is obvious, by definition.
The corresponding price in the row at which these quantities appear will be the equilibrium price.
This table can also be used to plot the demand and supply curves, and equilibrium can also be found graphically.
Demand is an inverse function. This means that the demand for a normal good falls as the price rises because consumers are less willing to buy the product at higher prices.
Supply, on the other hand, has a direct relation to price. As the price of goods increases, suppliers have more incentive to produce more, and thus, the supply increases.
To find the equilibrium quantity, draw a straight line vertically downwards from e to touch the x-axis. The point at which this line meets the x-axis gives you the equilibrium quantity. In the diagram above, this is shown by Eq=3.5.
Similarly, to find the equilibrium price, draw a straight line horizontally leftwards from e to touch the y-axis. The point at which this line meets the y-axis gives you the equilibrium price. In the diagram above, this is shown by Ep=250.
Sometimes, the demand and supply curves are not represented as graphs or tables but as equations. In this case, equilibrium can be found by solving the two equations simultaneously.
For instance, let the curves be represented by:
For all the following steps, our beginning point is the knowledge that at equilibrium, quantity demanded equals quantity supplied, Qd= Qs,
Step 1: Write the given equations in the form
Step 2: Equate Qd and Qs.
Since Pd = Ps, we can write both as P. Pd = Ps = P
Step 3: Find Q by plugging in the value of P in either the demand equation or the supply equation
Step 4: Cross-check by plugging in the values of Q and P in both equations.
Hence, the values obtained are correct.
Effect of change in Demand on Equilibrium Price and Quantity
The equilibrium price of a commodity is the price at which the quantity demanded of the commodity is equal to its quantity supplied. But what happens when the demand for commodity increases but its supply remains the same. An increase in the demand of the commodity will lead to an increase in equilibrium price, and quantity demanded and supplied of the commodity. On the other hand, if demand for the commodity decreases but its supply remains the same, it will lead to a decrease in equilibrium price, and quantity demanded and supplied of the commodity.
Effect of change in Supply on Equilibrium Price and Quantity
When the supply of a commodity increase but its demand remains the same, equilibrium price will decrease, but equilibrium quantity demanded and supplied will increase. On the other hand, when the supply of a commodity decreases but its demand remains the same, its equilibrium price will increase, but the equilibrium quantity demanded and supplied will decrease.
The Reference Point for Economic Welfare
In the practical world, markets hardly work in this way. Multiple factors come into play, like government taxes or subsidies. However, this study of equilibrium price and quantity provides a reference to the ideal case scenario where all entities in the market are benefitted, and resources are being used efficiently. This reference point is important for policymakers to ensure that the economic welfare of everyone is kept in mind.
Some things to keep in mind to avoid errors:
- In graphs, the horizontal axis or the x-axis shows quantity; and the vertical axis or y-axis shows the price.
- The demand curve will always be downward sloping, and the supply curve will always be upward sloping.
- In equations, Q represents the x-variable, and P represents the y-variable.
- When solving algebraically, keep in mind calculation errors. Always find the value of one variable by eliminating the other first. Once you have done this, substitute the value, you have found to find the second variable.
Context and Applications
This topic is significant in the professional exams for both undergraduate and graduate courses
- BA in Economics
- BS in Economics
- Masters in Economics
- Economic Theory
- Macro Economics
- Economics Growth and Development
- International Economics
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