07 Jun Equilibrium
What is Equilibrium?
Definition: A state of equilibrium is said to be achieved when the supply and demand for a product are equal. At this point, prices are stable.
What does Equilibrium mean?
In a free market, prices tend to rise when the demand for a product increases. Conversely, prices fall when demand decreases. A balance between demand and supply results in market equilibrium.
The chart shown above illustrates that the demand for a product varies at different price points. At higher prices, the quantity demanded falls. However, the supply of a product changes in the opposite manner. As prices rise, manufacturers are willing to supply greater quantities.
When the demand and supply lines intersect, equilibrium is achieved. It’s important to remember that an equilibrium between demand and supply does not happen instantaneously. There would be a period when, say, higher demand leads to inflated prices. When this happens, manufacturers would step up the volume of goods that they are supplying to the market.
This would take a certain amount of time. In the interim, prices would remain high. They would start trending downwards when new supplies are available. During this phase, the market is said to be in a state of disequilibrium.
But, in due course, equilibrium would be achieved as the market forces play out.
Example of Equilibrium
The owners of a theater have to decide on the pricing policy for their evening show. The theater can seat 600 people. They estimate the number of tickets that they can sell at various price points:
|Price per ticket $||Demand for tickets||Number of tickets that can be sold||Total sales $|
|30||800||600||$30 X 600 = $18,000|
|40||700||600||$40 X 600 = $24,000|
|50||600||600||$50 X 600 = $30,000|
|60||400||600||$60 X 400 – $24,000|
Note: The last column calculates total revenue by multiplying the price per ticket with the number of tickets that can be sold at that price. This number is subject to a maximum of 600, which is the seating capacity of the theater.
It is decided to price each ticket at $50. At this price, the demand for tickets and the supply is at an equilibrium. It is also the price at which the revenue from the show can be maximized.
In a free market with perfect competition, the demand for a product will equal its supply at the equilibrium quantity and price.