Equilibrium Price

Equilibrium price (EP) refers to the market price at which the quantity of a product demanded is equal to its quantity supplied. It is a stable price that has no tendency to change unless there are changes in the demand and/or supply. The purpose of finding the it is to identify the ideal price agreed upon for buying and selling.

On a graph, the intersection of the demand and supply curves represents the equilibrium price. At this price, both the consumers and manufacturers are content and there is no pressure from either side to change the price. It is also called the market-clearing price, is an important concept of microeconomics.

• The equilibrium price (EP) is the price where the demand for a product or service balances its supply. It helps maintain equality between the quantity demanded and quantity supplied.
• On a graph, the intersection of the demand and supply curves shows the equilibrium price. Any price above or below this price creates a surplus or shortage respectively.
• It's formula is Sq=Dq or quantity supplied=quantity demanded.
• At this price, whatever is produced by the manufacturer is purchased by the consumer. Hence, there is no tendency for the price to increase or decrease.

The equilibrium price and quantity are a part of the equilibrium market. A market is said to be in equilibrium when both the buyers and sellers are willing to exchange a product or service at an equal price. This price is the equilibrium price and its respective quantity is called the equilibrium quantity.

The market price of a product can increase, decrease or stay balanced. These three situations are inferred as follows:

• Increased market price (surplus): When the market price is higher than the equilibrium price, a surplus occurs. In case of a surplus, the quantity supplied exceeds the quantity demanded. This implies that at an increased market price, the producers are willing to supply more than what the consumers demand. The surplus forces the producer to reduce the price, which induces the consumer to increase their purchases. Consequently, the market price falls in order to adjust the market forces of demand and supply.
• Decreased market price (shortage): When the market price is lower than the equilibrium price, a shortage occurs. In case of a shortage, the quantity demanded exceeds the quantity supplied. Therefore, at a decreased market price, the producers are willing to supply less than what the consumers demand. The shortage forces the producer to increase the price, which persuades the consumer to reduce their purchases. This results in an increase in price. The market price increases till the balance is restored in the market.
• Balanced market price (equilibrium): The market price is said to be in balance when the quantity demanded is equal to the quantity supplied. In a balanced state, the market price is equal to the equilibrium price.

In the following image, the quantity of a product is plotted on the x-axis, while the price per unit is plotted on the y-axis.

The equilibrium price is $30, at which the demand and supply curves intersect. At this price, the quantity demanded and supplied are equal. The equilibrium quantity is 3000 units. Any change in either price or the quantity creates disequilibrium in the market.

The formula is based on the belief that the quantity demanded is equal to the quantity supplied. Let us derive the equilibrium price formula by equating the functions of demand and supply.

For the linear function of supply:

• Sq = the quantity supplied of the product
• Q = quantity of the product
• yP = price per unit

Therefore, the linear function of supply is represented as:

Sq = Q + yP ------------------------------------- (1)

For the linear function of demand:

• Dq = the quantity demanded of the product
• Q = quantity of the product
• yP = price per unit

Therefore, the linear function of demand is represented as:

Dq = Q + yP --------------------------------------- (2)

For the formula:

Quantity supplied = quantity demanded

Or, Sq = Dq

Let us consider an example to understand the working of equilibrium price.

In a particular month, a mobile seller sells 550 mobiles for $5 per piece. He wants to increase the monthly sales to 900 mobiles at $4 per piece. Let us find the equilibrium price for the seller.

From equation (1) of the formula (refer to the preceding heading), the supply function is given as follows:

Sq=Q+yP

where,

• Q=550
• yP=5P

So, Sq=550+5P -------------------- (3)

From equation (2) of the formula (refer to the preceding heading), the demand function is given as follows:

Dq=Q+yP

where,

• Q=900
• yP=4P

So, Dq=900+4P --------------------- (4)

At equilibrium price, quantity supplied from equation (3) = quantity demanded from equation (4)

550+5P=900+4P

5P-4P=900-550

P=350 or P=$3.50

The inferences are stated as follows:

• If the mobile is sold at a price above $3.50, the quantity supplied will be more than the quantity demanded. In this situation, the seller will be at a loss. This is because the seller would be left with unsold inventory.
• If the mobile is sold at a price below $3.50, the quantity demanded will be more than the quantity supplied. In this situation too, the seller will be at a loss. This is because the seller would be unable to satisfy the entire demand of his customers.
• If the mobile is sold at $3.50, all the mobiles of the seller will be sold. This is because only at $3.50, the quantity demanded equals the quantity supplied.

Hence, the equilibrium price for the mobile is $3.50.

This article has been a guide to Equilibrium Price (EP). Here, we explain how it find EP along with graph, formula, calculation and example. You can learn more from the following articles -

• Price Controls
• Price Sensitivity
• Market Economy