Equilibrium means a state of equality between demand and supply. Without a shift in demand and/or supply there will be no change in market price.
In the diagram below, the quantity demanded and supplied at price P1 are equal. (Baryla, 1995, 13)
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.
Consider the following example. The weekly demand and supply schedules for T-shirts (in thousands) in a city are shown in the table below:
The equilibrium price in the market is £5 where demand and supply are equal at 12,000 units.
If the current market price was £3 – there would be excess demand for 8,000 units.
If the current market price was £8 – there would be excess supply of 12,000 units.
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.
The entry of new producers of T-shirts 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.
Assuming there is pure competition in the market place, and no government intervention, we are able to focus on how the price mechanism determines the equilibrium price in the market. Markets can be effective at resolving the basic issues of what and how much to produce at a certain price level although left to operate on its own, the market can still create unsatisfactory outcomes. When markets do not produce the desired outcome, it is known as market failure and when this occurs, governments may intervene in the market. (Baryla, 1995, 13)
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How the price mechanism brings about the equilibrium price in the market can be determined assuming we have pure competition in the market place and no government intervention. Simply put, the concept of pure competition mean that no participant in the market has the power to influence market outcomes directly, such as by setting prices. The price mechanism is the interplay of the forces of supply and demand in determining the market prices at which goods and services are sold and the quantity of which is produced.
The quantities of goods and services demanded and supplied is regulated by the prices of those goods and services. If the price of a commodity for sale is too high according to consumer demand, the quantity supplied will exceed the quantity demanded. If the price of a commodity is too low according to consumer demand, the quantity that is demanded will exceed the quantity supplied. There is one price, and only one price, at which the quantity demanded, is equal to the quantity supplied. This is known as the equilibrium price. (Belkin, 1976, 57)
The market forces of supply and demand interacting to determine the equilibrium price which at this price the market clears and eliminates any excess supply or demand is the price mechanism in action. (Brown, 2000, 66) There is no tendency for change at the equilibrium point. In this way it is said that the market mechanism, besides being the natural consequences of the forces of supply and demand, provides the most efficient economic outcomes possible without any explicit coordination.
Although markets can be effective at resolving the basic issues of what and how much to produce, left to operate by it, the market can still create unsatisfactory outcomes. For goods and services in product markets, the market price may be considered to be too high or too low. From the free interplay of demand and supply, the equilibrium quantity that results may also be considered too high or too low. Some goods and services may not even be produced at all. Market failure occurs because the price mechanism takes account of the private costs and benefits of production, to producers and consumers, but does not take into account the impact of an economic activity on outsiders. For example, the market may ignore the costs imposed on outsiders by a firm polluting the environment. Governments may intervene in the market when market failure occurs.
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The market determined price for some commodities may be thought by the government to be too high or too low. The government may therefore intervene in the marketplace in order to apply either price ceilings, where the government imposes a limit on how high a price can be charged for a product, or price floors, the minimum price that can be charged for a particular commodity. (Geltner, 1995, 119) Affecting the distribution of income, the manner in which income is divided among the members of the economy, is the main reason for influencing prices in this way. Price ceilings will redistribute money from sellers to buyers, whereas price floors will redistribute money from buyers to sellers.
In conclusion, the market forces of supply and demand interact with each other to bring about market equilibrium, clearing the market of excess demand or supply. In this way, it is said that the market mechanism achieves consistency between plans and outcomes for consumers and producers without explicit coordination. Government intervention is very important in providing the desired outcomes of the society. Overall, market equilibrium is determined by the price mechanism, supply and demand curves, surplus and shortage, increases and decreases in supply and demand curves, market behaviours and government intervention. (Hendershott, 1997, 13)
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Belkin, J., Hempel, D., McLeavey, D. (1976), “An empirical study of time on the market using multidimensional segmentation of housing markets”, Journal of American Real Estate and Urban Economics Association, Vol. 4 No.2, pp.57-75.
Brown, G., Matysiak, G.A. (2000a), Real Estate Investment: A Capital Market Approach, Financial Times Prentice-Hall, Harlow, .
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Hendershott, P.H. (1997), “Uses of equilibrium models in real estate research”, Journal of Property Research, Vol. 14 No.1, pp.1-13.
Janssen, C.T.L., Jobson, J.D. (1980), “On the choice of realtor”, Decision Sciences, Vol. 11 No.April, pp.299-311.