The Free Market Price:EQUILIBRIUM

Ch. 6, Sect. 1-3

What does it mean when the “price is right”?

How does a free market determine equilibrium prices?

How do changes to demand and supply affect the equilibrium price?

How a market works• In a free market, demand and supply work

together to create prices

• This causes market equilibrium, where the quantity demanded of a g/s equals the quantity supplied of that g/s (Qd=Qs)– Satisfaction of both consumers & producers—

“balance” of the market

When the “Price is Right”

• Have to find the right price at which this happens in a market (equilibrium price)– Also called “market-clearing price”

because the market will be clear ofshortages and surpluses

• The quantity of g/s at equilibriumis called the equilibrium quantity– can be graphed using Qd/Qs

schedule

Graphing equilibrium

What is the equilibrium price?

What is the equilibrium quantity?

Quick check

• What is equilibrium?

• Why do consumers and producers care about equilibrium?

• What happens if the market isn’t in equilibrium (too much? too little?)

The Market Price

• Remember the “invisible hand”? When consumers and producers willingly interact in order to buy/sell g/s?

• This interaction will also push the market price, or the price a willing consumer will pay to a willing producer for a g/s, towards equilibrium price– Economists therefore say that the law of demand and

law of supply will always act together to reach equilibrium

What Happens if the Price Isn’t Right?

• If producers set a price above or below equilibrium, it is known as disequilibrium

• The result can be a shortage: Qd > Qs at a certain price– this is also called excess demand—too many

customers for too few goods– This means that the price is too low

• The result can be a surplus: Qd < Qs at a certain price– This is called excess supply—too many producers

for too few customers– This means the price is too high

Graphing disequilibrium:Excess demand (shortage)

What happens to demand when the price is set $1.00 below equilibrium?

Graphing disequilibrium: Excess supply (surplus)

What happens to supply when the price is set $1.00 above equilibrium?

Quick check

• What does it mean if there is disequilibrium?

• What does excess supply mean for the price of a good?

• What does excess demand mean for the price of a good?

• How long do you think it would take for a market to reach equilibrium?