Question -
Answer -
- Market equilibrium refers to that point which has come to be established under a given condition of demand and supply and has a tendency to stick to that level, i.e. where Demand = Supply.
- If due to some disturbance we divert from our position the economic forces will work in such a manner that it could be driven back to its original position, i.e., where Demand = Supply. In short it is the position of rest.
- It can be explained with the help of following schedule and diagram:
(a) • In the below schedule market equilibrium is determined at Price 3 where Market demand is equal to Market Supply.
• At price 1 and 2, there is excess demand, which leads to rise in price, resulting tendency is expansion in supply.
• Similarly, at price 4 and 5, there is excess supply, which leads to fall in price, resulting tendency is Contraction in supply.
(b) • In the given diagram, price is measured on vertical axis, whereas quantity demanded and supply is measured on horizontal axis.
• Suppose that initially the price in the market is P1. At this price, the consumer demand P1B and the producer supply P1A, i.e. consumers want more than what the producer are willing to supply. There is excess demand equal to AB. So, price cannot stay on P1 as excess demand will create competition among the buyers and push the price up till we reach equilibrium. Due to rise in price from P1 to P, there is upward movement along the supply curve (expansion in supply) from A to E and upward movement along the demand curve (contraction in demand) from B to E.
• Similarly, at price P2, the quantity demanded P2K is less than the quantity supplied P2L. There is excess supply, equal to KL, which will create competition among the sellers and lower the price. The price will keep falling as long as there is an excess supply.
Due to fall in price from P2 to P there is downward movement along the supply curve (contraction in supply) from L to E and downward movement along the demand curve (expansion in demand) from K to E.
• The situation of zero excess demand and zero excess supply defines market equilibrium (E). Alternatively, it is defined by the equality between quantity demanded and quantity supplied. The price P is called equilibrium price and quantity Q is called equilibrium quantity.