Market Equilibrium Market Equilibrating Process

Market Equilibrium

Market Equilibrating Process

Market equilibrium: Supply and demand

Market equilibrium: Supply and demand

When the market is in a state of equilibrium, "the supply of an item is exactly equal to its demand. Since there is neither a surplus nor shortage in the market, there is no innate tendency for the price of the item to change" (Market equilibrium, 2010, Business Dictionary). The law of demand states that as price increases, demand decreases, and conversely, as price decreases, demand increases. The law of supply states that as price increases, the willingness of supplier to meet demand increases but as price decreases, the willingness of suppliers to meet demand decreases.

When the market price is below the equilibrium price, consumers begin to buy more and more of the item yet suppliers have less and less of an incentive to produce. A shortage is the result, and to meet the upsurge in demand, producers raise prices (Demand, supply, and market equilibrium, 2010, Prentice Hall). A good example of this might be snow shovels during an unusually warm winter. To get rid of the surplus of snow shovels, retailers begin to price the shovels very low, to encourage consumers to buy these items. Suppliers stop making shovels, because of the upsurge in retailer's inventories and because the price they can command will not cover the costs of production. Some consumers may buy the shovels 'just in case' there is a storm. Then, when a storm finally hits the area, people begin to buy up the shovels quickly, and producers can raise prices dramatically, given that there is now a sudden shortage. Producers, anticipating more storms and the ability to price the item higher because of consumer fears of another snowstorm make more shovels. Supply increases and price goes down a bit, but not as low as before the storm. Now that snow storms seem like more of a possibility, demand and supply are at equilibrium, as consumers are buying shovels, but not in a last-minute panic.

A good example of the opposite possibility, when the market price is above the equilibrium level, comes during 'toy crazes.' When many people want to buy a toy suddenly, supply drops and price increases sharply. Eventually, retailers begin to buy large quantities of the item to meet heightened demand. The price is so high, consumers begin to become reluctant to pay for the item. Retailers must lower prices to unload their excess inventory of Tickle Me Elmos, Cabbage Patch Kids, or Zhu pets.

A state of perfect equilibrium for a long period of time is rare. Perhaps one example of perfect equilibrium might be found at an elementary school that sells pizza to its students. The demand is relatively constant, given that the student population remains the same from week to week, and students have relatively few other options. Students whose parents give them money for pizza have no choice but to buy food on-site, since they have cannot eat otherwise; students who 'brown bag it' are unlikely to buy lunch, even if the pizza is substantially cheaper one day. Because lunchtime is finite, few students have the time to eat more than one or two slices, so they will not buy more if price is lowered. The vendor has discovered over time what price students are willing to pay so the pizza parlor can still make a profit and can guess what the demand will be, based upon the fixed number of students and the time of year or week. Although some students may occasionally buy other items and some students may elect to throw out their bagged lunch and purchase pizza that day, overall the balance between supply and demand is relatively stable.