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Equilibrium

Equilibrium is a point of balance or a point of rest. A more complex definition is

Equilibrium is a state in market where economic forces are balanced and in the absence of external influences the (equilibrium) values of economic variables will not change.

It is the point at which quantity demanded and quantity supplied is equal. Market equilibrium, for example, refers to a condition where a market price is established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers. This price is often called the equilibrium price.

In the graph below the point at which the demand curve meets the supply curve is the equilibrium price.

market equilibrium

Equilibrium is ‘self righting’

It means that if we try to move away from the equilibrium situation it will revert back to its original position, if there is no external disturbance.

Figure below explains the concept.

excess supply

In this diagram the equilibrium price is P* and the quantity supplied Qe. However, the prices have been increased to P2. As the price has increased it will lead to more suppliers entering the market and supply increasing to Qs. At the same time, a increase in price to P1 will lead to a fall in demand (as per the law of demand) i.e. Qd. This will create an excess supply situation. Now the suppliers will find it difficult to sell their goods and they will have to reduce their price to attract more consumers. This will go on till the price again reaches its initial level i.e. P*. Hence the situation is self righting if the prices are raised without any external reason.

Similarly, in the figure below

excess demand

we can see that the prices have been artificially reduced from P* to P1. This leads to a fall in supply from Q* to Qs (as per law of supply). As the prices fall from P* to P1, people can afford to buy more of that good and demand increase from Q* to Qd. Again an excess demand situation is created. In order to get the most out of this situation the suppliers will start increasing their price. On the other hand demand will start falling as the prices increase. This will all continue till the prices settle at equilibrium price i.e. Pe. Hence we can say that equilibrium is ‘self-righting’

Movement to a new equilibrium

The equilibrium price remains unchanged till the demand and supply curves retain their position. The moment there is a shift in any of the components, a new equilibrium will be formed.

Effect of change in Demand and Supply

Demand

Supply

Equilibrium price

Equilibrium quantity

Increase

Unchanged

Rise

Rise

Decrease

Unchanged

Fall

Fall

Unchanged

Increase

Rise

Rise

Unchanged

Decrease

Rise

Fall

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