Market Equilibrium: How Supply and Demand Affect Equilibrium

Market equilibrium is a market state in which the supply and demand for a given product are equal. Economists refer to this as a competitive market—the market price is secure since the supply schedule aligns with consumer demand. The circular flow of production and purchasing is steady; that production amount is the competitive quantity or market-clearing price. Excess supply or demand, or limited supply or demand, will affect the initial equilibrium and cause the given price to rise or fall.

The equilibrium price is the point at which supply and demand meet. Supply equals demand, creating this equilibrium price level, but there is a new equilibrium point each time supply and demand shift. In graphing economic equilibrium, the demand and supply slopes intersect at the market equilibrium price, or equilibrium point, representing the point at which the demand for a product and the supply are equal. This point also demonstrates the equilibrium quantity.

The consumer demand curve—a graph representing the link between the cost of a good and consumer demand—shows quantity (the dependent variable) on the horizontal axis (x-axis) and price (the independent variable) on the vertical axis (y-axis). The graph shows the law of demand as a downward slope, called the market demand curve, which demonstrates that demand increases as the price of a good falls. Conversely, the graph shows the law of supply as an upward slope, called a supply curve, demonstrating that price increases lead suppliers to offer higher quantities.

Equilibrium and disequilibrium are distinct situations in economics. Equilibrium refers to perfect competition, a theoretical market structure in which all suppliers are equal, and overall supply and demand are equal. Conversely, disequilibrium describes a market with an imbalance of supply and demand. A market can be in disequilibrium briefly or for a more extended period. Buyers like predictable price points, and sellers rely on predictable production, so the quantity supplied must meet the quantity demanded to reset the equilibrium price. Disequilibrium is usually more common in labor markets than in financial ones, as the latter tends to overproduce over time.

The level of supply and demand dramatically affects the equilibrium point. Everything from good weather (for a farm’s harvesting) to a new business in the market (such as a rival sneaker company) can shift the demand schedule, changing the financial markets’ forecasts and the production of goods and services.

If demand shifts, businesses will respond by either changing the supply or market prices. Greater demand means higher prices; less means lower prices. Similarly, if the supply shifts, sellers can increase the price when supply is limited or offer discounts if there is excess supply.

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