Market Equilibrium

Where demand meets supply: equilibrium price and quantity, excess demand and supply, the effect of shifts, free entry and exit, wage = VMPL, and price ceilings and floors.

Key ideas

Equilibrium is where market demand equals market supply; there is then no pressure on price to change.
Excess demand pushes the price up and excess supply pushes it down until the market clears.
With a fixed number of firms, more demand raises price and quantity; more supply lowers price and raises quantity.
When both curves shift, one result is certain and the other depends on the sizes of the shifts.
With free entry and exit, price settles at minimum average cost; a rise in demand raises quantity and the number of firms, not the price.
A firm hires workers until the wage equals the value of marginal product of labour (VMPL = price × MPL).
A price ceiling below equilibrium causes excess demand (shortages, rationing); a price floor above it causes excess supply (surpluses).

Remember

Equilibrium (qD = a − bp, qS = c + dp)	a − bp = c + dp → p* = (a − c) ÷ (b + d); q* = a − bp*
Excess demand at a ceiling	qD − qS at the ceiling price
Excess supply at a floor	qS − qD at the floor price
Free entry and exit	p = min AC; number of firms = qD at that price ÷ each firm’s output
Value of marginal product	VMPL = p × MPL; hire while VMPL ≥ w
Both shift the same way	quantity certain, price uncertain
Shift in opposite ways	price certain, quantity uncertain

Watch out

Saying a price ceiling causes a surplus (it causes a shortage).
Expecting price to rise with demand when there is free entry and exit (it stays at min AC).
Subtracting the wrong way: excess demand is qD − qS.

Worked example

For onions, qD = 250 − 7p and qS = 6p − 10. Find the equilibrium price and quantity.

Working: 13p = 260 → p = 20; q = 250 − 140

Answer: p* = ₹20, q* = 110 units