In this article, we’re going to talk about how to find market equilibrium by using supply and demand. So in a free market, the price of a good or service is going to be determined by the forces of supply and demand so that price that we reach by the forces of supply and demand we’re going to call it the equilibrium price and that’s the price where the quantity of the good demanded is equal to the quantity supplied.
I want to give you an example and I’ll show you how this works, so let’s take the market for chocolate bars and so we can think about supply and demand for chocolate bars at different prices. Let’s say at a price of $1 that consumers would demand they want to buy 15 chocolate bars but producers would only be willing to supply three chocolate bars. Now we can think about four different prices for what is the quantity demanded by consumers, how much do they want to buy and how much our producers are willing to supply and then we can plot out those data points in a graph and then that will tell us where our equilibrium is.
Let’s do our demand curve first, at a price of $1 the quantity demanded is 15, at a price of $2 the amount demanded would be 12, at a price of $3 the amount demanded would be 9, at a price of $4 the amount demanded would be 6, and at a price of $5 the amount demanded would be 3. So this “D” is our demand curve which is downward sloping because the law demand, the price goes up quantity demanded goes down.
Now let’s put together our supply curve so at a price of $1 the amount that producers are willing to supply just 3 chocolate bars, at a price of $2 they willing supply 6 chocolate bars, at a price of $3 they’re willing to supply 9 chocolate bars, at a price of $4 they are willing to supply 12, and at a price of $5 they are willing to supply 15. Let’s draw a line this is our supply curve. So we’ve got an “S” supply curve.
Now where these two curves intersect which is at the point (3, 9). So a price of 3 equals Quantity Demanded equals 9. Our quantity our equilibrium quantity is 9 and our equilibrium price is $3. So what does that mean? That means that absent any government intervention or any kind of other issues in a free competitive market we would arrive at a price of $3 for our chocolate bars that will be the price that arrives at by the forces of supply and demand. There would be an equilibrium quantity of 9 chocolate bars and we’d have 9 chocolate bars there they’re ultimately consumed or made.
So let’s think about why not a price of $2? We’re saying that the equilibrium price is $3 but why not $2? Think about it, at $2 if we were to look at this graph here or we can go back we can even go back to our little supply schedule and demand schedule and we can see that the quantity demanded is 12 and the quantity supplied is 6 think about this gap here.
People at the price of $2 people are wanting 12 chocolate bars but they’re only getting 6 they’re only 6 being supplied. So we’d say if we set the price at $2 there would be a shortage. Conversely, if we were to set the price at $4 we would have a surplus because people are willing to supply more than what people are demanding. We would have chocolate bars left over, so the magic of supply and demand is that the free market ultimately arrives at this point here at $3, this equilibrium where the quantity demanded equals the quantity supplied and if you look back at our schedule of demand & supply we see that at a price of $3 there are nine chocolate bars demanded and nine chocolate bar supplied so that’s our equilibrium in a free market.