Question

Explain the determination of equilibrium price with the help of a diagram.

Hint:

Equilibrium is a "state of rest." Once the market reaches this price, there is no incentive for buyers or sellers to change it unless external factors shift the curves.

Answer 1

Step 1: Understanding the Concept:
In a free market, the equilibrium price is the price at which the quantity demanded by consumers exactly equals the quantity supplied by producers. At this price, there is neither a shortage nor a surplus.

Step 2: Interaction of Market Forces:

• Demand: Shows an inverse relationship with price (downward sloping).
• Supply: Shows a direct relationship with price (upward sloping).

Step 3: The Equilibrium Point:
The intersection of the Demand Curve (D) and Supply Curve (S) is the equilibrium point (E). The corresponding price is the Equilibrium Price ($P_e$), and the corresponding quantity is the Equilibrium Quantity ($Q_e$).

• If Price>$P_e$, there is Excess Supply (Surplus), leading to a price drop.
• If Price<$P_e$, there is Excess Demand (Shortage), leading to a price rise.

Step 4: Final Answer:
The equilibrium price is determined at the point where Market Demand = Market Supply.