Market Equilibrium and Changes in Equilibrium: Study Guide (Macroeconomics 1.6)

What equilibrium means

In Topics 1.4 and 1.5 you met the two sides of a market separately. Buyers’ plans are shown by the demand curve, which slopes down. Sellers’ plans are shown by the supply curve, which slopes up. This topic puts them together.

• Market equilibrium: the price at which the quantity buyers want to buy equals the quantity sellers want to sell. At this price the market clears: nothing is left unsold and no buyer who will pay the price goes without.
• Equilibrium price (Pₑ): the price where quantity demanded (Qd) = quantity supplied (Qs).
• Equilibrium quantity (Qₑ): the amount bought and sold at that price.
• Disequilibrium: any price at which Qd and Qs are not equal.

On a graph, equilibrium is where the demand curve and the supply curve cross. Read the price from the vertical axis and the quantity from the horizontal axis.

Equilibrium is a resting point. At the equilibrium price no buyer or seller has a reason to change the price, so it stays there until something shifts demand or supply.

Our fictional market: T-shirts in Valdoria

Valdoria is a fictional country. Its currency is the valda, written VD. The table shows the weekly market for plain cotton T-shirts. Quantities are in thousands of T-shirts per week. All figures are fictional.

Price (VD)	Quantity demanded (thousand)	Quantity supplied (thousand)	Qs − Qd	State of the market
4	100	40	−60	Shortage of 60
6	90	60	−30	Shortage of 30
8	80	80	0	Equilibrium
10	70	100	30	Surplus of 30
12	60	120	60	Surplus of 60
14	50	140	90	Surplus of 90

As the price rises, Qd falls (law of demand) and Qs rises (law of supply). The two columns meet at VD 8, where both equal 80 thousand.

Disequilibrium: surpluses and shortages

• Surplus (excess supply): at the current price, Qs is greater than Qd. Surplus = Qs − Qd. A surplus happens when the price is above equilibrium.
• Shortage (excess demand): at the current price, Qd is greater than Qs. Shortage = Qd − Qs. A shortage happens when the price is below equilibrium.

Always measure a surplus or shortage horizontally, at one price, between the two curves. It is a quantity, not a price.

How prices restore equilibrium

Markets do not need a planner to find the equilibrium price. Buyers and sellers push the price there themselves.

When there is a surplus (price too high):

1. Sellers cannot sell everything they produce, so unsold stock piles up.
2. To sell it, sellers cut the price.
3. As the price falls, Qd rises (a movement down along the demand curve) and Qs falls (a movement down along the supply curve).
4. The surplus shrinks until Qd = Qs at Pₑ.

When there is a shortage (price too low):

1. Buyers cannot get all they want; queues form and stock runs out.
2. Buyers compete for the goods, and sellers see they can charge more, so the price rises.
3. As the price rises, Qd falls and Qs rises, both movements along the curves.
4. The shortage shrinks until Qd = Qs at Pₑ.

Notice that neither curve shifts while the price adjusts. Only the quantities demanded and supplied change. This is the difference between a movement along a curve and a shift of a curve, which the course stresses.

Worked example 1: equilibrium, surplus and shortage

Question. Use the T-shirt table. (a) State the equilibrium price and quantity. (b) Calculate the surplus or shortage at VD 12 and at VD 6. (c) Explain what happens to the price if it starts at VD 12.

(a) Qd = Qs = 80 thousand at VD 8. So Pₑ = VD 8 and Qₑ = 80 thousand T-shirts per week.

(b) At VD 12: Qd = 60, Qs = 120. Qs > Qd, so there is a surplus of 120 − 60 = 60 thousand T-shirts.

At VD 6: Qd = 90, Qs = 60. Qd > Qs, so there is a shortage of 90 − 60 = 30 thousand T-shirts.

(c) At VD 12, sellers are left with 60 thousand unsold T-shirts each week. They cut the price to clear their stock. As the price falls, buyers move down the demand curve and buy more, and sellers move down the supply curve and offer fewer. At VD 10 there is still a surplus of 100 − 70 = 30 thousand, so the price keeps falling. It stops at VD 8, where the surplus is zero.

Check. The surplus at VD 12 is not 120 − 80 = 40. The comparison is between Qs and Qd at the same price, not between Qs and the old equilibrium quantity.

Changes in equilibrium: when a curve shifts

Equilibrium changes only when something shifts demand or supply. Recall the determinants from Topics 1.4 and 1.5.

• Demand shifts with consumers’ incomes, tastes, the prices of related goods (substitutes and complements), expectations and the number of buyers.
• Supply shifts with input prices, technology, the prices of other goods the firm could produce, expectations, taxes or subsidies on producers, and the number of sellers.

A change in the good’s own price never shifts either curve. It causes a movement along them.

The process is always the same:

1. Decide which curve shifts, and in which direction.
2. At the old equilibrium price, there is now a shortage or a surplus.
3. The price adjusts (as in the section above) until a new equilibrium is reached.
4. Compare the new price and quantity with the old ones.

Change	Effect on equilibrium price	Effect on equilibrium quantity
Demand increases (D shifts right)	rises	rises
Demand decreases (D shifts left)	falls	falls
Supply increases (S shifts right)	falls	rises
Supply decreases (S shifts left)	rises	falls

A useful pattern: a demand shift moves price and quantity in the same direction. A supply shift moves them in opposite directions.

Worked example 2: an increase in demand

Question. Valdorian incomes rise. T-shirts are a normal good, and buyers now want 30 thousand more T-shirts each week at every price. Supply does not change. (a) Find the new equilibrium. (b) Explain the adjustment from the old equilibrium. (c) Show the change on a graph.

Step 1: new demand schedule (old Qd + 30).

Price (VD)	New Qd (thousand)	Qs (thousand)
8	110	80
10	100	100
12	90	120

(a) New Qd = Qs = 100 at VD 10. The new equilibrium is P = VD 10, Q = 100 thousand. Price rose by VD 2 and quantity by 20 thousand.

(b) Higher income is a determinant of demand, so the demand curve shifts right from D₁ to D₂. At the old price of VD 8, buyers now want 110 thousand but sellers still offer 80 thousand: a shortage of 30 thousand. The shortage pushes the price up. As the price rises, sellers move up along the unchanged supply curve and offer more; buyers move up along the new demand curve D₂ and want fewer than 110 thousand. The shortage disappears at VD 10.

(c) See Figure 2.

Check. The supply curve did not shift. “Supply increased because the price rose” is wrong; the quantity supplied increased, along the same curve.

Worked example 3: both curves shift

Question. Incomes rise as in Worked example 2 (demand +30 thousand at every price). At the same time the price of raw cotton rises, so supply falls at every price. What happens to the equilibrium price and quantity?

Step 1: price. Demand shifting right pushes the price up. Supply shifting left also pushes the price up. Both effects agree, so the price definitely rises.

Step 2: quantity. Demand shifting right pushes the quantity up. Supply shifting left pushes the quantity down. The effects conflict, so the change in quantity is indeterminate (it cannot be known) without the sizes of the shifts.

Step 3: see it with numbers. New demand is Qd = 130, 120, 110, 100, 90 and 80 thousand at VD 4, 6, 8, 10, 12 and 14. Both schedules are straight lines, so extend them by one row: at VD 16, new Qd = 70 thousand and the original Qs = 160 thousand. Try three sizes of supply fall:

Supply falls by (thousand, at every price)	New equilibrium price	New equilibrium quantity	Quantity compared with 80
30	VD 12	90	rises
60	VD 14	80	unchanged
90	VD 16	70	falls

For example, with a fall of 30, supply at VD 12 is 120 − 30 = 90 thousand, and new demand at VD 12 is also 90 thousand. In all three cases the price rises, but the quantity can rise, stay the same or fall.

The rule for two shifts: work out each shift’s effect on price and on quantity separately. The variable on which they agree is certain; the variable on which they conflict is indeterminate.

Demand	Supply	Price	Quantity
increases	increases	indeterminate	rises
decreases	decreases	indeterminate	falls
increases	decreases	rises	indeterminate
decreases	increases	falls	indeterminate

Showing a change on a graph (exam skill)

Free-response questions often ask you to show a change on a graph. Many marks are lost on labels, not on economics. For every supply and demand graph:

1. Label the axes: “Price” (or “Price of good X”) on the vertical axis and “Quantity” on the horizontal axis.
2. Label each curve: D and S; after a shift, D₁ and D₂ (or S₁ and S₂).
3. Mark the equilibrium where the curves cross, and draw dashed lines to both axes: P₁ and Q₁.
4. Show the shift with an arrow and the new curve, and mark the new equilibrium P₂ and Q₂ on the axes.
5. Shift only the curve the determinant affects. One event usually shifts one curve.

Beyond this topic. Consumer and producer surplus, price ceilings and price floors, and elasticity are taught in the Microeconomics course, not here.

Common misconceptions

• “A surplus means the price is too low.” No. A surplus happens when the price is above equilibrium; sellers then cut the price.
• “A shortage means the good is scarce.” All goods are scarce. A shortage means Qd > Qs at the current price; a higher price removes it.
• Measuring a surplus from the equilibrium quantity. The surplus is Qs − Qd at the same price, not Qs − Qₑ.
• “Demand rose, so supply rose too.” When demand shifts right and the price rises, the quantity supplied rises along an unchanged supply curve. The supply curve does not shift.
• “The price fell, so demand increased.” A fall in the good’s own price increases quantity demanded, a movement along the curve. Only a determinant shifts demand.
• Shifting both curves for one event. A rise in cotton prices affects sellers’ costs, so only supply shifts.
• Giving a definite answer for a double shift. When the effects conflict, the answer is “indeterminate” unless you know the sizes of the shifts.
• “A supply increase raises the price.” More supply at every price lowers the equilibrium price and raises the equilibrium quantity.

Where this leads

This is the last topic of Unit 1. The same logic of equilibrium, surplus, shortage and shifting curves returns later in the course: in the AD–AS model (Topic 3.5), the money market (Topic 4.5), the loanable funds market (Topic 4.7) and the foreign exchange market (Topic 6.3). If the laws of demand and supply are not secure, revisit Topic 1.5, Supply.

Try the practice questions now, then use the revision notes and the checklist to consolidate, or go back to the course roadmap.