Determination of Market Equilibrium under Perfect Competition

Perfect competition is a market where there are a large number of buyers as well as sellers. Equilibrium under Perfect Competition is a state where market demand matches the market supply. When market demand and market supply balance each other, there occurs a situation of equilibrium in the market. During equilibrium, price and quantity become stable. Equilibrium is the state of no change. The stable price is known as the Equilibrium Price, and the stable quantity is known as the Equilibrium Quantity.

Market Supply = Market Demand

Geeky Takeaways:

• Market equilibrium under perfect competition occurs when market demand is equal to market supply, resulting in an equilibrium price and equilibrium quantity.
• Disequilibrium occurs when market demand is not equal to market supply. It is the opposite of equilibrium.
• The concept of equilibrium is theoretical. In reality, markets are never in perfect equilibrium. There is always either an excess supply or excess demand.
• In the long run, any firm in a perfect competition market always earns normal profits. Abnormal losses or abnormal gains get wiped out by the price mechanism and forces of market supply and market demand.

What is Equilibrium Price under Perfect Competition?

Equilibrium Price is also known as a market-clearing price. It is the price that is derived by market forces of demand and supply and occurs when market demand is equal to market supply. Technically, at an equilibrium price, the price at which the buyers want to purchase the product is equal to the price at which sellers want to sell the same product. Prices in the market tend to fluctuate too much due to dynamic factors. When there is a rise in prices, it will cause a contraction in quantity demanded and an expansion in quantity supplied, causing a surplus. When there is a decline in prices, it will cause an expansion in quantity demanded and a contraction in quantity supplied, causing a shortage.

What is Equilibrium Quantity under Perfect Competition?

Equilibrium Quantity is when there are no shortages or surpluses in a product in the market. The quantity that customers/consumers want to buy at a particular price at a particular point in time is equal to the quantity that the suppliers want to sell. When there is excess supply, i.e. surplus, prices will decline, and when there is more demand, i.e. shortage, prices will rise.

Determination of Equilibrium Price and Equilibrium Quantity under Perfect Competition

Equilibrium Price and Equilibrium Quantity are determined using the demand curve and supply curve. Demand Curve shows the quantity demanded that the consumers are willing and able to buy at a particular price during a specified period. The demand curve slopes downward, showing a negative relationship between quantity demanded and price. Supply curve shows the quantity supplied that the suppliers are willing to sell at a particular price. The supply curve slopes upward showing a positive relationship between quantity supplied and price. The intersection of the demand curve and supply curve decides the equilibrium price and the equilibrium quantity. There is only one point where equilibrium price and equilibrium quantity can be achieved; i.e., the intersection of the supply curve and the demand curve.

Example:

 

Graphical Representation:

 

Here, X-axis represents Quantity, and Y-axis represents Price. SS is the supply curve, and DD is the demand curve. They will interact at point E, causing an equilibrium level. The corresponding price of ₹6 will be termed the Equilibrium Price (P), and the corresponding quantity of 50 units will be termed the Equilibrium Quantity (Q).

Why any other price is not the Equilibrium Price?

At any other price, other than the equilibrium price of ₹6, two situation will arise –

(i) Any price above ₹6 is not equilibrium price because of surplus; i.e., excess supply would cause competition among sellers. Thus, to sell the excess stock, price would come down to the equilibrium price of ₹6.

(ii) Any price lower than ₹6, is also not the equilibrium price because due to excess demand, buyers would be ready to pay higher price to meet their demand. As a result, price would rise up to the equilibrium price of ₹6.

Equilibrium Price and Equilibrium Quantity in case of Excess Demand (Shortage)

When there is more demand for the product than supply in the market, the occurred situation is said to be Excess Demand or Shortage. It generally happens when prices are lower than the equilibrium price. It causes the customers/consumers to buy more products at lower prices. Expanded demand and constant supply affect the prices and quantity in the market. Sellers and their selling quantity will be less than the buyers and their buying demands. Sellers will be willing to sell less at lower prices, and buyers will be willing to buy more. There will be unfulfilled demand which will lead to an increase in prices. As prices will rise:

• There will be an expansion in quantity supplied (a movement along the supply curve)
• There will be a contraction in quantity demanded (a movement along the demand curve)

Due to these movements, prices will rise, restoring them to the level of equilibrium price. At the equilibrium price, the equilibrium quantity will be set accordingly, again forming a situation of equilibrium in the market.

Example:

 

Graphical Representation:

Here, X-axis represents Quantity, and Y-axis represents Price. SS is the supply curve, and DD is the demand curve. E is the Equilibrium Point at which P is the Equilibrium Price (₹6), and Q is the Equilibrium Quantity (50 units). P₁ are the lower prices causing D₁ as new demand, which is more than the equilibrium demand and S₁ as the new supply, which is less than the equilibrium supply. This will lead to a shortage. Due to shortage, demands will remain unfulfilled, causing an increase in prices from P₁ to P. Higher Prices will cause lower demand (a movement along the demand curve) and higher supply (a movement along the supply curve). Equilibrium E will be restored at the price of ₹6.

Equilibrium Price and Equilibrium Quantity in Case of Excess Supply (Surplus)

Excess supply is a market condition when the quantity supplied is greater than the demand for the commodity. It occurs at prices greater than the equilibrium price. There occur some conditions when prices in the market are higher than the equilibrium price. One common example of such a condition is Price Floor. The higher prices will lead to expansion in quantity supplied as the suppliers will want to sell more and more when prices are high. So, in the market, the quantity supplied will be more than the quantity demanded, creating a situation of Excess Supply or Surplus. Sellers and their selling quantity will be more than the buyers and their buying demands. Supplies will remain idle in the market as there will not be enough buying activities. In order to sell idle supplies, suppliers will decrease the selling price until they will be able to sell all their products. In this case, every seller will have the option to decrease their prices, since the consumers/customers will be willing to buy the supplies at lower prices. As prices will fall:

• There will be a contraction in quantity supplied (a movement along the supply curve), wiping the excess supply out of the market.
• There will be an expansion in quantity demanded (a movement along the demand curve).

Due to these movements, prices will fall, restoring them to the level of equilibrium price. At the equilibrium price, the equilibrium quantity will be set accordingly, again forming a situation of equilibrium in the market.

Example:

Graphical Representation:

Here, X-axis represents Quantity, and Y-axis represents Price. SS is the supply curve, and DD is the demand curve. E is the Equilibrium Point at which P is the Equilibrium Price (₹6), and Q is the Equilibrium Quantity (50 units). P₁ are the high prices causing d₁ as new demand, which is less than the equilibrium demand, and s₁ as the new supply, which is more than the equilibrium supply. This will lead to a surplus. Due to surplus, supplies will remain idle, causing a decline in prices from P₁ to P. Lower Prices will cause higher demand (a movement along the demand curve) and lower supply (a movement along the supply curve). Equilibrium E will be restored at a price of ₹6.