Market equilibrium

Market equilibrium

Properties of equilibrium

· Has to governed by Pareto Efficiency

· Has to create stability

· All parties should be satisfied

· Liable for market clearance

· Take budget of both parties into account

The British Economists, Alfred Marshall, introduced the notion of demand and supply in his book titled Principles of Economics, in 1890. The terminology demand refers to the quantity of goods and services that an individual (consumer) is willing and able to purchase, while the supply refers to the quantity of goods and services one (producer) is willing and able to produce/sell. Theoretically economists have been able to inform that there is an inverse relationship between the price and the quantity demanded, and graphically depicted by a downward slopping curve, whereas there is a direct or positive relationship between the price and the quantity supplied, which is graphically represented by an upward curve (from left-to-right).

Given this it is concluded that the higher the price the lower the quantity demanded, and vice versa, while the higher the price the supply. It causes a lot of tension in the market because consumers prefer lower prices to higher price to buy more and satisfy their utility, while producers prefer higher prices to maximize their profits. Suppose the government intervenes and impose an effective price ceiling lowering prices, consumers will be better-off while the producers will be worse, which is Pareto inefficiency. For it to be Pareto efficient no party must be made better-off by making the other worse-off. Even suppose the government imposes a price floor instead, it will favor producers while disfavoring consumers, which is why the Neoclassical Economists are not in favor of any kind of government intervention.

How can this be solved and encourage Pareto efficiency? This can be solved by what one of the Neoclassical Economists, Adam Smith, refer to it as ‘The Invisible Hand’ in his book called ‘The Wealth of Nations’. This means allowing the market forces of demand and supply to set the price and the quantity without interjection. The market forces of demand and supply work serves as market clearance, clearing shortages and surpluses caused by government intervention or the individuals setting the price and quantity for themselves. This works perfectly in the perfectly competitive market having said that there are many firms leading to each firm possessing a small fraction of the market share, hence they have no control over the price nor the quantity. However this is violated in the imperfect competition market, hence there is no more market equilibrium put the Nash equilibrium.

The demand equation is set to be equivalent to the supply to determine the market equilibrium, clearing up shortages and surpluses, and this is where all parties are satisfied, hence I refer the equilibrium point is where consumers agree to disagree acknowledging higher prices will favor producers only while lower prices will consumers, so why not settle for stability.

The equilibrium always takes into account into when setting the market price and quantity. Recall that in the study of consumer behavior, the demand is derived from the indifference curves also taking into consideration the budget constraints.