Supply & Demand

-Equilibrium-

There is one very special point on the supply-demand diagram.  The point is the intersection of the Supply and Demand curves and it is known as the market clearing or equilibrium level of Price and Quantity. At only that price will we have suppliers willing and able to bring to the market exactly what demanders want.   More importantly, if the market is in disequilibrium (wrong price), then there will be automatic forces bringing prices toward the equilibrium level.  For example, if the price is above the equilibrium you will find excess supply in the market.  This excess supply will mean inventories start to rise as buyers fail to purchase what sellers have produced/ordered.  Faced with the rising inventories suppliers will most likely announce a sale - simply a lower price.  The price should continue to fall as long as there is excess supply as the sellers attempt to bring sales into line with demand.   In this sense the equilibrium price can be viewed as the price the market will move toward, and once it is established, there will be no pressure for price to change.

P* = Equilibrium Price

Q* = Equilibrium Quantity