Finding the Equilibrium Price and Quantity

The easiest way to determine the equilibrium price and quantity in a market is by putting the supply curve and the demand curve on the same diagram. Since the supply curve shows the quantity supplied at any given price and the demand curve shows the quantity demanded at any given price, the price at which the two curves cross is the equilibrium price: the price at which quantity supplied equals quantity demanded.

Figure 3-11 combines the demand curve from Figure 3-1 and the supply curve from Figure 3-6. They intersect at point E, which is the equilibrium of this market; $3 is the equilibrium price and 10 trillion BTUs is the equilibrium quantity.

Market Equilibrium Market equilibrium occurs at point E, where the supply curve and the demand curve intersect. In equilibrium, the quantity demanded is equal to the quantity supplied. In this market, the equilibrium price is $3 per BTU and the equilibrium quantity is 10 trillion BTUs per year.

PITFALLS

PITFALLS: BOUGHT AND SOLD?

BOUGHT AND SOLD?
We have been talking about the price at which a good or service is bought and sold, as if the two were the same. But shouldn’t we make a distinction between the price received by sellers and the price paid by buyers? In principle, yes; but it is helpful at this point to sacrifice a bit of realism in the interest of simplicity—by assuming away the difference between the prices received by sellers and those paid by buyers.

In reality, there is often a middleman—someone who brings buyers and sellers together. The middleman buys from suppliers, then sells to consumers at a markup. For example, natural gas brokers buy natural gas from drillers, and then sell the natural gas to gas companies who distribute it to households and firms. The drillers generally receive less than the gas companies pay per BTU of gas. But no mystery there: that difference is how natural gas brokers make a living.

In many markets, however, the difference between the buying and selling price is quite small. So it’s not a bad approximation to think of the price paid by buyers as being the same as the price received by sellers. And that is what we assume in this chapter.

©Dan Piraro

Let’s confirm that point E fits our definition of equilibrium. At a price of $3 per BTU, natural gas producers are willing to sell 10 trillion BTUs a year and natural gas consumers want to buy 10 trillion BTUs a year. So at the price of $3 per BTU, the quantity of natural gas supplied equals the quantity demanded. Notice that at any other price the market would not clear: every willing buyer would not be able to find a willing seller, or vice versa. More specifically, if the price were more than $3, the quantity supplied would exceed the quantity demanded; if the price were less than $3, the quantity demanded would exceed the quantity supplied.

The model of supply and demand, then, predicts that given the demand and supply curves shown in Figure 3-11, 10 trillion BTUs would change hands at a price of $3 per BTU. But how can we be sure that the market will arrive at the equilibrium price? We begin by answering three simple questions:

  1. Why do all sales and purchases in a market take place at the same price?

  2. Why does the market price fall if it is above the equilibrium price?

  3. Why does the market price rise if it is below the equilibrium price?