Microeconomics guide, Unit 2, step 8 of 28Previous step Next step

Step 8: Market Equilibrium and Price

By the EconTutorials team. 10-minute read with 6 practice questions.

SyllabusAP Micro 2.6–2.7 · Cambridge 2.4 · IB 2.3

In 30 seconds

Equilibrium is the price where the quantity buyers want equals the quantity sellers offer. The market “clears”: no surplus, no shortage.
If the price is too high there is a surplus and the price falls. If it is too low there is a shortage and the price rises. The market corrects itself.
Demand shifts move price and quantity in the same direction. Supply shifts move them in opposite directions.
To find equilibrium from equations, set $ Q_d = Q_s $, solve for $ P^* $, then substitute back to get $ Q^* $.

Video lesson coming soonA short animated lesson for this step will appear here.

What equilibrium means

Picture a café that bakes cinnamon rolls every morning. If it charges too much, rolls are left on the counter at closing time. If it charges too little, the rolls sell out by 9 a.m. and a queue of disappointed customers walks away. Somewhere in between is a price where the café sells exactly what it baked, and everyone who wants a roll at that price gets one. That price is the equilibrium price.

In Steps 5 and 6 you studied demand and supply on their own. Now you put them on one diagram. The point where the demand curve crosses the supply curve is equilibrium. At that point, every buyer who wants to buy at that price can find a seller, and every seller who wants to sell can find a buyer. Nothing is left over and nobody goes without. Economists say the market clears.

Key termEquilibrium price (P*): the price at which quantity demanded equals quantity supplied, also called the market-clearing price.

Key termEquilibrium quantity (Q*): the quantity bought and sold at the equilibrium price.

Equilibrium has two features you should remember. First, it is self-correcting: if the price drifts away from P*, market forces push it back. Second, it only lasts while the demand and supply curves stay where they are. If either curve shifts, a new equilibrium forms. Most of this step is about what happens when the curves move.

How markets fix themselves: surplus and shortage

What happens when the price is not at equilibrium? There are two cases, and the price mechanism corrects both without anyone being in charge.

Surplus (price too high). At a price above P*, sellers offer more than buyers want: $ Q_s > Q_d $. Unsold goods pile up. To clear their stock, sellers cut prices. As the price falls, buyers want more (quantity demanded rises) and some sellers produce less (quantity supplied falls). This continues until the surplus is gone and the price is back at P*.

Shortage (price too low). At a price below P*, buyers want more than sellers offer: $ Q_d > Q_s $. Queues form and some buyers go home empty-handed. Sellers see the strong demand and raise prices. As the price rises, some buyers drop out (quantity demanded falls) and producers supply more (quantity supplied rises). This continues until the shortage is gone.

Key termSurplus (excess supply): a situation where quantity supplied is greater than quantity demanded at the current price, which puts downward pressure on price.

Key termShortage (excess demand): a situation where quantity demanded is greater than quantity supplied at the current price, which puts upward pressure on price.

Price compared with P*	What you see	What happens next
Above P*	Surplus: $ Q_s > Q_d $	Sellers cut prices; price falls
Below P*	Shortage: $ Q_d > Q_s $	Buyers bid prices up; price rises
Equal to P*	$ Q_d = Q_s $	No pressure to change

When demand or supply shifts

Suppose a celebrity posts about a new snack and suddenly everyone wants it. Demand shifts right. At the old price there is now a shortage, so the price rises. As it rises, firms supply more (a movement along the supply curve). The new equilibrium has a higher price and a higher quantity. If demand falls instead, the reverse happens: a surplus at the old price pushes the price down, and the new equilibrium has a lower price and a lower quantity.

Now suppose new technology makes the snack cheaper to produce. Supply shifts right. At the old price there is now a surplus, so the price falls. As it falls, buyers want more (a movement along the demand curve). The new equilibrium has a lower price and a higher quantity. If supply falls (higher input costs, a tax, fewer sellers, a natural disaster), the price rises and quantity falls.

Change	Price	Quantity
Demand increases (shifts right)	Rises	Rises
Demand decreases (shifts left)	Falls	Falls
Supply increases (shifts right)	Falls	Rises
Supply decreases (shifts left)	Rises	Falls

There is a neat way to remember this. When demand shifts, you slide along the upward-sloping supply curve, so P and Q move in the same direction. When supply shifts, you slide along the downward-sloping demand curve, so P and Q move in opposite directions.

The book tells the story of avocados. Around 2015 to 2017 they became a global food trend and demand shifted strongly right. New trees take 3 to 5 years to bear fruit, so supply could hardly respond at first. The result was a large rise in price and only a small rise in quantity. Years later, farmers in several countries had planted many new trees, supply shifted right, and prices came back down while quantity rose further.

When both curves shift at once

Sometimes demand and supply move together. Then the two effects can pull price or quantity in opposite directions. The rule is: you can predict one variable for certain, but the other is ambiguous unless you know which shift is bigger.

Demand up, supply up: quantity definitely rises; price is ambiguous.
Demand up, supply down: price definitely rises; quantity is ambiguous.
Demand down, supply up: price definitely falls; quantity is ambiguous.
Demand down, supply down: quantity definitely falls; price is ambiguous.

To work it out, ask what each shift does on its own. If both push the same way on a variable, that variable is certain. If they push opposite ways, it is ambiguous (also called indeterminate).

Common mistakePredicting both price and quantity when both curves shift. Without information about the size of each shift, one of them must be stated as ambiguous. Saying “price rises and quantity rises” when supply has also fallen will cost you marks.

Finding equilibrium with algebra

Exam questions often give demand and supply as equations instead of a diagram. Equilibrium is where the two quantities are equal, so you set them equal and solve.

\[ Q_d = Q_s \;\Rightarrow\; \text{solve for } P^*, \text{ then substitute back to find } Q^* \]

Worked example

A town’s market for cinema tickets has $ Q_d = 180 – 6P $ and $ Q_s = 20 + 4P $. Find the equilibrium. Then say what happens if the price is set at $12.

Step 1$ 180 – 6P = 20 + 4P \;\Rightarrow\; 160 = 10P \;\Rightarrow\; P^* = 16 $

Step 2$ Q^* = 180 – 6(16) = 84 $. Check: $ 20 + 4(16) = 84 $ ✓

Step 3At $ P = 12 $: $ Q_d = 180 – 72 = 108 $, $ Q_s = 20 + 48 = 68 $

Step 4$ Q_d – Q_s = 108 – 68 = 40 $, so there is a shortage of 40 tickets

The market clears at $16 with 84 tickets sold. At $12 the price is below equilibrium, so 40 more tickets are wanted than offered. Buyers compete for the scarce tickets and the price rises back towards $16.

Exam tipFor “is there a surplus or shortage at price X?” questions, work in three moves: (1) find $ Q_d $ and $ Q_s $ at that price; (2) compare them and name the result, with its size; (3) explain the mechanism, meaning why sellers cut prices or why buyers bid prices up. The explanation of the mechanism is where many students drop marks. Always check your Q* in both equations.

Practise: 6 questions

Try each one on paper first, then check the worked answer.

EasyQ1. At a price of $3, quantity demanded of rice is 800 bags and quantity supplied is 500 bags. Is there a surplus or a shortage? What will happen to the price? Show worked answer

$ Q_d = 800 > Q_s = 500 $, so there is a shortage of $ 800 – 500 = 300 $ bags.
Buyers compete for the limited rice and bid the price up. As the price rises, quantity demanded falls and quantity supplied rises until they are equal at the equilibrium price.

EasyQ2. A study finds that drinking coffee is good for your heart. What happens to the equilibrium price and quantity of coffee? Show worked answer

The study changes tastes, so demand shifts right. Supply is unchanged.
At the old price there is now a shortage, so the price rises and firms supply more.
New equilibrium: higher price and higher quantity. P and Q move in the same direction, as always with a demand shift.

MediumQ3. In a market, $ Q_d = 90 – 3P $ and $ Q_s = -10 + 2P $. Find the equilibrium price and quantity. Show worked answer

Set $ Q_d = Q_s $: $ 90 – 3P = -10 + 2P $
$ 100 = 5P $, so $ P^* = 20 $
$ Q^* = 90 – 3(20) = 30 $
Check: $ -10 + 2(20) = 30 $ ✓
Equilibrium: price $20, quantity 30 units.

MediumQ4. During a heatwave, demand for electric fans rises. At the same time, a factory fire reduces the supply of fans. What can you say about the equilibrium price and quantity? Show worked answer

Demand up → pushes P up and Q up.
Supply down → pushes P up and Q down.
Both push price up, so price definitely rises (determinate).
The effects on quantity oppose each other, so quantity is ambiguous (indeterminate). It rises if the demand shift is bigger and falls if the supply shift is bigger.

MediumQ5. A market has $ Q_d = 120 – 2P $ and $ Q_s = 3P $. Cheaper materials shift supply to $ Q_s = 30 + 3P $. Find the old and new equilibrium and describe the change. Show worked answer

Old: $ 120 – 2P = 3P \Rightarrow 120 = 5P \Rightarrow P = 24 $. $ Q = 3(24) = 72 $. Check: $ 120 – 48 = 72 $ ✓
New: $ 120 – 2P = 30 + 3P \Rightarrow 90 = 5P \Rightarrow P = 18 $. $ Q = 120 – 36 = 84 $. Check: $ 30 + 54 = 84 $ ✓
Price falls from $24 to $18 and quantity rises from 72 to 84. P and Q move in opposite directions, as expected for an increase in supply.

ExamQ6. The market for festival tickets has $ Q_d = 2{,}400 – 40P $ and $ Q_s = 400 + 60P $. (a) Calculate the equilibrium price and quantity. (b) If the organiser sets a price of $15, is there a surplus or shortage, and how large? (c) Good reviews shift demand to $ Q_d = 2{,}900 – 40P $. Find the new equilibrium and explain the change. [6 marks] Show worked answer

(a) $ 2{,}400 – 40P = 400 + 60P \Rightarrow 2{,}000 = 100P \Rightarrow P^* = 20 $. $ Q^* = 2{,}400 – 800 = 1{,}600 $. Check: $ 400 + 1{,}200 = 1{,}600 $ ✓ [2 marks]
(b) At $15: $ Q_d = 2{,}400 – 600 = 1{,}800 $; $ Q_s = 400 + 900 = 1{,}300 $. $ Q_d > Q_s $, so a shortage of 500 tickets. Buyers compete and the price would be bid up towards $20. [2 marks]
(c) $ 2{,}900 – 40P = 400 + 60P \Rightarrow 2{,}500 = 100P \Rightarrow P = 25 $. $ Q = 2{,}900 – 1{,}000 = 1{,}900 $. Check: $ 400 + 1{,}500 = 1{,}900 $ ✓. Price rises by $5 and quantity rises by 300. Both rise, which matches the rule for an increase in demand: at the old price of $20 there is a shortage, the price rises, and sellers move up their supply curve. [2 marks]

Check yourself

1. The current price is above the equilibrium price. What follows?

Above P*, sellers offer more than buyers want, so unsold stock pushes the price down.

2. New technology cuts the cost of making solar panels. The new equilibrium has:

Supply shifts right, so price falls and quantity rises: opposite directions.

3. If $ Q_d = 500 – 10P $ and $ Q_s = 100 + 15P $, the equilibrium price is:

$ 400 = 25P $, so $ P = 16 $; both equations then give 340.

Your score: 0 out of 3

The short version

Equilibrium is where demand meets supply: $ Q_d = Q_s $ at P*.
A price above P* creates a surplus and falls; a price below P* creates a shortage and rises.
Demand shifts: P and Q move together. Supply shifts: P and Q move in opposite directions.
If both curves shift, one variable is certain and the other is ambiguous.
Algebra: set $ Q_d = Q_s $, solve for P*, substitute back for Q*, and check in both equations.

This guide covers the core of the chapter. For the full Chapter 7, with diagrams, the avocado case study and 15 exam-style questions with a complete answer key, see the book Economics Made Simple.

Step 8: Market Equilibrium and Price

What equilibrium means

How markets fix themselves: surplus and shortage

When demand or supply shifts

When both curves shift at once

Finding equilibrium with algebra

Practise: 6 questions

Check yourself

The short version

Further reading on EconTutorials

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