Lesson Objectives:
By the end of this lesson you will be able to:
*Explain how supply and demand create equilibrium in the
marketplace.
*Identify two ways that the government intervenes in market to
control prices.
*Analyze the impact of price ceilings and price floors on a free
market.
Reaching Equilibrium
The easiest way to understand the relationship between supply and demand is the take a look at
a supply and demand schedule.
Supply Schedule: compares how much of a good a firm is willing to sell at various prices.
Demand Schedule: Compares how much of a good a consumer is willing to buy at various
prices.
Combined Supply & Demand Schedule
The chart below shows that equilibrium is reached when the price of a slice of pizza causes the
quantity demanded by consumers to be the same as the quantity supplied by the restaurant
owner.
Price of a slice of
Pizza
Quantity Demanded Quantity Supplied
Result
$1.00
300
100
Shortage From
Excess demand
$2.00
250
150
Shortage from
Excess demand
$3.00
200
200
Equilibrium
$4.00
150
250
Surplus from excess
demand
$5.00
100
300
Surplus from excess
demand
$6.00
50
350
Surplus from excess
demand
Supply and Demand Meet
The point where demand and supply come together is called the equilibrium. Equilibrium is the
point of balance at which the quantity demanded equals the quantity supplied. At equilibrium,
the market for a good is stable.
Market Benefits
In any market, supply and demand will be equal at only one price and one quantity. At this
equilibrium price, buyers will purchase exactly as much of a good as firms are willing to sell.
When a market is at equilibrium, both buyers and sellers benefit.
Disequilibrium
If the market price or quantity supplied is anywhere but at the equilibrium, the market is in a
state of disequilibrium. Disequilibrium occurs when quantity supplied is not equal to quantity
demanded in a market. Disequilibrium can produce one of two outcomes: shortage or surplus.
Shortage
Shortage exists when the quantity demanded in a market is more than the quantity supplied.
This happens when the price of the item is below the equilibrium price. The low price
encourages buyers and discourages sellers.
Surplus
A surplus exists when quantity supplied exceeds quantity demanded and the actual price of a
good is higher than the equilibrium price. The higher price encourages the firms to produce
more of the good, but it discourages customers from buying the good.
Price Ceiling
Sometimes the government intervenes to control prices. The government can impose a price
ceiling or a maximum price that can be legally charged for a good or service. The price ceiling is
set below the equilibrium price.
An example of a price ceiling is rent control which is a price ceiling placed on apartment rent.
Price Floors
A price floor is a minimum price, set by the government, that must be paid for a good or service.
Governments set price floors to ensure that certain sellers receive at least a minimum reward for
their efforts. Sellers can include workers, who sell their labor.
An example of a price floor is the minimum wage, which sets a minimum price that an
employers can pay a worker for one hour of labor.