Equilibrium is a state of the market in which demand and supply are balanced due to which prices are stable. There are several types of equilibrium in economics, but in general, price equilibrium is considered market equilibrium. The perfect equilibrium of a market is hypothetical and it is impossible to obtain perfect equilibrium in markets.
According to the market equilibrium theory, demand should meet supply. However, when the price of a product goes below the equilibrium price, excess demand takes place. In such circumstances, the quantity of products received from the manufacturers is lower than the required amount of consumers.
On the other hand, an excess supply situation occurs when the prices go above the equilibrium price. The manufacturers impose an excess quantity of products on the market.
In both cases mentioned above, market forces drive the situation to a balanced level.
In the case of excess demand, the prices of products go up as the number of products gets limited and consumers want the same product. So, the manufacturers increase production and the prices go down to a balanced level in the long run.
In the case of excess supply, the prices of products come down and producers tend to create less number of products. This ultimately means that the supply of the products would come to a normal level once the supply comes down to a level of required demand.
When there is a market equilibrium in a market with a fixed number of firms, it is considered that firms are price takers and not price makers. Every firm in such markets will only follow to affix the price as determined by the market forces. These firms cannot increase or decrease the prices of products they manufacture. In simpler words, firms cannot influence the price of products in the market.
Prices of products in the market are determined by the market forces of supply and demand. It is considered that firms produce a very minute fraction of products in comparison to the total products in the market. Due to this, the firms cannot decide the prices of products on their own. Rather, they have to produce and sell things at the market-determined price.
The concept of free entry and exit is related to the profits of the enterprises. It is believed that in the case of an equilibrium no firm in the market can earn a loss or a supernormal profit. Earning a supernormal profit will let the enterprise create a barrier to entry of other firms, but when there is an equilibrium state in the market, no entry or exit barriers should be present in the market.
The equilibrium cost price is equal to the minimum average cost of the enterprises. If we consider that there is a possibility of earning a supernormal profit in the market. This will attract more novice producers to enter the market. Due to this the supply curve will shift rightward.
However, as demand remains constant and more firms produce the products, the prices of the products will automatically come down. So, supernormal profit will cease to exist.
When there is no supernormal profit no new firm will enter the market. So, the firms in the market will have to bear the normal profit to stay afloat and do business in the market.
Similarly, if the profit is less than normal, some firms will leave the industry and the number of producers will decrease. This will limit the supply and the price of the limited supply will go up to match the demand in the market. Therefore, the prices will reach normal in due course of time.
Therefore, with free entry and exit, all firms will earn a fixed normal profit, and no firm will earn an acute loss or supernormal profit that is different from other competing firms.
The theory of market equilibrium can be used to determine the price ceiling and price floor, two distinct attributes related to the price of products in the market.
The price ceiling is the maximum amount of price a seller can charge for a product that is set by governments so that the cost of some commodities does not cross the affordable barrier. The price ceiling is essentially a type of price control that depends on the affordability of general citizens.
In India, examples of price ceilings can be seen in the pricing of essential commodities, such as rice, wheat, sugar, kerosene, etc. The price of these items is usually fixed at a lower rate than the market-decided cost price. The market-decided price is obtained from the equilibrium state of the products. So, the price ceiling is related directly to market equilibrium.
The price floor is the opposite of the price ceiling. Here, the minimum price of a commodity is set so that the prices do not go below a certain level. Usually, this is applied to products, the market-determined price of which is found to go below the desired level.
The most common example of a price floor can be seen in the pricing of agricultural products. In pricing these products if the prices go below a certain level, the producers may get harmed. Therefore, the minimum price or price floor for these products is fixed by the government.
A price floor is usually set at a lower rate than the market equilibrium price.
Market equilibrium is a handy concept that helps economists understand the true potential of a market. It helps in adjudging the prices of products at the desired level and offers consumers the opportunity to indulge in a fair-priced market.
Market equilibrium is also important because it helps companies to understand the exact equilibrium price of a product. By knowing this, they can determine the profitability of a product. In other words, market equilibrium is the situation that helps businesses affix the prices and the profitability of items.
Economists also use the concept of market equilibrium to check the potential affordability of consumers in an economy. This offers them insight into the purchasing power of consumers.
Q1. What is market equilibrium in simple words?
Ans. Market equilibrium is the state of a market where the demand in the market equals the supply from the producers. In a state of market equilibrium, the prices or products do not fluctuate. They remain stable for a considerable period of time.
Q2. What do the free entry and exit in an equilibrium state mean for the producers?
Ans. Free entry and exit in the market equilibrium mean that no producer can suffer a huge loss and they also cannot earn supernormal profits.
Q3. Is perfect market equilibrium achievable in reality?
Ans. Perfect equilibrium is a hypothetical concept that cannot be obtained in real markets.
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