Rybakov A. E., Reutskova O. N., Kucherenko S. K.

Oles Honchar Dnipropetrovsk National University


Market equilibrium

Consumers and producers react differently to price changes. Higher prices tend to reduce demand while encouraging supply, and lower prices increase demand while discouraging supply. Economic theory suggests that, in a free market there will be a single price which brings demand and supply into balance, called equilibrium price. Both parties require the scarce resource that the other has and hence there is a considerable incentive to engage in an exchange.

An equilibrium prevails when economic forces balance so that economic variables neither increase nor decrease. A market equilibrium is attained when the price of a good adjusts so that the quantity buyers are willing and able to buy at that price is just equal to the quantity sellers are willing and able to sup­ply. When a market equilibrium is attained, forces of supply and demand balance so that there's no tendency for the market price or quantity to change over a given period. The equilibrium price acts to ration the good so that everyone who is willing and able to buy the good will find it available. Similarly, at the equilibrium price, everyone who wants to sell the good will be able to do so successfully.Equilibrium price is also called market clearing price because at this price the exact quantity that producers take to market will be bought by consumers, and there will be nothing ‘left over’. This is efficient because there is neither an excess of supply and wasted output, nor a shortage – the market clears efficiently. This is a central feature of the price mechanism, and one of its significant benefits.

A shortage exists in a market if the quantity demanded exceeds the quantity supplied of a good over a given period. For example, there will be a monthly shortage of compact disc players if at the current market price the monthly number of players that sellers are willing and able to make available falls short of the monthly number that buyers are willing and able to purchase. A surplus exists in a market if the quantity sup­plied exceeds the quantity demanded of a good over a given period.

At the market equilibrium price of the good, there can be neither surpluses nor shortages in the market over any given period. When a market clears, the good is rationed in the sense that there are neither surpluses nor shortages over a period.

Consumer equilibrium

As a consumer, you have limited income available to spend on the goods that provide you with utility. Your problem is to allocate your income (for example, per month) among the items you want. The opportunity cost of spending some of your income on any one good is represented by the price of that good.

Each tune you buy more of an item you simultaneously obtain extra utility which is the marginal utility of an item and sacrifice the opportunity to purchase other goods. Assuming you can buy as much of an item as you want at the market price, the sum of expenditure on other goods you sacri­fice for each unit of a particular good is constant. For example, if buns and ice cream cones both cost $1, you ll have to give up one bun each time you buy another ice cream cone. However, the marginal utility per dollar of ice cream cones will therefore be less as you buy more cones per month. As a rational consumer, you presumably seek to obtain the greatest possible utility from spending your limited income. You'll gain utility each month by consuming more buns if your marginal utility per dollar of buns exceeds your marginal utility per dollar of ice cream cones.

As long as the marginal utility per dollar is not the same for all goods consumed, the consumer can gain by reallocating income to buy more of the goods that have higher marginal utility per dollar than others. Of course, when you consume more goods with high marginal utility per dollar, the marginal utility per dollar of those goods declines. Consuming fewer goods with low marginal utility per dollar increases their marginal utility per dollar. Adjusting marginal utility per dollar in this way by con­trolling the purchase of particular goods enables you to maximise your satisfaction from spending your income.

So, a consumer equilibrium is attained when a consumer purchases goods (for example, weekly) until the marginal utility per dollar is the same for all goods consumed.