Equilibrium and Adjustment Process

Key Points

• Equilibrium Price: The price at which quantity demanded equals quantity supplied.
  • At this price, no forces are acting to change the price.
  • It is considered a stable price.

Price Dynamics

• Above Equilibrium Price ($80/barrel example):
  • Surplus occurs: quantity supplied > quantity demanded.
  • Sellers have an incentive to lower prices to reach equilibrium.
• Below Equilibrium Price:
  • Shortage occurs: quantity demanded > quantity supplied.
  • Buyers compete for limited goods, pushing prices up to equilibrium.

Equilibrium Quantity

• Definition: The quantity where quantity demanded equals quantity supplied.
• Any quantity other than equilibrium results in unexploited gains from trade.
  • Example: At 50 million barrels/day, a potential gain of $40 exists between buyer's willingness to pay ($90) and seller's cost ($50).
  • Economics assumes gains from trade will be realized, pushing quantity toward equilibrium.

Market Efficiency

• Free Market Operation:
  • Quantity can't sustainably be above equilibrium (e.g., 90 million barrels/day leads to waste).
  • Suppliers' costs exceed buyers' willingness to pay above equilibrium quantity, leading to waste.
  • Free markets aim to eliminate waste by aligning trade.

Gains from Trade

• Maximized at Equilibrium:
  • Split into Consumer and Producer Surplus.
  • Goods are allocated to those who value them most (high willingness to pay) and produced by those who can do so at lower cost.

Additional Points

• Demand Curve Split by Equilibrium Price:
  • Buyers with highest demand purchase goods.
  • Sellers with lowest costs sell goods.
• Market Efficiency: No unexploited gains or wasteful trades at equilibrium.

Conclusion

• Free markets maximize trade gains, aligning supply with high willingness to pay and low cost.

For further practice, explore practice questions or advance to the next video.