Economics | Market equilibrium

Chapter 3: Market Equilibrium - Where Buyers Meet Sellers!

Hey everyone! Welcome to one of the most important chapters in Economics: Market Equilibrium. Don't let the fancy name scare you. This is all about how the price of things, from your favourite bubble tea to the latest smartphone, is decided.

By the end of these notes, you'll understand:

• What 'equilibrium' means and how to find it.
• What happens when prices are too high or too low (shortages and surpluses).
• How real-world events (like a new trend or a typhoon) can change market prices.
• How we can measure the 'happiness' of buyers and sellers (surplus!).
• What happens when the government steps into the market.

Think of this chapter as the 'heart' of microeconomics. Understanding this will make so many other topics click into place. You've got this!

1. Finding the "Sweet Spot": What is Market Equilibrium?

Before we start, let's quickly remember what a market is. It's any place or arrangement where buyers (demand) and sellers (supply) come together to trade. It can be a wet market, the Hong Kong Stock Exchange, or even an app like Carousell!

Market Equilibrium is the 'sweet spot' or 'balance point' in a market. It's a situation where the quantity of a good that buyers want to buy (quantity demanded) is exactly equal to the quantity that sellers want to sell (quantity supplied). When a market is in equilibrium, there is no tendency for the price or quantity to change.

The price at this point is called the Equilibrium Price (P*).
The quantity at this point is called the Equilibrium Quantity (Q*).

How to find Equilibrium (Two ways!)

Method 1: Using a Demand & Supply Schedule (A Table)

Let's look at the market for face masks. Just find the price where Quantity Demanded (Qd) equals Quantity Supplied (Qs).

Example: Market for Face Masks

Price per box	Quantity Demanded (Qd)	Quantity Supplied (Qs)	Market Situation
$120	1,000 boxes	9,000 boxes	Surplus (Qs > Qd)
$100	3,000 boxes	7,000 boxes	Surplus (Qs > Qd)
$80	5,000 boxes	5,000 boxes	Equilibrium (Qd = Qs)
$60	7,000 boxes	3,000 boxes	Shortage (Qd > Qs)
$40	9,000 boxes	1,000 boxes	Shortage (Qd > Qs)

As you can see, at a price of $80, Qd = Qs. So:

• Equilibrium Price (P*) = $80
• Equilibrium Quantity (Q*) = 5,000 boxes

Method 2: Using a Demand & Supply Diagram

This is the way you'll see it most often! The equilibrium is simply where the demand curve (D) and the supply curve (S) intersect.

Imagine plotting the points from the table above...

(Diagram showing a standard demand and supply graph. The downward-sloping demand curve and upward-sloping supply curve intersect. The intersection point is labelled 'E'. A dotted line goes from E to the vertical (Price) axis, labelled 'P* = $80'. Another dotted line goes from E to the horizontal (Quantity) axis, labelled 'Q* = 5000'.)

Key Takeaway

Market equilibrium occurs where the demand curve and supply curve intersect. At this point, Quantity Demanded = Quantity Supplied. This gives us the equilibrium price (P*) and equilibrium quantity (Q*).

2. When the Market is Unbalanced: Shortage & Surplus

What happens if the market price isn't at P*? The market becomes unstable, and forces will push it back towards equilibrium. It's like a balancing act!

Shortage (or Excess Demand)

A shortage happens when the current price is BELOW the equilibrium price (P < P*).

• At this low price, consumers want to buy a lot (high Qd).
• But producers don't want to sell much (low Qs).
• Result: Qd > Qs. There isn't enough to go around!

Real-world example: When a new, popular iPhone model is released, everyone rushes to buy it. The initial stock runs out quickly, creating a shortage. People might even pay more than the official price to get one!

How the market fixes it:

1. Buyers are frustrated they can't get the product. Some are willing to pay more.
2. Sellers see this and realize they can raise the price.
3. As the price rises:
   • Quantity demanded decreases (Law of Demand).
   • Quantity supplied increases (Law of Supply).
4. This process continues until the price reaches P*, where Qd = Qs and the shortage is gone.

(Diagram showing a D&S graph. A price line 'P1' is drawn BELOW P*. The points where P1 hits the D and S curves are marked, showing Qd > Qs. The gap between them is labelled 'Shortage'.)

Surplus (or Excess Supply)

A surplus happens when the current price is ABOVE the equilibrium price (P > P*).

• At this high price, producers are excited to sell a lot (high Qs).
• But consumers don't want to buy much (low Qd).
• Result: Qs > Qd. Sellers have too much stock left over.

Real-world example: After the Mid-Autumn Festival, shops are full of unsold mooncakes. To get rid of them, they have big sales and cut the prices. This is a surplus.

How the market fixes it:

1. Sellers have unsold goods and want to clear their stock.
2. They start lowering the price to attract more buyers.
3. As the price falls:
   • Quantity demanded increases (Law of Demand).
   • Quantity supplied decreases (Law of Supply).
4. This process continues until the price reaches P*, where Qd = Qs and the surplus is gone.

(Diagram showing a D&S graph. A price line 'P2' is drawn ABOVE P*. The points where P2 hits the D and S curves are marked, showing Qs > Qd. The gap between them is labelled 'Surplus'.)

A Common Mistake to Avoid!

Shortage vs. Scarcity: Don't mix them up!

• Scarcity is the basic economic problem that our wants are unlimited but resources are limited. Everything that has a price is scarce. Scarcity always exists.
• Shortage is a market condition where P < P*. It's temporary and can be solved by raising the price.

Key Takeaway

If Price < P*, there is a shortage (Qd > Qs), and the price will be bid up.
If Price > P*, there is a surplus (Qs > Qd), and the price will be pushed down.
This is the "invisible hand" of the market pushing prices towards equilibrium!

3. Let's Get Moving: Changes in Market Equilibrium

In the real world, things are always changing! A celebrity endorses a product, a new technology is invented, or incomes change. These events shift the demand or supply curves, creating a NEW equilibrium.

The Golden 3-Step Rule for Analysing Changes:

Whenever you're asked about how an event affects a market, ALWAYS follow these three steps. It makes it so much easier!

1. Decide: Does the event shift the Demand curve or the Supply curve? (Hint: Does it affect buyers' behaviour or sellers' behaviour?)
2. Direction: Which way does the curve shift? (Increase = Rightward shift; Decrease = Leftward shift)
3. Diagram: Draw the shift on a new D&S diagram. Compare the new equilibrium (E2) with the old one (E1) to see what happened to P* and Q*.

Scenario 1: A Shift in Demand

Event: A heatwave hits Hong Kong, making everyone want to buy air conditioners.

1. Decide: This affects buyers' preferences. It's a shift in Demand.
2. Direction: People want more ACs at any price. Demand increases (shifts right).
3. Diagram:

   (Diagram shows an initial equilibrium E1 at P1, Q1. The demand curve shifts right from D1 to D2. The new intersection with S1 is at E2. The new equilibrium is at a higher price P2 and higher quantity Q2.)

   Result: The equilibrium price increases (P1 → P2) and the equilibrium quantity increases (Q1 → Q2).

Scenario 2: A Shift in Supply

Event: A new, more efficient coffee bean harvesting machine is invented.

1. Decide: This lowers the cost of production for sellers. It's a shift in Supply.
2. Direction: Sellers can now supply more coffee at any price. Supply increases (shifts right).
3. Diagram:

   (Diagram shows an initial equilibrium E1 at P1, Q1. The supply curve shifts right from S1 to S2. The new intersection with D1 is at E2. The new equilibrium is at a lower price P2 and higher quantity Q2.)

   Result: The equilibrium price decreases (P1 → P2) and the equilibrium quantity increases (Q1 → Q2).

Scenario 3: Simultaneous Shifts (The tricky one!)

What if both curves shift at the same time? For example, during Chinese New Year, the demand for flowers increases, but bad weather decreases the supply of flowers.

• Demand increases (shifts right). This pushes P* up and Q* up.
• Supply decreases (shifts left). This pushes P* up and Q* down.

Result:

• Price (P*): Both shifts push the price UP. So, the equilibrium price will definitely increase.
• Quantity (Q*): One shift pushes quantity UP, the other pushes it DOWN. The final result depends on which shift is bigger. So, the change in equilibrium quantity is uncertain (or ambiguous).

Quick Review: Summary of Shifts

• Demand ↑ => P* ↑, Q* ↑
• Demand ↓ => P* ↓, Q* ↓
• Supply ↑ => P* ↓, Q* ↑
• Supply ↓ => P* ↑, Q* ↓
• D↑ and S↑ => P* ?, Q* ↑
• D↓ and S↓ => P* ?, Q* ↓
• D↑ and S↓ => P* ↑, Q* ?
• D↓ and S↑ => P* ↓, Q* ?

(The '?' means the result is uncertain without knowing the size of the shifts.)

Key Takeaway

Changes in the market are shown by shifting the D or S curves. Use the 3-step rule to find the new equilibrium price and quantity. When both curves shift, one variable (P* or Q*) will have an uncertain outcome.

4. Market Efficiency and "Happiness": Consumer & Producer Surplus

We know the market finds an equilibrium. But is this equilibrium a "good" outcome? Economists measure the benefits to buyers and sellers using the idea of surplus.

Consumer Surplus (CS)

Consumer Surplus is the difference between the highest price a consumer is willing to pay for a good and the actual price they pay (the market price).

Analogy: You are really thirsty and would be willing to pay $20 for a bottle of water. You get to the 7-Eleven and see it only costs $8. Your consumer surplus is $20 - $8 = $12. It's the 'extra happiness' or 'good deal' feeling you get!

On a diagram, CS is the area BELOW the demand curve and ABOVE the equilibrium price, up to the equilibrium quantity.

(Diagram showing a D&S graph. The triangle area above the P* line and below the D curve is shaded and labelled 'Consumer Surplus (CS)'.)

Producer Surplus (PS)

Producer Surplus is the difference between the actual price a producer receives for a good (the market price) and the lowest price they would be willing to accept (their cost of production).

Analogy: You are selling a second-hand textbook. Your minimum price is $100 (you won't sell for less). A buyer offers you the market price of $150. Your producer surplus is $150 - $100 = $50. It's the 'extra profit' you made above your minimum.

On a diagram, PS is the area ABOVE the supply curve and BELOW the equilibrium price, up to the equilibrium quantity.

(Diagram showing a D&S graph. The triangle area below the P* line and above the S curve is shaded and labelled 'Producer Surplus (PS)'.)

Total Surplus and Efficiency

Total Social Surplus (TSS) = Consumer Surplus + Producer Surplus

Here's the really cool part: A competitive market in equilibrium maximizes total social surplus. This is called allocative efficiency. It means that resources are allocated in the best possible way to make society as a whole as well-off as possible. No other price or quantity combination can create more total surplus.

Efficiency happens when Marginal Benefit (MB) = Marginal Cost (MC).

• The Demand curve represents the Marginal Benefit to society.
• The Supply curve represents the Marginal Cost to society.
• Their intersection (equilibrium!) is where MB = MC, the efficient point.

Key Takeaway

Consumer Surplus (CS) is the benefit to buyers. Producer Surplus (PS) is the benefit to sellers. The free market equilibrium is efficient because it maximizes the sum of CS and PS (Total Social Surplus).

5. Government Intervention: Price Controls, Quotas & Taxes

Sometimes, the government believes the market equilibrium price is 'unfairly' high or low. They might intervene, but this usually comes at a cost: a loss of efficiency.

When intervention prevents the market from reaching the efficient equilibrium quantity (Q*), it creates a Deadweight Loss (DWL). This is the loss of total surplus that nobody gets. It's a measure of inefficiency.

Price Ceiling (Maximum Price)

A price ceiling is a legal maximum price that can be charged for a good.

• It's effective only if it is set BELOW the equilibrium price.
• Purpose: To protect consumers from high prices (e.g., rent control).
• Effects of an effective price ceiling:
  • Creates a permanent shortage (Qd > Qs).
  • Quantity transacted falls (to Qs).
  • Consumer surplus may increase or decrease, producer surplus definitely decreases.
  • Creates a deadweight loss (DWL) because the quantity is below Q*.

(Diagram showing a price ceiling 'Pc' below P*. Show the new quantity transacted, the shortage, and the shaded triangle of Deadweight Loss.)

Price Floor (Minimum Price)

A price floor is a legal minimum price that can be charged for a good.

• It's effective only if it is set ABOVE the equilibrium price.
• Purpose: To protect producers from low incomes (e.g., minimum wage for labour).
• Effects of an effective price floor:
  • Creates a permanent surplus (Qs > Qd).
  • Quantity transacted falls (to Qd).
  • Consumer surplus definitely decreases, producer surplus may increase or decrease.
  • Creates a deadweight loss (DWL).

(Diagram showing a price floor 'Pf' above P*. Show the new quantity transacted, the surplus, and the shaded triangle of Deadweight Loss.)

Quota (Quantity Control)

A quota is a legal limit on the quantity of a good that can be produced or sold.

• It's effective only if it is set BELOW the equilibrium quantity.
• Purpose: To restrict supply (e.g., taxi licenses in some cities).
• Effects of an effective quota:
  • Price increases.
  • Quantity transacted falls (to the quota amount).
  • Creates a deadweight loss (DWL).

Unit Tax

A unit tax is a fixed amount of tax on each unit of a good sold (e.g., a $2 tax per pack of cigarettes).

• Effect: It decreases supply (shifts the supply curve vertically upwards by the amount of the tax).
• Results:
  • Price paid by buyers (Pb) increases.
  • Price received by sellers (Ps) decreases.
  • Quantity transacted (Qt) decreases.
  • The government gets tax revenue (Tax x Qt).
  • Creates a deadweight loss (DWL).
• Tax Incidence (Who pays the tax?): The burden of the tax is shared between buyers and sellers. The side of the market that is more price inelastic (less responsive to price changes) will bear a larger share of the tax burden. Think about it: if buyers are desperate for the good (inelastic demand), they will pay most of the tax.

(Diagram showing a tax. S1 shifts up to S2. Show the new higher price Pb, lower price Ps, new quantity Qt, the rectangle of government revenue, and the triangle of Deadweight Loss.)

Key Takeaway

Government interventions like effective price ceilings, price floors, quotas, and taxes prevent the market from reaching the efficient equilibrium. This leads to a lower quantity being transacted and creates a deadweight loss, which represents the lost value to society.