Key Points

Market equilibrium is a situation where the market clears, meaning the quantity consumers wish to buy (market demand) equals the quantity firms wish to sell (market supply). The price at this point is the equilibrium price and the quantity is the equilibrium quantity.

Excess demand occurs when, at a given price, market demand is greater than market supply. This condition causes competition among buyers and tends to push the price up towards equilibrium.

Excess supply occurs when, at a given price, market supply is greater than market demand. This condition causes competition among sellers and tends to push the price down towards equilibrium.

When the number of firms is fixed, market equilibrium is determined graphically at the intersection of the market demand curve and the market supply curve. This point establishes the market-clearing price and quantity.

An increase (rightward shift) in demand leads to a higher equilibrium price and quantity. A decrease (leftward shift) in demand leads to a lower equilibrium price and quantity, assuming supply remains constant.

An increase (rightward shift) in supply leads to a lower equilibrium price and a higher equilibrium quantity. A decrease (leftward shift) in supply leads to a higher equilibrium price and a lower equilibrium quantity, assuming demand remains constant.

When both demand and supply curves shift rightward, the equilibrium quantity increases, but the effect on price is uncertain. When both shift leftward, the equilibrium quantity decreases, while the effect on price is again uncertain.

When demand shifts rightward and supply shifts leftward, the equilibrium price increases, but the effect on quantity is uncertain. When demand shifts leftward and supply shifts rightward, the equilibrium price decreases, while the effect on quantity is uncertain.

In a market with free entry and exit, firms earn only normal profits in the long run. The equilibrium price will always be equal to the minimum average cost (min AC) of the firms.

With free entry and exit, a shift in the demand curve does not change the equilibrium price, which stays at the minimum average cost. Instead, it changes the equilibrium quantity and the number of firms in the market.

A price ceiling is a government-imposed maximum price on a good or service, set below the equilibrium price. It is typically used for necessary items to make them more affordable.

A binding price ceiling creates excess demand, or a shortage, of the good. This can lead to rationing, long queues, and the development of a black market where the good is sold at a higher price.

A price floor is a government-imposed minimum price on a good or service, set above the equilibrium price. Common examples include agricultural price support programs and minimum wage laws.

A binding price floor creates excess supply, or a surplus, of the good. To maintain the floor price, the government often needs to purchase the surplus, as seen in agricultural markets.

In the labor market, households supply labor and firms demand it. The equilibrium wage rate is determined at the intersection of the downward-sloping labor demand curve and the upward-sloping labor supply curve.

A firm's demand for labor is determined by the Value of Marginal Product of Labor (VMPL), which equals the price of the output multiplied by the Marginal Product of Labor. A competitive firm hires labor until the wage rate equals the VMPL.