Determination of Market equilibrium Under Perfect Competition

Market equilibrium is a situation of the market in which demand for a commodity is exactly equal to its supply, corresponding to a particular price.
Thus, in a state of equilibrium, the market clears itself, as

Market demand = Market Supply

There is neither excess demand nor excess supply.
In this situation , the price that prevails in the market is called Equilibrium Price, Quantity supplied and demanded is called Equilibrium Quantity.

In a competitive market a single consumer or a single seller has no influence over the market price and so has no role to play in the determination of price.

Instead the price is determined in the competitive market through the interaction of market demand and supply.

How is the equilibrium price determined by the market forces of demand and supply?

Explanation through Table :

Price of X(apples) (Rs.)	Quantity Supplied (kg/week)	Quantity demanded (kg/week)	Market Position
5 4 3 2 1	50 40 30 20 10	10 20 30 40 50	Excess supply Excess supply Equilibrium Excess demand Excess demand

The above table shows as the price of commodity X falls, quantity demanded rises (law of demand)

and quantity supplied falls(law of supply).

Also it is clear from the table above that there is only one price of X 
i.e. Rs 3, at which quantity demanded is equal to quantity supplied.
So the equilibrium price is Rs 3 and equilibrium quantity is 30 kg/week.

Let us now understand why no price other than Rs.3 can be equilibrium price.

Firstly, taking prices below Rs.3. At these prices, consumers are willing to purchase a larger quantity than the producers are willing to sell.

Thus at price Rs.2, the buyers would be willing to buy 40 kg apples whereas the supplier would be willing to supply only 20 kg apples. There exists an excess demand of 20 kg apples.

The amount by which quantity demanded exceeds the quantity supplied is called ‘excess demand’.

In case of excess demand, the demand of all the buyers cannot be fulfilled due to less supply, shortage of goods will arise leading to rise in the price of the commodity to acquire it.

Producer will charge higher price for in view of the fact that there are not enough goods to meet the demand.
Thus price will rise and will happen until market reaches the equilibrium price and quantity, the point at which shortage disappears.

This situation is seen at price Rs.3.

Now, take prices higher than Rs.3. At these prices, consumers are willing to purchase a smaller quantity than the producers are willing to sell.

Thus, at price Rs.5, the buyers would be willing to buy 10 kg apples and the suppliers are willing to sell 50 kg apples. There exists an excess supply of 40 kg apples.

The amount by which quantity supplied exceeds the quantity demanded is called ‘excess supply’.

In case of excess supply producers would not be able to sell some of the apples at the price of Rs.5.
There are surplus stock with the producers, so to attract the consumers he has to lower the price.

When one producer lower the price all the producers has to do the same to sell off their goods. Consumers, on the other hand, may begin to offer lower prices seeing that producers have unsold stock of apples.

Thus price will start falling. This fall in price will happen until market reach the equilibrium price and quantity, the point at which surplus disappears.

This situation is seen at price Rs.3.

It is only at equilibrium price that there would be no tendency for price to change.

Diagrammatic Presentation

market equilibrium

DD is the demand curve and SS is supply curve. They intersect each other at point E, where market demand = market supply.

Point E is the equilibrium point. This point shows that equilibrium price is Rs.3 and equilibrium quantity is 30 kg/week.

If initially price happens to be Rs.5, then market supply (50 kg) exceeds market demand (10 kg).There is an excess supply equal to AB.
It is a situation of surplus stock of goods. Pressure of excess supply will cause a reduction in market price.

Due to fall in the price, quantity supplied start declining (law of supply), movement along the supply curve is seen from B towards E. Quantity demanded sees an extension (law of demand), and movement along the demand curve from A towards E.

At point E situation of excess supply is eliminated. The market is cleared.

If initially price happens to be Rs.2, then market supply (20 kg) will be less than market demand (40 kg).There is an excess demand equal to CD.

It is a situation of shortage of goods. Pressure of excess demand will cause a rise in market price.

Due to rise in the price, quantity supplied start rising (law of supply), movement along the supply curve is seen from C towards E.
Quantity demanded sees a contraction (law of demand), and movement along the demand curve from D towards E.

At point E situation of excess demand is eliminated. The market is cleared.

Thus it is seen equilibrium price is Rs.3 and equilibrium quantity is 30 kg/week.

This denotes the situation of stable equilibrium – A stable equilibrium is one which, if displaced due to some small disturbance, brings forces in operation which restore the initial equilibrium position.

Marshall said that – just as both upper and lower blades of scissor are necessary to cut a piece of cloth, similarly both the forces of demand and supply are essential to determine the price of the commodity.