Competitive markets and equilibrium

Through economic efficiency, it is possible to reach the optimal level of social welfare.

This requires the market to be perfectly competitive, where:

• The goods offered for sale are all the same.
• There are so many buyers and sellers that no single buyer or seller has any influence over the market price (Gans, J. et al, 2018).

In such a market – and under several strict assumptions of property rights – prices and self-interest will guide the decisions of organisations and households. We will look at some property rights assumptions in the next section.

Buyers and sellers freely interacting in this kind of market will create an outcome that allocates goods to the people who value them the most.

Exchanges through this free interaction eventually lead to an equilibrium point. Equilibrium is found where the supply and demand curves intersect. Demand reflects the quantity that consumers are willing and able to buy at alternative prices.

Equilibrium is a situation in which supply and demand have been brought into balance.

Here, we see an efficient market allocation for seven cups of coffee at $4 each. It maximises the economic surplus, and is equal to the sum of consumer and producer surpluses.

_{Adapted from Lewis, L., & Tietenberg, T. H. (2018), Figure 2.4.}

If buyers are willing to buy seven coffees at $4 each, the market will be in equilibrium at the price of $4 and the quantity of seven coffees. This maximises social welfare as well.

The equilibrium price is where the quantity demanded is equal to the amount quantity supplied. This quantity is called the equilibrium quantity.

Share your thoughts

Consider the following questions and try to answer at least one of them in the comments below. Read what other learners are saying. Do you agree?

• What happens when the supply for a product decreases while demand increases? (What does this mean for its price? Can we make any guesses about its quantity?)
• What happens if supply increases as demand decreases?
• What if supply and demand both increase?
• What if supply and demand both decrease?

References

_{Gans, J., King, S., Stonecash, R., Byford, M., Libich, J., & Mankiw, N. G. (2018). Principles of Economics (7th Asia-Pacific edition.). Cengage Learning Australia.}

_{Lewis, L., & Tietenberg, T. H. (2018). Environmental and Natural Resource Economics (11th edition.). Routledge.}