find 2 good palces tro add annotaitons that are thoiguhufril aroind 2-4 ssetnecs max 40 MACROECONOMICS: AP®
 EDITION
Topic 1.6
Market Equilibrium, Disequilibrium,
and Changes in Equilibrium
“The concept of equilibrium is very useful. It allows us to focus on the final
outcome rather than the process that leads up to it. But the concept is
also very deceptive. . . . Equilibrium itself has rarely been observed in real
life—market prices have a notorious habit of fluctuating.”
George Soros, The Alchemy of Finance (1987)
Essential Question: How do demand for and supply of a good or service
determine the equilibrium price in a competitive market?
Up to now, the concepts of demand and supply have been investigated
separately—the quantities that consumers and producers are willing to consider
at different prices and how these quantities fluctuate in response to changes in
price. But people are not always able to do what they are willing to do. Both
consumers and producers are limited by what they can afford. This topic looks
at how the prices of goods are set in the U.S. market system.
How Supply and Demand Determine Price
The law of supply says that as price increases, the quantity of goods or services
offered for sale increases, while the law of demand says that as price increases,
the quantity that consumers are willing and able to buy decreases. How can
these two economic laws that seem to be diametrically opposed be reconciled?
Equilibrium and Market Price As it turns out, there is a price at which
supply and demand are equal. On a graph, this price is the point at which the
demand and supply curves intersect. This price is referred to as the equilibrium
price because it is the price at which supply and demand are in balance, or equal.
In other words, the price at which the quantity of goods or services demanded
is equal to the quantity supplied is the price at which sales take place.
The graph “Supply/Demand Equilibrium” charts both the demand and
supply curves for an item. Here the equilibrium price is $2.50. At that price, 5
units of the item are demanded, and 5 units are supplied. As long as demand
and supply do not change, this is the only price at which all of the items can
be sold. At the equilibrium or market price, the market is cleared—that is,
all possible sales are made. The quantity demanded by consumers equals the
quantity supplied by producers so that there is no leftover supply or demand.
 Topic 1.6 Market equilibrium, disequilibrium, and changes in equilibrium 41 Price (in dollars)
Quantity
0
0
2
1
2 4 6 8 10
3
4
5
Equilibrium Quantity
Demand
Supply
Equilibrium
Equilibrium
Price
Supply/Demand Equilibrium
Market Imbalances Market pressures push prices toward equilibrium,
but prices never quite reach it. Rather, they are at disequilibrium prices, ones
that have some type of imbalance.
• At any price higher than the equilibrium price, producers will be left
with surplus items, excess supply for that price. If producers want to
sell all they have produced, they have to accept a lower price.
• At prices lower than the equilibrium price, consumers will find a shortage
of items, a supply too small to fill demand at that price. If consumers want
to buy the item, they have to be willing to pay a higher price.
Graphing Surpluses and Shortages The paired graphs “Markets Not in
Equilibrium” shows how markets may be out of equilibrium. In the first graph,
the price is $3, which is above the equilibrium price of $2.50. The quantity
supplied at that price is 6 units, but the quantity demanded is 4 units, so there
is a surplus of 2 units. Producers can try to increase sales by cutting prices,
moving the price toward the equilibrium price so that they can get rid of their
surplus.
In the second graph, the price is $2, which is below the equilibrium price of
$2.50. The quantity supplied at that price is 4 units, but the quantity demanded
is 6, so there is a shortage of 2 units due to excess demand. In other words,
producers will run out of the item. Because demand exceeds supply, producers
can raise the price without losing sales. In both cases, price adjustments move
the market toward the equilibrium of supply and demand.
42 MACROECONOMICS: AP®
 EDITION
Price (in dollars)
Quantity
0
0
2
1
2 4 6 8 10
3
4
5
Quantity
Demanded
Surplus
Quantity
Supplied
Supply
Demand
Price (in dollars)
Quantity
0
0
2
1
2 4 6 8 10
3
4
5
Quantity
Supplied
Quantity
Demanded
Supply
Demand
Shortage
Markets Not in Equilibrium
Excess Supply Excess Demand
Whether the price of a good or service starts out too high or too low, the
activities of many consumers and producers push the market price toward the
equilibrium price. Surpluses and shortages are usually temporary since prices
generally move toward their equilibrium levels.
Changes in Equilibrium Price
The equilibrium price increases or decreases depending on the positions of the
demand and supply curves. If one of the determinants of demand (see Topic 1.4) or
determinants of supply (see Topic 1.5) change, the equilibrium price also changes.
You can analyze how an event affects the equilibrium in three steps:
1. Determine whether the shift affects the demand curve, the supply curve,
or both curves.
2. Determine whether the curve shifts to the left or to the right.
3. Use the supply-and-demand graph to compare the original equilibrium
with the new one.
Graphing Changes in Equilibrium Price The paired graphs “Changes
in Demand and Supply” show how changes in demand and supply affect the
equilibrium price. The first graph shows an increase in demand, and the second
one shows a decrease in supply. To see how a decrease in demand would affect
the equilibrium, draw a new demand curve to the left of and parallel to the
original one. To see how an increase in supply would affect the equilibrium,
draw a new supply curve to the right of and parallel to the original one.
These examples illustrate two principles:
• Price varies directly with changes in demand.
• Price varies inversely with changes in supply.
Since there can be changes in either demand or supply, it should come as
no surprise that both may change. If both the demand and the supply shift, the 
 Topic 1.6 Market equilibrium, disequilibrium, and changes in equilibrium 43
new equilibrium price and quantity cannot be predicted without knowing the
amount and direction of each shift.
Competition and Prices in a Market Economy This analysis of market
price has been based on a concept known as perfect competition, which holds
that price is determined solely by supply and demand. Perfect competition
assumes the existence of several conditions:
• There are many consumers and producers.
• Competing products are virtually identical.
• All consumers and producers have full knowledge of market conditions.
• Consumers are free to buy or not to buy and producers are free to sell
or not to sell.
However, these conditions are rarely met in real life. One company may
control the production of an item. Similar products usually are not identical.
Consumer demand may be influenced by advertising or brand loyalty rather
than the intrinsic value of an item. These are just some of the reasons that the
laws of supply and demand do not operate in the real world as they do in the
model. But in spite of its limitations, perfect competition highlights the forces
that influence prices. And prices are what make the market system work. Prices
play several roles in a market economy:
• They act as signals to consumers and producers. When prices are low
enough, they send a signal to consumers to buy. When they are high
enough, they send a signal to producers to sell.
• They encourage efficient production. Producers strive for efficient
use of resources as a way of increasing their profits. In turn, consumers
benefit because they are provided with the things they want at lower
prices.
• They determine who will receive goods and services. Prices help
determine who will be able to afford an economy’s output of goods
and services.
Supply
Original
Demand
Original
Supply
Demand
New
Demand
Increase
in Demand
Higher
Quantity Sold
Higher
Price
 Decrease
in Supply
Higher
Price
Lower
Quantity Sold
New
Supply
New
Equilibrium
New
Equilibrium
Price
(in dollars)
Price
(in dollars)
Quantity
0
0
2
1
2 4 6 8 10
3
4
5
Quantity
0
0
2
1
2 4 6 8 10
3
4
5
Changes in Demand and Supply
Increase in Demand Increase in Supply
44 MACROECONOMICS: AP®
 EDITION
Prices make things happen. If consumers want something sufficiently
enough and have enough money, they will pay more for it. If producers want
to sell something sufficiently enough, they will lower its price. Prices react to
demand and supply. The changes in demand and supply and their affect on the
equilibrium price are summarized in the chart below.
EFFECT ON EQUILIBRIUM PRICE OF CHANGES IN SUPPLY AND DEMAND
Supply
Demand
Increases:
Curve shifts right
Stays Constant:
Curve does not shift
Decreases:
Curve shifts left
Increases:
Curve shifts right
Varies Increases Increases
Stays Constant:
Curve does not
shift
Decreases Stays Constant Increases
Decreases:
Curve shifts left
Decreases Decreases Varies
ANSWER THE TOPIC ESSENTIAL QUESTION
1. In one to three paragraphs, explain how demand for and supply of
a good or service determine the equilibrium price in a competitive
market.
KEY TERMS
equilibrium price
disequilibrium price
surplus
shortage
MULTIPLE-CHOICE QUESTIONS
1. When the demand curve shifts left and the supply curve does not
change, what happens to the equilibrium price?
(A) It decreases.
(B) It stays the same.
(C) It shifts right.
(D) It increases.
(E) It is no longer on the supply curve.