3.3 The Determination of Price LO 5
The equilibrium price is the price at which the quantity demanded
equals the quantity supplied. At any price below equilibrium, there
will be excess demand; at any price above equilibrium, there will be
excess supply. Graphically, equilibrium occurs where the demand and
supply curves intersect.
Price rises when there is excess demand and falls when there is
excess supply. Thus, the actual market price will be pushed toward
the equilibrium price. When it is reached, there will be neither excess
demand nor excess supply, and the price will not change until either
the supply curve or the demand curve shifts.
By using the method of comparative statics, we can determine the
effects of a shift in either demand or supply. An increase in demand
raises both equilibrium price and equilibrium quantity; a decrease in
demand lowers both. An increase in supply raises equilibrium
quantity but lowers equilibrium price; a decrease in supply lowers
equilibrium quantity but raises equilibrium price.
The absolute price of a product is its price in terms of money; its
relative price is its price in relation to other products.
The demand and supply of specific products depend on their relative,
not absolute, prices.