The equilibrium price is understood to be a market price at which both the supply and the demand in a market for a certain good match. The determination of the respective equilibrium price is based on the assumption that companies want to sell their goods at a maximum price. For the consumers, the contrary assumption is formulated that they want to buy the respective product as cheaply as possible. Companies try to achieve the equilibrium price successively by making price adjustments.
In the following lesson, you will learn everything you need to know about equilibrium price and what it means to businesses. There are also some exercises at the end of the lesson to help you learn the content.
- Synonyms: market equilibrium price | Market equilibrium
- English: equilibrium price
Why is the equilibrium price important?
According to lawfaqs.net, the equilibrium price is important for companies that want to determine the price of certain goods as part of their pricing policy. The equilibrium price acts as an important benchmark to which those responsible can orient themselves. After all, it is inherent in this price that the quantity of products offered corresponds to the quantities demanded on the market. There is therefore no excess.
Conversely, this means that there are surpluses if prices are different. Either the demand is greater than the supply or the supply is greater than the demand. Companies have to take this into account as part of their pricing policy and, at best, achieve the equilibrium price.
What is the equilibrium price?
Economic goods such as services or products can be traded at different prices. The so-called equilibrium price is when the amount of supply corresponds exactly to the amount of demand. Then it is the equilibrium price of the product, which is also known as the optimal price. The market is now in perfect equilibrium. There is no longer any surplus.
Supply function and demand function
Both the supply function and the demand function are of eminent importance when it comes to calculating the equilibrium price. It is inherent in the demand function that with rising prices the demand falls, while with the supply function with rising prices the willingness of the companies for a larger supply increases.
Consequently, the equilibrium price is the intersection of both functions:
- Supply function: sets price and quantity of goods in relation to one another
- Demand function: sets consumer price and demand in relation to one another
Equilibrium price: graphical representation
Different constellations far from the equilibrium price
At the equilibrium price, supply and demand are in equilibrium. In addition, two different constellations are conceivable:
- Price above equilibrium price: supply exceeds demand
- Price below the equilibrium price: demand exceeds supply
Business adjustments to the equilibrium price
An equilibrium price is only conceivable with comprehensive transparency of demand and supply. However, this transparency is utopian. That is why companies and consumers do not know the equilibrium price. With the help of adjustments, the company can modify the price in order to gradually approach the equilibrium price. After making some price adjustments, companies find the price that approximates the equilibrium price.
The “Drinking Water GmbH” offers a new water at a price of 10 € per bottle. However, some bottles remain in the warehouse – there is an excess supply. As a result, the company corrects the price to € 8. Now consumers come to the store even though the bottles are already sold out. For this reason, Drinking Water GmbH is raising the price to € 9. This price corresponds at least approximately to the equilibrium price.
The equilibrium price in science and practice
Even if companies certainly use the equilibrium price to calculate the product price, the meaning of this term differs in practice and science.
Equilibrium Prize in Science
In economics and business administration the thesis is represented that an equilibrium price is possible in almost every market environment. The graphical intersection of the demand and supply curve can always be calculated. However, from a scientific point of view, this constellation is only possible if it is a perfect market. For the inquiring consumer, it is irrelevant from which supplier they buy their product. If a provider increases its price, this no longer works.
The companies “Müller GmbH”, “LuBa GmbH” and “Fischer AG” are active in the market for hot air balloons. For years it was a perfect market with all three companies offering the same products at the same price. Now the company “LuBa GmbH” wants to earn more money and is increasing the prices. Consumers notice this and turn to the competition. The equilibrium price is a thing of the past.
Equilibrium price in practice
In practice, an equilibrium price is seldom or even impossible. Rather, the companies are responsible for numerous different price adjustments. These all aim to tend to reach the equilibrium price. However, this often fails because of the certain lack of transparency that accompanies almost all markets.
On the one hand, the companies do not know exactly how high the demand is, while the consumers cannot judge exactly how high the supply is. For this reason, companies cannot precisely determine and set the equilibrium price. Only price adjustments are possible.