Competitive Market Equilibrium
Market equilibrium occurs where the quantity demanded equals the quantity supplied, establishing a market-clearing price. At this price, there is neither a surplus (excess supply) nor a shortage (excess demand). The price mechanism acts as a signalling and incentive system — when markets are in disequilibrium, price changes guide the market back toward equilibrium through the forces of supply and demand.
Key Terms & Definitions
Equilibrium
The price at which quantity demanded equals quantity supplied — the market clears with no surplus or shortage.
Surplus (Excess Supply)
When quantity supplied exceeds quantity demanded at a given price, causing downward pressure on price.
Shortage (Excess Demand)
When quantity demanded exceeds quantity supplied at a given price, causing upward pressure on price.
Price Mechanism
The process by which prices signal information to buyers and sellers, coordinating economic decisions in a free market.
Signalling Function
Rising prices signal to producers to increase supply and to consumers to reduce demand.
Rationing Function
Prices ration scarce goods to those willing and able to pay the equilibrium price.
Incentive Function
Higher prices incentivise producers to increase output; lower prices incentivise consumers to buy more.
IB Diagram
Accurate IB-style diagram — straight lines, labelled axes
IB Diagram
Market Equilibrium (D = S)IB standard: straight lines · P on Y-axis · Q on X-axis · labels at end of curves · dashed drop lines to axes
Diagram Notes: Supply and demand diagram showing equilibrium at intersection (E). Show surplus above equilibrium price (horizontal gap between S and D) and shortage below. Arrow showing price adjustment back to equilibrium.