What are the factors affecting equilibrium?

In economic theory consumers and producers react differently to price changes. Higher prices tend to reduce demand while boosting supply, and lower prices increase demand while depressing supply.

In a free market there will be a single price which brings demand and supply into balance, known as equilibrium price. Consumers and producers engage in commerce because one party requires what the other party has to offer.

Price setting

The constant interaction between buyers and sellers allows a given price to emerge over time. It is often problematic to appreciate this process because the retail prices of most manufactured goods are set by the seller. The buyer either accepts the price or does not. An individual shopper has no influence in price but a group of shoppers do and but the seller will set the maximum price buyers are willing to pay for the merchandise offered. However as a group, buyers have influence over market price. Eventually a price is found which enables an exchange to take place. Price setting by a seller is found initially by gathering as much market information as possible in an attempt to set a price which maximizes a profitable number of sales when a new item is introduced to the market. For markets to work, both a well-informed buyer and seller acting must act on effective flow of information to consummate a transaction.

Market clearing

Market clearing price is used to describe equilibrium price because at this price level the exact quantity that producers take to market will be bought by consumers, and all the merchandise is sold and cleared. This is efficient because there is neither an excess of supply with lost output, nor a scarcity – the market clears efficiently. This is a central feature of the price mechanism, and one of its significant benefits of market economics.

How is this equilibrium found theoretically?

At a price higher than equilibrium, demand will be less than the quantity offered. If supply is more than the units needed by the market there will be an excess of supply until the market clears it with pricing strategy.

In a Graphic, demand contracts inwards along the curve and supply extend outwards along the curve. Both of these changes are called price shifting along the demand or supply curve in response to a price change.