Definition: Equilibrium refers to the economic situation where supply and demand for a certain good or service in the market is equal, which represents a stable market price to purchase and sell. In other words, consumers are purchasing the same value of goods or services that suppliers are willing to supply at the current, stable market price.
What Does Economic Equilibrium Mean?
Equilibrium is used mostly by economists in order to explain rational market behavior: buyers and sellers continually purchase and sell goods until a point is reached where the market price is set so that the demand from consumers, and the supply from suppliers, is exactly equal. This naturally happens in the course of business. As consumers desire more products, prices increase because of the lack of supply. In turn manufacturers start producing more products to meet the market’s needs, thus, lowering the price and creating a new equilibrium at the new price and quantity levels.
In the actual market, equilibrium is very hard to achieve, but the same interaction between supply and demand can occur: demand for food during a natural disaster when supply is low automatically raises the price.
Let’s look at an example.
In order for equilibrium to occur, a market should have many companies and customers, selling an identical product. Let’s consider the market for pencils.
Pencils are nondescript objects, bought and sold by a nearly countless number of consumers and companies. The market for pencils would be the closest real-world market in equilibrium, where the demand from buyers and the supply from suppliers are balanced by the equilibrium market price of a pencil.
There is no incentive for consumers to pay more for an identical pencil, and there is no incentive for suppliers to offer less per item if it means selling less units at this equilibrium price. At the market price, demand equals supply for pencils, and the market is as close to equilibrium as can be possible outside of economic theory.