Student Question from: Shannon P.
Course:  Fundamentals of Financial Planning – Economic Concepts

Student Question:

I need a better understanding of the relationship between supply and demand, in particular the equilibrium price.

Instructor Response:

Hi Shannon!

The short of it is that the equilibrium price is the point at which the demand for a good meets the supply of the good.  Let’s take a very small example:

  • Company ABC produces widgets.  They can produce 200 of them per year.  In the marketplace, the current demand is 200 per year.  They currently sell at $500.  At this point, we have an equilibrium price.
  • Now let’s say the company found a way to make more of them and can make 400 per year.  IF they can make 400 per year, the 200 people in the market will find it easier to get them, so they would pay less for them.  That will drive the price down, making it more affordable for other people, thus raising the demand.  Once the price falls low enough that 400 people are willing to buy it, we have hit price equilibrium.
  • But what if, instead, the demand for the widget went up to 400 per year while they could still only make 200?  Well, the price is going to rise until there are only 200 people in the market willing to pay the higher price.  At that point, we have again hit equilibrium price.

So hopefully that helps clarify.  Please let me know!