Demand, Supply and Market Equilibrium
Senior 4 · Economics
Demand, Supply and Market Equilibrium
Lesson 3 of 3
23 min
No official in Rwanda sits down each morning to decide the price of a tomato. Yet a price exists, it is roughly the same across a market, and it changes when conditions change. Where does it come from? It comes from buyers and sellers acting on the demand and supply you have just studied, pushing against each other until their plans agree. That meeting point is the market equilibrium, and understanding it is the payoff of the whole unit.
The practical power of this lesson is prediction. When a government caps the price of a staple to protect the poor, or sets a floor to protect farmers, or subsidises a good to make it affordable, the effect is not whatever the policy intends — it is whatever the demand and supply curves say it will be. You will learn to work out the real result.
Put the two egg schedules from the earlier lessons side by side:
| Price (Frw) | Qd = 600 − 2P | Qs = 2P | Pressure |
|---|---|---|---|
| 100 | 400 | 200 | shortage of 200 → price rises |
| 150 | 300 | 300 | balanced |
| 200 | 200 | 400 | surplus of 200 → price falls |
At 150 Frw, and only there, the quantity buyers want (300) exactly equals the quantity sellers offer (300). This is the equilibrium: the price at which quantity demanded equals quantity supplied, so the market clears — nothing is left unsold and no buyer is turned away. There is no pressure to change, which is why it is called equilibrium (a state of rest).
You do not need the table; the two equations give the answer directly. Equilibrium is where Qd = Qs, so set the right-hand sides equal:
Step 1 — set demand equal to supply.
600 − 2P = 2P
Step 2 — collect the P terms. Add 2P to both sides:
600 = 4P
Step 3 — solve for the equilibrium price. Divide both sides by 4:
P = 600 ÷ 4 = 150 Frw
Step 4 — find the equilibrium quantity by putting P = 150 into either equation. Using supply: Qs = 2(150) = 300 eggs. Using demand as a check: Qd = 600 − 2(150) = 600 − 300 = 300 ✓. Both give 300, which confirms the answer.
Equilibrium is not just a number; it is where the market is pulled if it starts anywhere else.
Above equilibrium there is a surplus. At P = 200, buyers want only 200 but sellers offer 400. The excess of 200 (a surplus, or excess supply) piles up unsold. Sellers cut the price to shift stock, and as the price falls quantity demanded rises and quantity supplied falls, closing the gap until 150 is reached.
Below equilibrium there is a shortage. At P = 100, buyers want 400 but sellers offer only 200. The excess of 200 (a shortage, or excess demand) means some willing buyers go home empty-handed and bid the price up. As the price rises, quantity demanded falls and quantity supplied rises, again closing on 150.
So any surplus pushes the price down and any shortage pushes it up: the market self-corrects toward the single clearing price. This is what people mean by prices being set by the market rather than by decree.
Governments sometimes override the market price. When they do, the curves still hold, so the outcome is predictable — and often not what was hoped.
A price ceiling is a legal maximum: the price may not go above it. To have any effect it must be set below the equilibrium (a ceiling above equilibrium is simply never reached). It is used to keep essentials — rent, a staple food, fuel — affordable.
Worked example
The government caps the egg price at 100 Frw. Read off the schedules at P = 100: Qd = 600 − 200 = 400, Qs = 2(100) = 200. Demand exceeds supply, so there is a shortage of 400 − 200 = 200 eggs. The low price is meant to help buyers, but now only 200 eggs exist to be shared among people wanting 400. The predictable side effects are queues, sellers rationing to favoured customers, falling quality, and an illegal black market where the scarce eggs change hands above the legal price.
A price floor is a legal minimum: the price may not go below it. To bite it must be set above equilibrium. It is used to protect producers' incomes — a guaranteed minimum price to coffee farmers — or workers' pay (a minimum wage is a floor in the labour market).
Worked example
The government sets a minimum egg price of 200 Frw. At P = 200: Qd = 600 − 400 = 200, Qs = 2(200) = 400. Now supply exceeds demand, so there is a surplus of 400 − 200 = 200 eggs. The high price is meant to help sellers, but 200 eggs go unsold. To keep the floor from collapsing, the government often has to buy up and store the surplus, at taxpayers' expense.
Instead of fixing the price, the government can pay producers a subsidy: a fixed amount for each unit they sell. This lowers producers' effective cost, so they supply more at every price — the supply curve shifts right — and the market is left to find a new, lower equilibrium of its own.
Worked example
The government pays producers 40 Frw per egg. For any price P that consumers pay, producers now effectively receive P + 40, so they supply according to the old rule evaluated at P + 40:
New supply: Qs = 2(P + 40) = 2P + 80
Step 1 — new equilibrium. Set demand equal to the new supply:
600 − 2P = 2P + 80
Step 2 — solve. 600 − 80 = 4P, so 520 = 4P and P = 520 ÷ 4 = 130 Frw.
Step 3 — quantity. Qs = 2(130) + 80 = 260 + 80 = 340 eggs; check with demand: 600 − 2(130) = 600 − 260 = 340 ✓.
Step 4 — read the outcome. The price to consumers falls from 150 to 130 Frw and the quantity traded rises from 300 to 340. Producers receive the 130 the buyer pays plus the 40 subsidy = 170 Frw per egg, more than before. Everyone appears better off — but the subsidy costs the government 40 × 340 = 13,600 Frw per day, money raised from taxes elsewhere. There is no free lunch; the cost has only moved.
Tip
Exam technique
Use these curves for all four parts: Qd = 90 − P and Qs = 2P, with P in Frw.
Find the equilibrium price and quantity.
The government sets a maximum price of 20 Frw. Is there a shortage or a surplus, and how big?
Instead, the government sets a minimum price of 40 Frw. Is there a shortage or a surplus, and how big?
Instead, the government pays producers a subsidy of 15 Frw per unit, so supply becomes Qs = 2(P + 15). Find the new equilibrium price and quantity, and state what each producer receives per unit.
Set Qd = Qs: 90 − P = 2P. Then 90 = 3P, so P = 90 ÷ 3 = 30 Frw. Quantity: Qs = 2(30) = 60 units; check with demand: 90 − 30 = 60 ✓.
A maximum of 20 Frw is below the equilibrium of 30, so it bites. At P = 20: Qd = 90 − 20 = 70, Qs = 2(20) = 40. Demand exceeds supply, so a shortage of 70 − 40 = 30 units. (A ceiling below equilibrium always gives a shortage.)
A minimum of 40 Frw is above the equilibrium of 30, so it bites. At P = 40: Qd = 90 − 40 = 50, Qs = 2(40) = 80. Supply exceeds demand, so a surplus of 80 − 50 = 30 units. (A floor above equilibrium always gives a surplus.)
New supply: Qs = 2(P + 15) = 2P + 30. Set equal to demand: 90 − P = 2P + 30, so 60 = 3P and P = 20 Frw. Quantity: Qs = 2(20) + 30 = 70, checked by demand 90 − 20 = 70 ✓, so 70 units. The consumer price has fallen from 30 to 20 and quantity has risen from 60 to 70. Each producer receives the 20 paid by the buyer plus the 15 subsidy = 35 Frw per unit.
Summary — what to remember
