The Equilibrium Price

{'type': u'plain'}

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- [Narrator] We know
from previous lessons

that the demand curve
and the supply curve show

how buyers and sellers
respectively respond to changes

in the price of a good.

In this lesson, we'll show you
how the interactions

of buyers and sellers
determine the price.

Let's start with the punch line.

The equilibrium price is the price
where the quantity demanded

is equal to the quantity supplied,

right here, and this is
the equilibrium quantity.

Why is this the equilibrium price?

At any other price, forces are put
into play that will push

the price towards
the equilibrium price.

It's kind of like a ball in a bowl,
where the ball always

returns to one stable position.

The equilibrium price is
the only place

where the price is stable.

To see why, the first thing
to understand is

that buyers don't
compete against sellers.

Buyers compete
against other buyers.

A buyer obtains goods by bidding
higher than other buyers.

And sellers compete
against other sellers

by offering
to sell at lower prices.

Think about it -- at an auction,
the buyer with the highest bid

gets the item, and the seller with
the lowest price makes the sale.

So let's say the price of oil is
currently 50 bucks a barrel --

that's above the equilibrium
price of $30 a barrel.

At $50, the quantity supplied is
more than the quantity demanded

so we say there is a surplus.
So what happens?

It's sale time!
[party noisemakers]

When there's a surplus,
sellers can't sell as much

as they would like to
at the going price

so sellers have an incentive
to lower their price a little bit

so they could outcompete
other sellers and sell more.

The price will continue to fall
until the quantity demanded is

equal to the quantity supplied,
and equilibrium is reached.

Now let's say the price is less
than the equilibrium price,

say 15 bucks a barrel.

At 15 bucks a barrel,
the quantity demanded exceeds

the quantity supplied, a shortage.

And what happens now?

When there's a shortage,
buyers can't get as much

of the good as they want
at the going price so they compete

to buy more
by bidding up the price.

Now since buyers are easy to find,

sellers also have an incentive
to raise the price.

The price will continue to rise
until quantity demanded is equal

to the quantity supplied
and equilibrium is reached.

At any price other
than the equilibrium price,

the incentives of the buyers
and sellers push the price

towards the equilibrium price.

Only the equilibrium
price is stable.

Now let's take a deeper look
at the market equilibrium

and some of its properties.

Remember that there are
many different users of oil

and many different uses for oil,

each with substitutes,
alternatives, and values.

At any specific price of oil,
there's a group of buyers

who value oil enough
to demand it at that price.

And as the price changes,
so do the buyers and their uses.

On the supply side, at each price
on the supply curve, we're looking

at a group of suppliers whose cost
of extraction is low enough

to be profitable at that price.

At the equilibrium price, these
higher value groups are the buyers,

and these lower value groups
are the non-buyers.

[toy squeak]

Also notice that every seller has

lower cost than any
of the non-sellers.

Since the buyers
with the highest values buy,

and the sellers
with the lowest cost sell,

the gain from trade --
the difference between

the value a good creates
and its cost -- is maximized.

In addition, at the equilibrium
quantity, every trade that can

generate value does generate value
up until the very last trade

where the value to buyers is
just equal to the cost to sellers.

- [low voice] Yeah!

- [Narrator] In a free market,

there are no unexploited
gains from trade,

and there are no wasteful trades.

If the quantity exchanged
were greater than

the equilibrium quantity,
for example,

we would be drilling
deep and expensive oil wells

just to produce more rubber duckies,
and that would be wasteful.

- [whiny voice] Oh no!

- [Narrator] In a free market,
buyers and sellers acting

in their own self interest
end up at a price and quantity

that allocates oil
to the highest value buyers

produced by the lowest cost sellers
in a way that maximizes

the gains from trade -- the sum of
the benefits to buyers and sellers.

[crowd cheering]

This is one of the reasons
Adam Smith said that

the market process works
like an invisible hand

to promote the social good.

- [Narrator] If you want to test
yourself, click "Practice Questions."

Or, if you're ready to move on,
just click "Next Video."

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