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- How To Calculate Equilibrium Price
By Indeed Editorial Team
Updated May 23, 2022 | Published March 8, 2021
Updated May 23, 2022
Published March 8, 2021
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
When the quantity of supplies in demand is equal to the quantity of supplies available, a market has reached equilibrium. The delicate balance of supply and demand is a basic business principle that affects most economic systems. Many companies make equilibrium price a priority in order to find a balance between the low prices that customers want and the high prices that create a profit.
In this article, we discuss equilibrium pricing, the formula used to calculate it and how to solve the calculation, plus we provide an example of finding the equilibrium price.
What is equilibrium price?
Equilibrium price is the point where the cost of a product and the demand for that product intersect, creating a price compromise. At the equilibrium price, there is a balance between customers purchasing the product and companies supplying the product.
When a product is at market equilibrium, there's no pressure from the customer or the company to increase or decrease the price, and the supply and demand quantities are in check. The price point for a product stays stable when it's at market equilibrium, raises when there's a shortage and decreases when there's a surplus.
In other words, if you had a graph of the supply and demand for a product, the point where the supply curve intersects with the demand curve is the point of equilibrium. At this point, both consumers and producers agree on the quantity and cost of the product. If either the quantity or the cost changes, then the market for that product no longer has equilibrium quantity or equilibrium price.
Related: Why Market Value Is Important
Formula for equilibrium price
It is possible to mathematically calculate the equilibrium price of a product, assuming the quantity of the demanded product is equal to the quantity supplied. You can use linear algebraic equations to find the supply line and demand line of a product on a graph to see where they intersect. This point of intersection is the equilibrium price formula, which sets the supply function and demand function equal to each other. These three formulas look like this:
The linear supply function is:
Qs = x + yP
Where:
Qs = the quantity supplied
X = quantity
P = price
The linear demand function is:
Qd = x + yP
Where:
Qd = the quantity of demand
X = quantity
P = price
The equilibrium price sets the two equal to each other:
Qs = Qd
Related: Understanding Consumer Demand (With Examples and FAQs)
How to solve for equilibrium price
You can calculate the equilibrium price for a product using the supply function, demand function and equilibrium price formula, which sets the first two functions equal to each other. To better understand how to use the formula, these directions will use a fictional company that sells hats. Here is how to find the equilibrium price of a product:
1. Use the supply function for quantity
You use the supply formula, Qs = x + yP, to find the supply line algebraically or on a graph. In this equation, Qs represents the number of supplied hats, x represents the quantity and P represents the price of hats in dollars. Assume that at a price of $1, the demand is 100 hats.
Qs = 100 + 1P
2. Use the demand function for quantity
You use the demand formula, Qd = x + yP, to find the demand line algebraically or on a graph. In this equation, Qd represents the number of demanded hats, x represents the quantity and P represents the price of hats in dollars. Assume that at a price of $5.00 per hat, the supplier can supply 400 hats.
Qd = 400 + 5P
3. Set the two quantities equal in terms of price
In order to find the equilibrium price, you set the supply function equal to the demand function so that Qs = Qd. For this problem, it looks like this if Qs = 100 + 1P and Qd = 400 + 5P:
100 + 1P = 400 + 5P
4. Solve for the equilibrium price
Use the basic rules of algebraic equations to solve for P, or the price. The steps are:
100 + 1P = 400 + 5P (subtract 1P from both sides of the equation)
100 = 400 +4P (subtract 400 on both sides of the equation)
-300 = 4P (divide by 4 on both sides of the equation)
-75 = P
$-0.75 = P
Because this example has a negative equilibrium price, this means that there is a negative slope and there is a greater quantity demanded than is available at the equilibrium price. In this instance, the company has learned that there's a shortage of hats. During the next accounting period, they should produce more hats to meet the demand.
Related: Types of Price Ceilings (With Examples)
Example of equilibrium price
Here is an example of finding the equilibrium price for organic pineapples sold at a fruit stand:
The fruit stand was selling 500 pineapples for $4.00 each every month but wants to begin selling 900 pineapples for $3.00 each every month. With this information, the fruit stand can calculate whether the new supply and demand quantities are at the equilibrium price.
Here, we take the quantity of supplied pineapples and the price of those pineapples and put them into the equation.
Qs = 500 + 4P
Next, we use the number of demanded pineapples and the price at which the fruit stand is considering selling them.
Qd = 900 + 3P
Set the two quantities equal in terms of price:
Qs = Qd
500 + 4P = 900 + 3P
Take the equation above and simplify it:
500 + 4P = 900 + 3P
500 + 1P = 900
1P = 400
P = 400
P = $4.00
This means that the equilibrium price for the pineapples at the fruit stand is $4.00. If the fruit stand lowers the price below $4.00, an excess in demand would cause the buyers to want more pineapples than the fruit stand can sell.
If the fruit stand raises the price above $4.00, an excess in supply would cause buyers to want fewer pineapples than the fruit stand can sell. If the fruit stand keeps the price of their pineapples at $4.00, then there is a balance between supply and demand, which is good for both the buyers and the fruit stand.