Market equilibrium

In this topic we will see how demand and supply leads to price equilibrium. But before we do, it is time to define some key terms. We define consumption as “the realization of want-satisfying capabilities”, which means that when our pressing needs are being satisfied, we are consuming. But although it is consumption that we value, first we must produce. We define production as “the creation of want-satisfying capabilities”. If we produce more than we currently plan to consume, we are “saving”. For example if I like to consume two fish per day and today I catch three, I have savings of one fish. So far, there’s no need for markets. But my consumption set is highly limited if it’s constrained by things that I am able to produce on my own. At some point I may decide that I wish to satisfy more of my pressing needs than I am able to do by myself, and so I choose to enter the market. As mentioned, if you produce more than you currently plan to consume, you are saving. But if you start to produce more than you ever plan to consume, you are doing something else. You are becoming a “producer”. We call this specialization. By trading some of the good you have produced, you can access other goods (ones you cannot produce for yourself) that provide you with more utility. Exchange is simply the transfer of a property right. And when exchange occurs between two people voluntarily, both must believe they are being made better off.

Not to produce was not to trade, and not to trade was to die.

john le carre, the honourable schoolboy

Here’s a video showing how the demand curve and supply curve interact to find equilibrium:

Here is a summary of the main factors that affect demand:

And here are the key factor impacting supply: