Market Equillibrium

In microeconomic theory the partial equilibrium supply and demand economic model originally developed by Alfred Marshall attempts to describe, explain, and predict the price and quantity of goods sold in competitive markets. It is one of the most fundamental models, widely used as a basic building block in a wide range of more detailed economic models and theories. The theory of supply and demand is important in the functioning of a market economy in that it explains the mechanism by which many resource allocation decisions are made. However, unlike general equilibrium models, supply schedules in this partial equilibrium model are fixed, as the long run reciprocal relationship between demand and supply is ignored.

In general, the theory claims that where goods are traded in a market at a price where consumers demand more goods than firms are prepared to supply, this shortage will tend to increase the price of the goods. Those consumers that are prepared to pay more will bid up the market price. Conversely prices will tend to fall when the quantity supplied exceeds the quantity demanded. This price/quantity adjustment mechanism causes the market to approach an equilibrium point, a point at which there is no longer any impetus to change. This theoretical point of stability is defined as the point where producers are prepared to sell exactly the same quantity of goods as the consumers want to buy (Pearson Education , 2010) .

The theory of supply and demand is usually developed assuming that markets are perfectly competitive. This means that there are many small buyers and sellers, each of which is unable to influence the price of the good on its own. This assumption is central to the simple understanding of supply and demand taught in introductory economics. In many actual economic transactions, the assumption fails because some individual buyers or sellers have enough market power to influence prices. In this situation, the simple microeconomic theory of supply and...