MARKET EQUILIBRIUM

Equilibrium is a point of balance or a point of rest. A more complex definition is a state

in market where economic forces are balanced and in the absence of external
influences the (equilibrium) values of economic variables will not change.

It is the point at which quantity demanded and quantity supplied is equal. Market
equilibrium, for example, refers to a condition where a market price is established
through competition such that the amount of goods or services sought by buyers is
equal to the amount of goods or services produced by sellers. This price is often called
the equilibrium price.

In the graph below the point at which the demand curve meets the supply curve is the
equilibrium price.

DEMAND AND SUPPLY IN RELATION TO BASIC COMMODITIES

MARKET EQUILIBRIUM

If the forces of demand and supply operate together, we can show price is
determined in market economy. Alfred Marshall, a British economist, defined the Law of
Demand and Supply.

Equilibrium is a state of balance when demand is equal to supply. The equality

means that the quantity that sellers are willing to sell is also the quantity that sellers are
willing to sell is also the quantity that buyers are willing to buy for a price. As market
experience, equilibrium is an implicit agreement between how much buyers are willing
to transact. The price at which demand and supply are equal is the equilibrium price. In
Figure 2.5, market equilibrium is attained at the point of intersection of the demand and
supply curves.
Figure 2.5.Market Demand and Supply Curves for Fish in the Quinta Market for One
Week

In Figure 2.5, the price of good in the market is the equilibrium price. It is the
price at which the quantity demanded is equal to the quantity supplied. This is how most
commodities in the market are priced by their producers or sellers.

Determination of Market Equilibrium

Market equilibrium is attained when the quantity demanded is equal to the

quantity supplied.

Assuming that the demand function for Good X is Q d = 60 – P/2 and the supply
function for Good X is Q s = 5 + 5P.

Applying the equations, we derive the following demand and supply schedules
given the following prices:

Demand Schedule of Good X Supply Schedule of

Good X
Price
Php 0 60 5
2 59 15
4 58 25
6 57 35
8 56 45
10 54 55
12 55 65
14 53 75
16 52 85

Equilibrium quantity is attained where Qd = Q s

 Equilibrium quantity is 55 since quantity supplied and quantity demanded are
both 55 at the price of Php 10, which is the equilibrium price.

Example of Determination of Market Equilibrium

Assume a demand and a supply function as the following:

P = 50 -2Q d (Demand) P = 20 + 4Q s Qs = Supply in

thousands

The demand curve is downward sloping with the negative slope -2 while the
supply curve is upward sloping with positive slope .4 at equilibrium, the price at which
the buyers are willing to buy a certain volume is also the price at which the sellers are
willing to sell the same volume. To compute equilibrium price (P) and quantity (Q), we
have to equate the demand and supply functions, as follows:

50 - 2Q d = 20 + 4Q s

At equilibrium, P = 40 and Q = 5 as illustrated by the demand and supply

schedule and graph below.

Figure 2.6 Demand – Supply Graph

Effect of change in Demand and Supply

APPLICATION OF SUPPLY AND DEMAND TO HOUSING SHORTAGE

With close to 10 Million Filipinos, limited land area and shortage of funds to build
houses for all the Filipino Families, the country continues to suffer from a shortage in
mass housing that is expected to reach 6.5 million units by 2030, Profriends aPresident
and CEO Guillermo Choa told reporters in a briefing in Makati City. (Danessa O. Rivera,
GMA News October 2,2014). Housing shortage has been a perennial problem in the
country with accumulated backlog of about 3.92 million units from 2001 to 2011.
(Source:Subdivision and Housing Developers Association (SHDA).

As population increases, the demand for housing also increases. The supply of
houses less than the existing demand for them since more and more Filipinos are
added to the population annually. There is seemingly a lack-of government priority to
build homes for the homeless. Filipinos are seen putting up shanties and makeshift
homes in the streets, under bridges, close to the railroad tracks, and near creeks, which
proves dangerous since these overflow during typhoons and inundate the areas,
causing risk to the lives of the poor who have no other choice.

Hardly does housing grow faster than population to decrease the housing
backlog. It is the poor who suffer an increasing backlog of decent-housing due to
increasing population.

There is obviously an excess demand compared to the supply of housing

even among ordinary Filipinos.

ADDITIONAL INFORMATION ( ACROSS BORDERS)

On a study by Kenny(2015) titled Modelling the demand and supply sides of the
housing market: evidence from Ireland showed that the analysis suggests that in the
long-run the demand side of the market can be modelled using a stable relationship
between house prices, the housing stock, income and mortgage interest rates. To
model the supply side of the market, the empirical section of the paper tests the data for
the existence of a stable ratio of house prices to construction costs (including land
costs) which is consistent with `normal profits' in the house building sector. Impulse
response functions are employed in order to shed light on the issue of short-term
dynamics about the identified cointegrating relationships. Interestingly, the dynamics
implied by the VECM specification suggest significant constraints on the supply side of
the market and the potential for house prices to overshoot their long-run equilibrium
level following a sudden increase in housing demand.

Factors affecting supply and demand of housing

A look at factors affecting the demand and supply of housing.

Demand-side factors

1. Affordability. Rising incomes mean that people are able to afford to spend more
on housing. During periods of economic growth, demand for houses tends to
rise. Also, demand for housing tends to be a luxury good. So a rise in income
causes a bigger % rise in demand.

This graph shows that house prices (and therefore demand for housing can rise much
faster than earnings, suggesting there are many other factors influencing demand – at
least in the short run.

2. Confidence

Demand for houses depends on consumer confidence. In particular, it depends on

people’s confidence about the future of the economy and housing market. If people
expect prices to rise, demand will rise so people can gain from rising wealth. In a boom,
demand for houses rises faster than incomes as seen in the graph above.

3. Interest Rates
Interest rates play a big factor in determining the cost of mortgage interest repayments.

The majority of UK homeowners still prefer to take out variable mortgage rates (unlike
the continent where fixed rate mortgage deals are more common). Therefore any
change in the base rate by the Bank of England will immediately affect the mortgage
interest payments. This is a major factor in determining the affordability of housing.
Mortgage payments take a high % of people’s personal disposable income. (average is
25%, but, for some homeowners, it is higher.) If you have a £150,000 mortgage a 0.5%
change in base rates will change your monthly payments by about £60 a month.
Therefore, even small changes in interest rates can deter people from buying.

When interest rates reached 15% in 1992, demand for housing collapsed, causing a
large fall in demand for housing. The relatively low-interest rates of the 90s and 2000s
encouraged more to buy a house.

However, in 2008-09, interest rates were cut to 0.5%. Even though interest rates were
very low, demand also remained low. This was because, other factors were reducing
demand for housing – like the recession and prospect of rising unemployment.

4. Population
A very important factor. It is not just the number of people but demographic changes.
e.g. growing number of single people living alone has led to increasing demand for
houses.

The demand for housing doesn’t just depend on the population but also the average
size of a household. Certain social and demographic factors are causing a rise in the
number of households (faster than the population increase). These demographic
changes include issues such as:

age of people leaving home

Increased life expectancy, leading to more single old people

Divorce rates, – increasing number of single-parent families.

5. Mortgage availability

Another factor that determines the effective demand for houses is the willingness of
banks to lend mortgages. If banks give mortgages with bigger income multiples, then
the effective demand for houses is greater. The willingness of banks to lend mortgage
finance can vary depending on the strength of the interbank lending sector. The Credit
crisis of 2008, has seen a sharp rise in the cost of interbank lending and a fall in
availability of mortgage finance. Many mortgage products have been withdrawn, making
it more difficult for would-be homeowners to get on the property ladder.

 For example, mortgages such as 125% and 100% mortgages have been
withdrawn. Banks are increasingly demanding a higher deposit before lending
mortgages.
6. Economic growth and real incomes. Rising incomes enable people to afford bigger
mortgages and encourages demand for housing. In boom times, demand for housing
grows rapidly suggesting demand for houses is income-elastic
7. Cost of renting.

This shows 22% increase in the cost of renting – despite the financial crisis and housing
‘crash’ – this helped to cause UK house prices to continue rising after 2011.

If the cost of renting rises, then households will make greater efforts to try and buy a
house as buying a house through mortgage becomes relatively cheaper. The UK
housing market has been buoyed by expensive renting costs, which encourages buy to
let lenders and encourages households to stretch their budget as much as possible to
get on the housing ladder.

Factors affecting supply

 The number of new houses being built. The graph above shows how the number
of new houses built in Great Britain has varied over the past century. The peak
was in the late 1960s with over 400,000 built per year, Inthe late 1990ss and
early 2000s that has fallen to 150,000 (less than required)
 Planning restrictions on the use of land. A big issue in the UK is planning
restrictions and limitations on building on green-belt land
 Local opposition to new home builds. There is widespread opposition to building
new houses as local communities usually prefer to live in smaller villages without
increased congestion.
 The profitability of building new houses. This is dependent on the demand for
houses and prices. In a boom, builders are usually keener to build more. Falling
house prices can lead to a restriction in supply.
 See factors that affect supply.
REFERENCES:

Bautista, C. (n.d.). Applied Economics. Manila: Ateneo De Manila Blue Press.

Kenny, G. (2015). Modelling the demand and supply sides of the housing market:
evidence from Ireland. Economic Modelling, 16(3), 389–409. doi: 10.1016/s0264-
9993(99)00007-3

Unlimited BooksLibrary Services. (2016). Applied Economics. Manila.