DEMAND. SUPPLY,
AND MARKET PRICE

You may have visited the “wheat pit” at the Board of Trade in Chicago, which is one of the world’s major wheat-trading markets. Here millions of bushels of wheat are bought and sold daily by a relatively small number of men, acting largely as dealers and agents for others. Suppose the supply and demand for wheat in the pit on some particular day are as shown in Table 21-2, and that these schedules are constant for the entire day.

Suppose that the first bid on this day is $1.50 a bushel for 1000 bushels. It is readily filled, but it’s clear that at this price there’s going to be trouble, because buyers will demand 17 million bushels whereas sellers are willing to offer only 12 million bushels. Table 21-2 shows that lots of buyers are willing to pay more than $1.50 if they have to. And most of them soon discover they have to, because offerings are 5 million bushels short of demand at $1.50. We say there is an “excess demand” of 5 million bushels at $1.50. As buyers bid higher prices to get the wheat they want, the price will move up toward $2.00. As price rises, those unwilling to pay the higher price will drop out and new sellers will come in, until at $2.00 the amount offered for sale just matches the amount demanded. There is no reason to suppose that the price will be bid higher this day, because everyone who is willing to pay $2.00 is getting his wheat and everyone who has wheat for sale at $2.00 sells it.

Try starting with a price of $3.00 to sec whether that price could last long in this market. Where does the price stabilize?

This same analysis can be done graphically just as well. Figure 11-4 graphs these same demand and supply schedules. The curves intersect at a price of $2.00 with 14 million bushels traded. This is the only price at which the amount demanded just matches the amount supplied, and it is the price that will be reached through bargaining in the market. The reasoning is the same as with the schedules. Try any higher price, say $3.00, and you can see from Fig. 21-4 that it can’t last.

FIG. 21-4 With these supply arid demand curves, the
equilibrium price will be $2.00, with 14 million bushels
exchanged.

At $3.00, 18 million bushels will be offered but only 8 million bushels demanded; there is an “excess supply” of 10 million bushels. Competition among sellers will push the price down. At any price higher than $2.00, there is excess supply. There will be too many sellers for the buyers, and sellers will shade their prices in order to find buyers. At any lower price, buyers won’t be able to get the wheat they demand and will shade up the prices they offer.

Equilibrium Price and Market Equilibrium

When a price is established that just clears the market, economists call it an “equilibrium price.” The amount offered just equals the amount demanded at that price. Price is in equilibrium when, with the given demand and supply curves, it stays put at that level. At any other level, price will not be in equilibrium, since there will be excess supply or excess demand, and price will move up or down toward a level that will elim- inate the excess supply or excess demand.

When an equilibrium price has been reached, with given demand and supply curves, we say the market is in equilibrium. At the prevailing price, all those who want to sell are selling and all those who want to buy are buying. There is neither excess supply nor excess demand. Unless either demand or supply changes, price will remain unchanged, as will the amount bought and sold each time period.

Consumer demands and producers’ responses to those demands are meshed together through market adjustments toward equilibrium. Once a market has reached equilibrium, it has impersonally and automatically:

1. Reflected the wants of all consumers willing to spend their dollars in that market, weighting each want by the number of dollars that particular consumer will spend at different prices. If each consumer’s demand schedule truly reflects the marginal utilities of different amounts of the product to him, the market has given him the largest utility obtainable for his dollars.

2. Led firms to produce as much of the product as consumers will buy, taking into account the costs of producing the commodity. These costs are reflected in the supply curve; the higher costs of production are, the less will be produced at each price offered by consumers.

Only when the market is in equilibrium~ are the combined wants of consumers and the costs of prodtiction meshed together so as to give consumers the most that can be obtained of the commodity, given the costs of producing it. And we can be reasonably sure this equilibrium accurately reflects the preferences of all the parties concerned, buyers and sellers, because the exchanges are voluntary. If any individual saw the purchase or sale as against his best interests, he would not have bought or sold at that price. ~This evaluation of the results of market equi1ibriui~t~is preliminary and oversimplified. But it’s a useful first approximation to keep in mind as we look in more detail at the operation of different markets through the chapters to come.