Equilibrium

In the gold chain and bedding discussions we took the selling price as a given. Whether gerbil bedding was shipped or not depended upon the total cost to package and ship the bags compared to the given selling price. We assumed a sufficiently low price such that it was not feasible to ship the bags of gerbil bedding cross-country. On the other hand, the gold necklaces sold at a high enough price that you could ship them anywhere and still make a profit. Just what determined the selling prices for those items?

Gold, as you probably are aware, is considered a precious metal. There is a limited (actually, carefully controlled) supply of gold on the world market at any time. Since gold is highly sought after worldwide, there is a more or less constant demand. As long as the supply of gold does not run ahead of demand, its price will remain relatively high.

Gerbil bedding, on the other hand, is not a precious commodity. Although gerbil owners might consider commercial bedding superior, they will resort to newspaper if the commercial product gets too expensive. This means there is a maximum retail price that consumers are willing to pay, so the costs to package and ship gerbil bedding become extremely important. Even though gerbil bedding is a very inexpensive product to produce, package, and ship, its limited demand constrains possible sales opportunities and profits.

We’ve discussed supply, demand, and the relationships among them. Another term you will often hear is equilibrium, which can be thought of as two equal and opposing forces. Supply and demand must be in equilibrium for prices to be stable. For example, if everyone in the world suddenly wanted a gold necklace, the demand would far outstrip the supply of necklaces, and gold prices would increase dramatically. In a similar fashion, if the huge increases in gold prices caused an abnormally large number of gold suppliers to increase their supply, the price would stabilize, or maybe even drop. As long as demand and supply are equal, the price for gold will remain about the same.

Without resorting to too much economic jargon to explain equilibrium, let’s just leave it as meaning equal forces (or pressures). In our example, the demand and supply for gold are equal. Suppliers are willing to provide the amount of gold that consumers are willing to purchase (i.e., the upward pressure on price caused by demand and the downward pressure on price caused by supply are perfectly balanced). Prices are stable because there is no pressure to push them higher or lower.

Equilibrium is shown graphically below. Notice how higher prices will create excess supply, while lower prices generate excess demand.