"Equilibrium Prices" And Real Prices

equilibrium

By the popular way of thinking, the determination of the prices of goods is summarized by means of supply and demand curves, which describe the relationship between the prices and the quantity of goods supplied and demanded.

Within the framework of supply-demand curves, an increase in the price of a good is associated with a fall in the quantity demanded and an increase in the quantity supplied. Conversely, a decline in the price of a good is associated with an increase in the quantity demanded and in a decline in the quantity supplied.

The law of supply is depicted by an upward-sloping curve while the law of demand is presented by a downward-sloping curve. The equilibrium price is established at the point where the two curves intersect. At this point, the quantity supplied and the quantity demanded is equal—at the equilibrium price the market is said to "clear."

The framework of supply-demand curves rests upon the assumptions of unchanged consumer preferences and income and the unchanged prices of other goods. In reality, however, consumer preferences are not frozen, and other things do not remain constant. Obviously, then, no one could have possibly observed these curves. 

In the Supply-Demand Framework Consumers and Producers Confront a Given Price

In the conventional supply-demand framework, consumers and producers confront a given price; that is, at a given price, consumers demand and producers supply a certain quantity of a good. Note that the quantities here are imaginary, they are not ascertained in the real world. Economists just assume that at a particular price a particular quantity is going to be supplied and a particular quantity is going to be demanded.

Demand is not a particular quantity, such as 10 potatoes, but rather a full description of the quantity of potatoes the buyer would purchase at each and every price that might be charged. Likewise, supply is not a particular quantity but a complete description of the quantity that sellers would sell at each and every possible price. Again, at a given price, people demand a certain quantity of a good while producers are willing to supply a certain quantity.

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