11: - [Narrator] We know from previous lessons

13: that the demand curve and the supply curve show

16: how buyers and sellers respectively respond to changes

19: in the price of a good.

21: In this lesson, we'll show you how the interactions

23: of buyers and sellers determine the price.

26: Let's start with the punch line.

28: The equilibrium price is the price where the quantity demanded

31: is equal to the quantity supplied,

34: right here, and this is the equilibrium quantity.

37: Why is this the equilibrium price?

39: At any other price, forces are put into play that will push

43: the price towards the equilibrium price.

46: It's kind of like a ball in a bowl, where the ball always

48: returns to one stable position.

51: The equilibrium price is the only place

53: where the price is stable. Buyers and Sellers

55: To see why, the first thing to understand is

57: that buyers don't compete against sellers.

60: Buyers compete against other buyers.

63: A buyer obtains goods by bidding higher than other buyers.

67: And sellers compete against other sellers

69: by offering to sell at lower prices.

72: Think about it -- at an auction, the buyer with the highest bid

75: gets the item, and the seller with the lowest price makes the sale.

80: So let's say the price of oil is currently 50 bucks a barrel -- Surplus Example - Price is Too High

84: that's above the equilibrium price of $30 a barrel.

87: At $50, the quantity supplied is more than the quantity demanded

92: so we say there is a surplus. So what happens?

95: It's sale time! [party noisemakers]

97: When there's a surplus, sellers can't sell as much

100: as they would like to at the going price

102: so sellers have an incentive to lower their price a little bit

105: so they could outcompete other sellers and sell more.

107: The price will continue to fall until the quantity demanded is

110: equal to the quantity supplied, and equilibrium is reached. Shortage Example - Price is Too Low

114: Now let's say the price is less than the equilibrium price,

117: say 15 bucks a barrel.

119: At 15 bucks a barrel, the quantity demanded exceeds

123: the quantity supplied, a shortage.

125: And what happens now?

127: When there's a shortage, buyers can't get as much

129: of the good as they want at the going price so they compete

131: to buy more by bidding up the price.

134: Now since buyers are easy to find,

136: sellers also have an incentive to raise the price.

139: The price will continue to rise until quantity demanded is equal

143: to the quantity supplied and equilibrium is reached.

145: At any price other than the equilibrium price,

148: the incentives of the buyers and sellers push the price

151: towards the equilibrium price.

153: Only the equilibrium price is stable. Properties of Market Equilibrium

156: Now let's take a deeper look at the market equilibrium

159: and some of its properties.

160: Remember that there are many different users of oil

163: and many different uses for oil,

165: each with substitutes, alternatives, and values.

168: At any specific price of oil, there's a group of buyers

171: who value oil enough to demand it at that price.

175: And as the price changes, so do the buyers and their uses.

179: On the supply side, at each price on the supply curve, we're looking

182: at a group of suppliers whose cost of extraction is low enough

186: to be profitable at that price.

189: At the equilibrium price, these higher value groups are the buyers,

194: and these lower value groups are the non-buyers.

196: [toy squeak]

199: Also notice that every seller has

201: lower cost than any of the non-sellers.

208: Since the buyers with the highest values buy,

211: and the sellers with the lowest cost sell,

213: the gain from trade -- the difference between

216: the value a good creates and its cost -- is maximized.

220: In addition, at the equilibrium quantity, every trade that can

222: generate value does generate value up until the very last trade

226: where the value to buyers is just equal to the cost to sellers.

230: - [low voice] Yeah!

232: - [Narrator] In a free market,

233: there are no unexploited gains from trade,

235: and there are no wasteful trades.

237: If the quantity exchanged were greater than

239: the equilibrium quantity, for example,

241: we would be drilling deep and expensive oil wells

243: just to produce more rubber duckies, and that would be wasteful.

247: - [whiny voice] Oh no!

248: - [Narrator] In a free market, buyers and sellers acting

250: in their own self interest end up at a price and quantity

254: that allocates oil to the highest value buyers

257: produced by the lowest cost sellers in a way that maximizes

261: the gains from trade -- the sum of the benefits to buyers and sellers.

265: [crowd cheering]

267: This is one of the reasons Adam Smith said that

269: the market process works like an invisible hand

271: to promote the social good.

275: - [Narrator] If you want to test yourself, click "Practice Questions."

279: Or, if you're ready to move on, just click "Next Video."