Introducing Supply and Demand
3. Market Equilibrium - Clearing the Market at Equilibrium Price and Quantity
Market Clearing Assumptions
A market clearing, by definition, is the economic assumption that the quantity supplied will consistently align with the quantity demanded. This definition requires a variety of assumptions which simplify the complexities of real markets to coincide with a more theoretical framework, most centrally the assumptions of perfect competition and Say's Law:
- Perfect competition is a market where the price determined for a given good or service is not affected by external forces or competition in a way that allows incumbents (companies) to attain market influence.
- Say's Law hinges on the concept that capital loses value over time, or that money is essentially perishable. The simplest way to view this law is interest rates. When you invest or owe money, that capital accrues interest due to the fact that there is an opportunity cost in not investing that money elsewhere. This opportunity cost creates the assumption that money will not go unused.
Combining these two assumptions, in a perfectly competitive market the amount of a product or service that is supplied at a given price will equate to the amount demanded, clearing the market of all goods/services at a given equilibrium point.