Eco/561: Market Equilibration Process

Market Equilibration Process

John Vicciardo

ECO/561 - Economics

January 19, 2015

Laurie Klosk-Gazzale

Market Equilibration Process

The movement of the market price for a specific product in a free market is called equilibration.  This movement is almost always caused by a disruption in the market causing the existing equilibrium price to adjust to changes in the market until a new equilibrium price is found and settled into.  This paper will discuss the changes in organic produce after Wal-Mart and other commercial food producers entered into the organic food market and how this disruption affected the supply and demand for product, which subsequently impacted the equilibrium price.

According to McConnell, Brue, & Flynn (2009), the law of supply states that there is a direct relationship between the quantity supplied and price.  As price rises so does the quantity supplied and conversely as price falls so does the quantity supplied.  The law of demand, on the other hand, signifies that as price falls the quantity demanded rises and conversely as price rises the quantity demanded falls (McConnell, Brue, & Flynn, 2009).  It’s easy to see that these two laws push and pull on the price of a product until a market equilibrium is reached.

Organic foods and products are not a new market but very recently there has been a significant increase in the amount of organic goods demanded from the market, particularly organic produce (Dolan, 2008).  This demand had caused already high prices, as compared to traditional produce (Jordan, 2002), to increase since the retailers in the market were mostly specialty food stores (Dolan, 2008).  However, after Wal-Mart entered the organic produce market, retailers that had a Wal-Mart in their market had to adjust their pricing by as much as 42 percent less in order to remain competitive in the market (Dolan, 2008).  Local organic and natural food producers will usually not adjust prices as compared to commercial food producers seeking to work with the community rather seeking the best possible price (McCarthy, 2014).  This approach to the market is in stark contrast to the laws of supply and demand.  However, the entrance into the market of a major producer like Wal-Mart always affects other commercial producers, but for organic produce it causes even these local, specialty producers to adjust their pricing to remain competitive.  The chart below shows the shift in equilibrium price for Super Stop and Shop stores with a Wal-Mart in the market.

Market Price without Wal-Mart

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Market Price with Wal-Mart

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When Wal-Mart enters the market they do so at a lower price causing the demand for the product to increase.  For a time there is a shortage of supply, meaning that there are more consumers demanding organic produce at this lower price than there is supply.  The specialty retailers adjust their pricing to meet this demand and the shortage is overcome.  After the market adjusts to this lower pricing, the specialty retailers attempt to raise prices again in an attempt to regain some profit.  The increase in price means an increase in supply and a surplus of products amongst all producers in the local market.  This surplus only exists for a short time until the price equilibrium is reached and a new, lower level.  This adjustment in price occurs because the commercial chains and specialty food stores in the local market are aware of the entrance of Wal-Mart into the market and determine whether or not they want to adjust their prices to compete (Busch & Bain, 2004).  The idea that all firms in this local market are aware of the latest and current information, such as Wal-Mart’s entrance into the market and their pricing reduction of ~30 percent, is the efficient markets theory.  This theory is behind the price adjustment for the market to reach price equilibrium.