Everything about Economic Equilibrium totally explained
In
economics,
economic equilibrium is simply a state of the world where economic forces are balanced and in the absence of external influences the (equilibrium) values of economic variables won't change. Market equilibrium, for example, refers to a condition where a market price is established through competition such that the amount of goods or services sought by
buyers is equal to the amount of goods or services produced by
sellers. This price is often called the
equilibrium price or
market clearing price and will tend not to change unless demand or supply change.
Traits
When the price is above the equilibrium point there's a surplus of supply; where the price is below the equilibrium point there's a shortage in supply.
Different supply curves and different demand curves have different points of economic equilibrium.
In most simple microeconomic stories of supply and demand in a market a
static equilibrium is observed in a market; however, economic equilibrium can exist in non-market relationships and can be
dynamic. Equilibrium may also be multi-market or
general, as opposed to the
partial equilibrium of a single market.
As in most usage (say, that of chemistry), in economics equilibrium means "balance," here between supply forces and demand forces: for example, an increase in supply will disrupt the equilibrium, leading to lower prices. Eventually, a new equilibrium will be attained in most markets. Then, there will be no change in price or the amount of output bought and sold — until there's an
exogenous shift in supply or demand (such as changes in
technology or
tastes). That is, there are no
endogenous forces leading to the price or the quantity.
Not all economic equilibria are
stable. For an equilibrium to be stable, a small deviation from equilibrium leads to economic forces that returns an economic sub-system toward the original equilibrium. For example, if a movement out of supply/demand equilibrium leads to an excess supply (glut) that induces price declines which return the market to a situation where the quantity demanded equals the quantity supplied. If supply and demand curves intersect more than once, then both stable and unstable equilibria are found.
Most economists (for example Samuelson 1947, Chapter 3, p. 52) caution against attaching a
normative meaning (value judgement) to the equilibrium price. For example, food markets may be in equilibrium at the same time that people are starving (because they can't afford to pay the high equilibrium price).
Interpretations
In most interpretations,
classical economists such as
Adam Smith maintained that the
free market would tend towards economic equilibrium through the
price mechanism. That is, any excess supply (market surplus or glut) would lead to
price cuts, which decrease the quantity supplied (by reducing the incentive to produce and sell the product) and increase the quantity demanded (by offering consumers bargains), automatically abolishing the glut. Similarly, in an unfettered market, any excess demand (or shortage) would lead to
price increases, reducing the quantity demanded (as customers are priced out of the market) and increasing in the quantity supplied (as the incentive to produce and sell a product rises). As before, the disequilibrium (here, the shortage) disappears. This automatic abolition of
non-market-clearing situations distinguishes markets from
central planning schemes, which often have a difficult time getting prices right and suffer from persistent shortages of goods and services.
This view came under attack from at least two viewpoints. Modern mainstream economics points to cases where equilibrium doesn't correspond to market clearing (but instead to
unemployment), as with the
efficiency wage hypothesis in
labor economics. In some ways parallel is the phenomenon of
credit rationing, in which banks hold interest rates low in order to create an excess demand for loans, so that they can pick and choose whom to lend to. Further, economic equilibrium can correspond with
monopoly, where the monopolistic firm maintains an artificial shortage in order to prop up prices and to maximize profits. Finally,
Keynesian macroeconomics points to
underemployment equilibrium, where a surplus of labor (for example,
cyclical unemployment) co-exists for a long time with a shortage of
aggregate demand.
On the other hand, the
Austrian School and
Joseph Schumpeter maintained that in the short term equilibrium is never attained as everyone was always trying to take advantage of the pricing system and so there was always some
dynamism in the system. The free market's strength wasn't creating a
static or a
general equilibrium but instead in organising resources to meet individual desires and
discovering the best methods to carry the economy forward.
Further Information
Get more info on 'Economic Equilibrium'.
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