Equilibrium (Economics) - Explained
What is Economic Equilibrium
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What is Economic Equilibrium?
Equilibrium is the economic condition where market demand and market supply are equal to each other, which ultimately brings stability in the price levels. Normally, when the supply of goods and services exceeds over time, it causes a decline in price, that ultimately, generates more demand. This cycle of balancing the supply and demand creates an equilibrium stage.
How does Economic Equilibrium Work?
The equilibrium price can be ascertained at a point where demand of goods meet supply. A primary index having a consolidation stage causes the supply and demand levels to be equal to each other, and this is where, the state of equilibrium takes place. The term equilibrium was coined by New Keynesian researcher, and Ph. D. Hum Dixon. According to him, the equilibrium consists of three main elements or principles: there is consistency in the agents behavior, there is no incentive provided to agents for changing their behavior, and a dynamic process results in the equilibrium. He refers to these principles as P1, P2, and P3 respectively. There are many economic researchers such as Adam Smith who were of the view that equilibrium would prevail in a free market. For instance, if there is a scarcity of a good, it would lead to higher prices, causing the demand to fall, and creating an increase in supply with the appropriate incentive offered. In case, there was a surplus, the same thing would take place but in the reverse form. Contemporary economic researchers say that monopolistic organizations have control over prices, and can keep them higher for making more profits. For instance, the demand sector has a huge demand, but it ensures to keep its supply artificially low so as to sell their diamond-based products at high prices. Harvard University published a research paper Foundations of Economic Analysis written by Paul Samuelson in 1983 that stated equilibrium markets were not sufficient to ascertain the market value. Even if the markets have reached equilibrium stage, it doesnt mean that the market condition is good. For instance, during the great potato famine in the 1800s in Ireland, the food industry was still in equilibrium. The equilibrium price was kept higher than the price farmers or peasants could afford to pay, and this scenario caused many people to starve.
Equilibrium vs. Disequilibrium
When the demand and supply of a market are not equal to each other, the market is said to be in disequilibrium. It is a feature that a particular market exhibits. Sometimes, disequilibrium can transfer from one sector to another. For example, due to insufficient international shipping facility for coffee, there would be a decrease in coffee supply in some specific areas, thereby affecting the equilibrium stage of coffee industry. As per economists, there prevails a state of disequilibrium in labor markets because of the way public policies safeguard peoples interests as well as their occupations, or the way they get paid.
States of economic equilibrium
Economic equilibrium can be seen in two different states: static and dynamic. Static equilibrium, as the name suggests, doesnt undergo any changes and remains consistent over a period of time. However, the stability of dynamic equilibrium relies on equal yet opposing market forces. Also, one can observe economic equilibrium either in one or different markets.
Pricing and economic equilibrium
Considering the concept of product pricing, equilibrium takes place at a stage where product point arrives at a point where the product demand at that specific price becomes equal to the production levels, or the related present supply. However, it doesnt mean that everyone who is having resources to buy the product they want. It refers to the point at which people who have the purchasing capacity for the product will utilize the opportunity for buying it.
Barriers to economic equilibrium
Several factors such as changes in consumer tastes and interest can act as a disruption for the economic equilibrium. This ultimately reduces the demand, and exaggerates the condition of market supply. In such cases, there exists a non-permanent stage of market disequilibrium that is gradually rectified once the economy reaches a new equilibrium. Additionally, there are many huge events causing equilibrium disruption in the economy. For instance, the major 2008 global financial crisis created prominent imbalances in the housing sector. Also, a natural calamity or disaster can also cause disruptions in the equilibrium stage of economy. For instance, if a major manufacturing equipment catches fire, the other resources may not be adequate to meet demand in the long-run. On the other hand, if a particular state gets caught in floods, the affected people will shift their spending priorities towards new concerns like replacing damaged goods with new ones. In case, temporary unemployment occurs as a consequence of a natural calamity, consumers will not spend unnecessarily on the products that are not highly required, therefore creating an increase in supply.
- Total Utility (Economics)
- Efficiency Principle
- Indifference Curve
- Time Preference Theory of Interest
- Diminishing Marginal Utility
- Sunk Costs
- Production Possibilities Frontier
- Law of Diminishing Returns
- Economic Efficiency
- Efficiency Theory
- Productive Efficiency
- Capacity Utilization Rate
- Pareto Efficient
- Comparative Advantage
- Criticisms of the Economic Approach
- Behavioral Economics
- Normative Economics
- Positive Economics
- Invisible Hand
- Sunk cost