Equilibrium – Definition

Cite this article as:"Equilibrium – Definition," in The Business Professor, updated September 19, 2019, last accessed October 27, 2020, https://thebusinessprofessor.com/lesson/equilibrium-definition/.


Equilibrium Definition

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.

A Little More on What is Equilibrium

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 doesn’t 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 people’s interests as well as their occupations, or  the way they get paid.

References for “Equilibrium”



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