What Is Equilibrium?
Let me explain equilibrium directly: it's the state where market supply and demand balance each other, making prices stable. You see, when there's too much supply of goods or services, prices drop, which boosts demand. On the flip side, a shortage pushes prices up, reducing demand. This balancing act between supply and demand creates that state of equilibrium we're talking about.
Key Takeaways
- A market reaches equilibrium price when supply matches demand.
- Equilibrium shows consistent agent behavior, no incentives to change, and a dynamic process guiding outcomes.
- Economics uses several types of equilibrium.
- Disequilibrium, the opposite, involves changes affecting market balance.
- In reality, markets aren't perfectly in equilibrium, but prices move toward it.
Understanding Equilibrium
The equilibrium price is exactly where supply meets demand. Think about a major index in a consolidation phase— that's when supply and demand forces are equal, putting the market in equilibrium. Economists observe that prices fluctuate around these equilibrium levels. If prices climb too high, sellers get motivated to produce more. If they're too low, buyers push them up. These actions maintain relative balance over time.
Special Considerations
Economists like Adam Smith argued that free markets naturally head toward equilibrium. For instance, a shortage of a good raises its price, cutting demand and encouraging more supply if incentives align. The reverse happens with excess supply. But modern economists note that cartels or monopolies can keep prices artificially high for bigger profits. Take the diamond industry: high demand, but companies limit supply to maintain high prices. As Paul Samuelson pointed out in his 1983 book Foundations of Economic Analysis, market equilibrium isn't always positive from a normative view—calling it 'good' can be a mistake. Markets can equilibrate in ways that aren't beneficial; during Ireland's potato famine in the mid-1800s, food markets hit equilibrium at prices too high for many, leading to starvation as profits went to British sales.
Equilibrium vs. Disequilibrium
When markets aren't in equilibrium, they're in disequilibrium, which can strike quickly in stable markets or persist in others. Disequilibrium might spill over; if transport shortages limit coffee shipping, it disrupts coffee market equilibrium in affected areas. Many labor markets stay in disequilibrium due to laws, policies, or wage protections.
Types of Equilibrium
Economic equilibrium broadly means any balanced state in the economy, like equal supply and demand, employment levels, or interest rates. Competitive equilibrium comes from competition: sellers aim to be cheapest for market share, buyers hunt best deals. General equilibrium looks at macro-level forces across the economy, key in Walrasian economics. Underemployment equilibrium describes persistent unemployment even in general equilibrium, as per Keynesian theory. Lindahl equilibrium is theoretical, producing optimal public goods with fair cost-sharing—ideal for tax policy but rare in practice. Intertemporal equilibrium examines supply-demand swings over time, helping understand budgeting by firms and households. Nash equilibrium in game theory is where players' optimal strategies consider opponents', like in the prisoner's dilemma.
Example of Equilibrium
Consider a store making 1,000 spinning tops sold at $10 each, but no buyers bite. They drop to $8, attracting 250 buyers. At $5, 500 buy in. Finally, at $2, all 1,000 sell—supply equals demand, so $2 is the equilibrium price.
What Happens During Market Equilibrium?
In equilibrium, prices balance buyers' demand and sellers' supply precisely. Though theoretically elegant, markets seldom hit exact equilibrium at any moment—view it as a long-term average.
How Do You Calculate Equilibrium Price?
Set the supply and demand functions equal and solve for price—that's the equilibrium price in economics.
What Is Equilibrium Quantity?
It's the supplied amount that exactly matches demand, avoiding oversupply or shortage.
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