Equilibrium is when the market supply and demand balance each other, and as a result, prices become fix. Generally, an over-supply of products and services causes prices to fall down, which results in higher demand. The balancing effect of supply and demand stem in a state of equilibrium.
Understanding the Equilibrium
The equilibrium rate is where the supply of products matches demand. When a major index experiences a time of consolidation or sideways moments, it can be said that the power of supply and demand are equal and that the market is in a state of equilibrium.
As proposed by New Keynesian economist and Ph.D., Huw Dixon, there are three aspects to a state of equilibrium: the behavior of agents is consistent, no agent has an inducement to shift its behavior, and that the equilibrium is the result of some dynamic process. Dr. Dixon name these principles: equilibrium property 1, e, and 3, or P1, P2, and P3.
Notes on the Equilibrium
Economists such as Adam Smith believed that a free market would trend toward equilibrium. For instance, a shortage of any product would make a higher price generally, which would decrease demand, leading to a surge in supply given the right incentive. The same would happen in reverse order given that there was excess in any one market.
Modern economists highlighted that cartels or monopolistic firms can artificially hold rates higher and keep them there to reap higher gains. The diamond industry is a usual example of a market where demand is high. Still, supply is made artificially scarce by firms selling fewer diamonds to keep rates high.
Paul Samuelson argued in the 1983 paper Foundations of Economic Analysis published by Harvard University that providing equilibrium markets what he described as a ‘normative meaning’ or a value judgment was a mistake. Markets may be in equilibrium, but it may not mean that all is good. For instance, the food markets in Ireland were at equilibrium during the potato famine in the mid-1800s. Higher profits from trading to the British made it, so the Irish/British market was at equilibrium price was at equilibrium price was higher that what farmers could compensate, contributing to one of the reasons why people starved.
Equilibrium and Disequilibrium
When markets are not in a state of equilibrium, they are in disequilibrium. Disequilibrium either occurs in a flash or is a characteristic of a particular market. At times, disequilibrium can overflow from one market to another; for instance, if there are not enough firms to ship coffee internationally, then the coffee supply for particular regions could be decreased, affecting the equilibrium of coffee markets. Economists see many labor markets as being in disequilibrium due to how bill and public policy protect individual and their jobs, or the amount they are being paid for their work.
Example of the Equilibrium
A store manufactures 1,000 tops and sell them at $10 each. But one is willing to purchase them at that price. To pump up demand, the store reduce its rate to $8. There are 250 purchasers at that price point. As a return, the store further cuts the retail cost $5 and get 500 buyers overall. Upon further cuts of the price to $2, 1000 buyers of the spinning top materialize. At this price, supply equals demand. Thus, $2 is the equilibrium price for the spinning tops.
Capital Pro provides digital classes headed by expert and professional analysts with the goal of spreading useful insights about the investing world. Capital Pro Goal is to provide Financial Education.