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In
economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plant life and a bran ...

economics
, economic equilibrium is a situation in which economic forces such as
supply and demand In microeconomics Microeconomics is a branch of that studies the behavior of individuals and in making decisions regarding the allocation of and the interactions among these individuals and firms. Microeconomics focuses on the study ...

supply and demand
are balanced and in the absence of external influences the (
equilibrium List of types of equilibrium, the condition of a system in which all competing influences are balanced, in a wide variety of contexts. Equilibrium may also refer to: Film and television * Equilibrium (film), ''Equilibrium'' (film), a 2002 scien ...
) values of economic variables will not change. For example, in the standard text
perfect competition In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods ...
, equilibrium occurs at the point at which quantity demanded and quantity supplied are equal. Market equilibrium in this case is a condition where a market
price A price is the (usually not negative) quantity Quantity is a property that can exist as a multitude or magnitude, which illustrate discontinuity and continuity. Quantities can be compared in terms of "more", "less", or "equal", or by ...

price
is established through competition such that the amount of goods or services sought by
buyers Procurement is the process of finding and agreeing to terms, and acquiring goods, Service (economics), services, or works from an external source, often via a tendering or competitive bidding process. Procurement generally involves making buying ...
is equal to the amount of goods or services produced by sellers. This price is often called the competitive price or
market clearing{{Unreferenced, date=May 2009 In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (econo ...
price and will tend not to change unless demand or supply changes, and quantity is called the "competitive quantity" or market clearing quantity. But the concept of ''equilibrium'' in economics also applies to imperfectly competitive markets, where it takes the form of a
Nash equilibrium In game theory, the Nash equilibrium, named after the mathematician John Forbes Nash Jr., is the most common way to define the solution concept, solution of a non-cooperative game involving two or more players. In a Nash equilibrium, each player ...
.


Understanding Economic Equilibrium

An economic equilibrium is a situation when the economic agent cannot change the situation by adopting any strategy. To fully grasp the concept of economic equilibrium, it must be highlighted that it has been borrowed from the physical sciences. Take a system where physical forces are balanced for instance.This economically interpreted means no further change ensues.


Properties of equilibrium

Three basic properties of equilibrium in general have been proposed by
Huw Dixon Huw David Dixon (/hju: devəd dɪksən/), born 1958, is a United Kingdom, British economist. He has been a professor at Cardiff Business School since 2006, having previously been Head of Economics at the University of York (2003–2006) after bein ...

Huw Dixon
. These are: Equilibrium property P1: The behavior of agents is consistent. Equilibrium property P2: No agent has an incentive to change its behavior. Equilibrium property P3: Equilibrium is the outcome of some dynamic process (stability).


Example: competitive equilibrium

In a
competitive equilibriumCompetitive equilibrium (also called: Walrasian equilibrium) is a concept of economic equilibrium introduced by Kenneth Arrow and Gérard Debreu in 1951 appropriate for the analysis of commodity markets with flexible prices and many traders, and ...
, supply equals demand. Property P1 is satisfied, because at the equilibrium price the amount supplied is equal to the amount demanded. Property P2 is also satisfied. Demand is chosen to maximize utility given the market price: no one on the demand side has any incentive to demand more or less at the prevailing price. Likewise supply is determined by firms maximizing their profits at the market price: no firm will want to supply any more or less at the equilibrium price. Hence, agents on neither the demand side nor the supply side will have any incentive to alter their actions. To see whether Property P3 is satisfied, consider what happens when the price is above the equilibrium. In this case there is an excess supply, with the quantity supplied exceeding that demanded. This will tend to put downward pressure on the price to make it return to equilibrium. Likewise where the price is below the equilibrium point there is a shortage in supply leading to an increase in prices back to equilibrium. Not all equilibria are "stable" in the sense of equilibrium property P3. It is possible to have competitive equilibria that are unstable. However, if an equilibrium is unstable, it raises the question of reaching it. Even if it satisfies properties P1 and P2, the absence of P3 means that the market can only be in the unstable equilibrium if it starts off there. In most simple microeconomic stories of supply and demand a static equilibrium is observed in a market; however, economic equilibrium can be also
dynamic Dynamics (from Greek Greek may refer to: Greece Anything of, from, or related to Greece Greece ( el, Ελλάδα, , ), officially the Hellenic Republic, is a country located in Southeast Europe. Its population is approximately 10.7 million ...

dynamic
. Equilibrium may also be economy-wide or
general A general officer is an officer of high rank in the armies, and in some nations' air forces, space forces, or marines Marines or naval infantry, are typically a military force trained to operate on Littoral Zone, littoral zone in suppo ...
, as opposed to the
partial equilibrium In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods ...
of a single market. Equilibrium can change if there is a change in demand or supply conditions. 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 is an
exogenous In a variety of contexts, exogeny or exogeneity () is the fact of an action or object originating externally. It contrasts with endogeneity or endogeny, the fact of being influenced within a system. Economics In an economic An economy (; ) ...
shift in supply or demand (such as changes in
technology Technology ("science of craft", from Greek#REDIRECT Greek Greek may refer to: Greece Anything of, from, or related to Greece Greece ( el, Ελλάδα, , ), officially the Hellenic Republic, is a country located in Southeast Europe. I ...

technology
or
tastes
tastes
). That is, there are no
endogenous Endogenous substances and processes are those that originate from within a system such as an organism, Tissue (biology), tissue, or Cell (biology), cell. Endogenous substances and processes contrast with exogenous ones, such as Drug, drugs, which ...
forces leading to the price or the quantity.


Example: Monopolist equilibrium

In a monopoly, marginal revenue (MR) equals marginal cost (MC). The equilibrium quantity is obtained from where MR and MC intersect and the equilibrium price can be found on the demand curve where MR = MC. Property P1 is not satisfied because the amount demand and the amount supplied at the equilibrium price are not equal. Property P2 is not satisfied. Because the monopolist's profit-maximizing quantity is different from the socially-maximizing quantity, consumer's have an incentive to demand more at the equilibrium price. However, at the market price, monopolists maximize their profits so they have no incentive to change their price. Therefore, agents on the demand side have an incentive to alter their actions while the agents on the supply side do not have any incentive to alter their actions. In order to determine if Property P3 is satisfied, the same situations used to determine P3 in a competitive equilibrium can be used. When there is an excess in supply, monopolists will realize that the equilibrium is not at the profit-maximizing quantity and will put upward pressure on the price to make it return to equilibrium. This is the same case when the price is above the equilibrium and the shortage in supply leads the monopolist to decrease the supply to return to the profit-maximizing quantity. Therefore the equilibrium is the result of stability.


Example: Nash equilibrium

The Nash equilibrium is widely used in economics as the main alternative to competitive equilibrium. It is used whenever there is a strategic element to the behavior of agents and the "price taking" assumption of competitive equilibrium is inappropriate. The first use of the Nash equilibrium was in the
Cournot duopoly Cournot competition is an economic An economy (; ) is an area of the production Production may be: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organiz ...
as developed by
Antoine Augustin Cournot Antoine Augustin Cournot (28 August 180131 March 1877) was a French philosopher A philosopher is someone who practices philosophy. The term ''philosopher'' comes from the grc, φιλόσοφος, , translit=philosophos, meaning 'lover of wi ...

Antoine Augustin Cournot
in his 1838 book. Both firms produce a homogenous product: given the total amount supplied by the two firms, the (single) industry price is determined using the demand curve. This determines the revenues of each firm (the industry price times the quantity supplied by the firm). The profit of each firm is then this revenue minus the cost of producing the output. Clearly, there is a ''strategic interdependence'' between the two firms. If one firm varies its output, this will in turn affect the market price and so the revenue and profits of the other firm. We can define the payoff function which gives the profit of each firm as a function of the two outputs chosen by the firms. Cournot assumed that each firm chooses its own output to maximize its profits given the output of the other firm. The Nash equilibrium occurs when both firms are producing the outputs which maximize their own profit given the output of the other firm. In terms of the equilibrium properties, we can see that P2 is satisfied: in a Nash equilibrium, neither firm has an incentive to deviate from the Nash equilibrium given the output of the other firm. P1 is satisfied since the payoff function ensures that the market price is consistent with the outputs supplied and that each firms profits equal revenue minus cost at this output. Is the equilibrium stable as required by P3? Cournot himself argued that it was stable using the stability concept implied by best response dynamics. The reaction function for each firm gives the output which maximizes profits (best response) in terms of output for a firm in terms of a given output of the other firm. In the standard Cournot model this is downward sloping: if the other firm produces a higher output, the best response involves producing less. Best response dynamics involves firms starting from some arbitrary position and then adjusting output to their best-response to the previous output of the other firm. So long as the reaction functions have a slope of less than -1, this will converge to the Nash equilibrium. However, this stability story is open to much criticism. As Dixon argues: "''The crucial weakness is that, at each step, the firms behave myopically: they choose their output to maximize their current profits given the output of the other firm, but ignore the fact that the process specifies that the other firm will adjust its output''...". There are other concepts of stability that have been put forward for the Nash equilibrium, evolutionary stability for example.


Normative evaluation

Most economists, for example
Paul Samuelson Paul may refer to: *Paul (given name), a given name (includes a list of people with that name) *Paul (surname), a list of people People Christianity *Paul the Apostle (AD 5–67), also known as Saul of Tarsus or Saint Paul, early Christian mis ...

Paul Samuelson
, caution against attaching a
normative Normative generally means relating to an evaluative standard. Normativity is the phenomenon in human societies of designating some actions or outcomes as good or desirable or permissible and others as bad or undesirable or impermissible. A norm Nor ...
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 cannot afford to pay the high equilibrium price). Indeed, this occurred during the Great Famine in
Ireland Ireland ( ; ga, Éire ; Ulster Scots dialect, Ulster-Scots: ) is an island in the Atlantic Ocean, North Atlantic. It is separated from Great Britain to its east by the North Channel (Great Britain and Ireland), North Channel, the Irish Sea ...

Ireland
in 1845–52, where food was exported though people were starving, due to the greater profits in selling to the English – the equilibrium price of the Irish-British market for potatoes was above the price that Irish farmers could afford, and thus (among other reasons) they starved.


Interpretations

In most interpretations, classical economists such as
Adam Smith Adam Smith ( 1723 – 17 July 1790) was a Scottish economist, philosopher as well as a moral philosopher Ethics or moral philosophy is a branch of philosophy that "involves systematizing, defending, and recommending concepts of right and ...

Adam Smith
maintained that the
free market In economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of pl ...
would tend towards economic equilibrium through the
price mechanism In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods ...
. 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 A planned economy is a type of economic system An economic system, or economic order, is a system A system is a group of interacting Interaction is a kind of action that occurs as two or more objects have an effect upon one another. T ...
schemes, which often have a difficult time getting prices right and suffer from persistent shortages of goods and services.Smith, Adam (1776)
Wealth of Nations
, Penn State Electronic Classics edition, republished 2005, Chapter 7: p.51-58
This view came under attack from at least two viewpoints. Modern
mainstream economics Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a basis for discussion. Also known as orthodox economics, it can be contrasted to he ...
points to cases where equilibrium does not correspond to market clearing (but instead to
unemployment Unemployment, according to the OECD The Organisation for Economic Co-operation and Development (OECD; french: Organisation de Coopération et de Développement Économiques, OCDE) is an intergovernmental economic organisation with 38&nbs ...
), as with the efficiency wage hypothesis in
labor economics Labour economics seeks to understand the functioning and dynamics of the Market (economics), markets for wage labour. Labour is a commodity that is supplied by labourers in exchange for a wage paid by demanding firms. Because these labourers ex ...
. In some ways parallel is the phenomenon of
credit rationing Credit rationing is the limiting by lenders of the supply of additional credit to borrowers who demand funds at a set quoted rate by the financial institution. It is an example of market failure In neoclassical economics, market failure is a si ...
, in which banks hold interest rates low to create an excess demand for loans, so they can pick and choose whom to lend to. Further, economic equilibrium can correspond with
monopoly A monopoly (from Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none) is as described by Irving Fisher, a market with the "absence of competition", creating a situation where a specific ...

monopoly
, where the monopolistic firm maintains an artificial shortage to prop up prices and to maximize profits. Finally, Keynesian macroeconomics points to
underemployment equilibrium In Keynesian economics, underemployment equilibrium is a situation with a persistent shortfall relative to full employment and potential output so that unemployment is higher than at the NAIRU or the natural rate of unemployment, "natural" rate of u ...
, where a surplus of labor (i.e.,
cyclical unemployment Unemployment, according to the OECD The Organisation for Economic Co-operation and Development (OECD; french: Organisation de Coopération et de Développement Économiques, OCDE) is an intergovernmental organization, intergovernmental eco ...
) co-exists for a long time with a shortage of
aggregate demand In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This i ...
.


Solving for the competitive equilibrium price

To find the equilibrium price, one must either plot the supply and demand curves, or solve for the expressions for supply and demand being equal. An example may be: : \begin Q_s & = 125 + 1.5 \cdot P \\ Q_d & = 189 - 2.25 \cdot P \\ \\ Q_s & = Q_d \\ \\ 125 + 1.5 \cdot P & = 189 - 2.25 \cdot P \\ (1.5 + 2.25) \cdot P & = (189 - 125) \\ P & = \frac \\ P & = \frac \\ P & = 17.067 \\ \end In the diagram, depicting simple set of supply and demand curves, the quantity demanded and supplied at price P are equal. At any price above P supply exceeds demand, while at a price below P the quantity demanded exceeds that supplied. In other words, prices where demand and supply are out of balance are termed points of disequilibrium, creating shortages and oversupply. Changes in the conditions of demand or supply will shift the demand or supply curves. This will cause changes in the equilibrium price and quantity in the market. Consider the following demand and supply schedule: * The equilibrium price in the market is $5.00 where demand and supply are equal at 12,000 units * If the current market price was $3.00 – there would be excess demand for 8,000 units, creating a shortage. * If the current market price was $8.00 – there would be excess supply of 12,000 units. When there is a shortage in the market we see that, to correct this disequilibrium, the price of the good will be increased back to a price of $5.00, thus lessening the quantity demanded and increasing the quantity supplied thus that the market is in balance. When there is an oversupply of a good, such as when price is above $6.00, then we see that producers will decrease the price to increase the quantity demanded for the good, thus eliminating the excess and taking the market back to equilibrium.


Influences changing price

A change in equilibrium price may occur through a change in either the supply or demand schedules. For instance, starting from the above supply-demand configuration, an increased level of
disposable income :''country lists in disposable household and per capita income Household income is a measure of the combined incomes of all people sharing a particular household or place of residence. It includes every form of income, e.g., salaries and wages, ...
may produce a new demand schedule, such as the following: Here we see that an increase in disposable income would increase the quantity demanded of the good by 2,000 units at each price. This increase in demand would have the effect of shifting the demand curve rightward. The result is a change in the price at which quantity supplied equals quantity demanded. In this case we see that the two now equal each other at an increased price of $6.00. Note that a decrease in disposable income would have the exact opposite effect on the market equilibrium. We will also see similar behaviour in price when there is a change in the supply schedule, occurring through technological changes, or through changes in business costs. An increase in technological usage or know-how or a decrease in costs would have the effect of increasing the quantity supplied at each price, thus reducing the equilibrium price. On the other hand, a decrease in technology or increase in business costs will decrease the quantity supplied at each price, thus increasing equilibrium price. The process of comparing two static equilibria to each other, as in the above example, is known as
comparative statics In economics Economics () is a social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the science of plant ...
. For example, since a rise in consumers' income leads to a higher price (and a decline in consumers' income leads to a fall in the price — in each case the two things change in the same direction), we say that the comparative static effect of consumer income on the price is positive. This is another way of saying that the
total derivative In mathematics Mathematics (from Ancient Greek, Greek: ) includes the study of such topics as quantity (number theory), mathematical structure, structure (algebra), space (geometry), and calculus, change (mathematical analysis, analysis). I ...
of price with respect to consumer income is greater than zero.


Dynamic equilibrium

Whereas in a static equilibrium all quantities have unchanging values, in a dynamic equilibrium various quantities may all be growing at the same rate, leaving their ratios unchanging. For example, in the
neoclassical growth model Neoclassical or neo-classical may refer to: * Neoclassicism Neoclassicism (also spelled Neo-classicism; from Greek Greek may refer to: Greece Anything of, from, or related to Greece Greece ( el, Ελλάδα, , ), officially the Helle ...
, the working population is growing at a rate which is exogenous (determined outside the model, by non-economic forces). In dynamic equilibrium, output and the
physical capital Physical capital represents in economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economi ...
stock also grow at that same rate, with
output Output may refer to: * The information produced by a computer, see * An output state of a system, see * , the amount of goods and services produced ** in economics, the value of net output or GDP plus intermediate consumption ** in economics, ...
per worker and the capital stock per worker unchanging. Similarly, in models of
inflation In economics, inflation refers to a general progressive increase in prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a r ...

inflation
a dynamic equilibrium would involve the
price level The general price level is a hypothetical measure of overall prices for some set of Good (economics), goods and Service (economics), services (the consumer basket), in an economy or monetary union during a given interval (generally one day), num ...
, the nominal
money supply In macroeconomics, the money supply (or money stock) refers to the total volume of money held by the public at a particular point in time in an economy. There are several ways to define "money", but standard measures usually include Circulati ...
, nominal
wage rates
wage rates
, and all other nominal values growing at a single common rate, while all real values are unchanging, as is the
inflation rate In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of go ...
. The process of comparing two dynamic equilibria to each other is known as comparative dynamics. For example, in the neoclassical growth model, starting from one dynamic equilibrium based in part on one particular saving rate, a permanent increase in the saving rate leads to a new dynamic equilibrium in which there are permanently higher capital per worker and productivity per worker, but an unchanged growth rate of output; so it is said that in this model the comparative dynamic effect of the saving rate on capital per worker is positive but the comparative dynamic effect of the saving rate on the output growth rate is zero.


Disequilibrium

Disequilibrium characterizes a market that is not in equilibrium. Disequilibrium can occur extremely briefly or over an extended period of time. Typically in
financial market A financial market is a market (economics), market in which people trade financial Security (finance), securities and derivative (finance), derivatives at low transaction costs. Some of the securities include stocks and Bond (finance), bonds, ra ...
s it either never occurs or only momentarily occurs, because trading takes place continuously and the prices of
financial asset A financial asset is a non-physical asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information abou ...
s can adjust instantaneously with each trade to equilibrate supply and demand. At the other extreme, many economists view
labor market Labour economics seeks to understand the functioning and dynamics of the markets Market may refer to: *Market (economics) *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an island shared by Finland ...
s as being in a state of disequilibrium—specifically one of excess supply—over extended periods of time. Goods markets are somewhere in between: prices of some goods, while sluggish in adjusting due to
menu costsIn economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and ...
, long-term contracts, and other impediments, do not stay at disequilibrium levels indefinitely.


Example: public transport in Armenia

In the city of
Yerevan Yerevan ( , , hy, Երևան , sometimes spelled Erevan) is the capital and largest city of Armenia and one of the world's List of oldest continuously inhabited cities, oldest continuously inhabited cities. Situated along the Hrazdan River, Y ...

Yerevan
,
Armenia Armenia (; hy, Հայաստան, translit=Hayastan, ), officially the Republic of Armenia,, is a landlocked country A landlocked country is a country A country is a distinct territory, territorial body or political entity. It is ...

Armenia
, there is an extensive public transport network. The price for most lines is forced by the government to be 100AMD or 50AMD, hence the prices are not allowed to fluctuate to respond to the changes in demand. Consequently, most lines are unable to match the demand and buses become overcrowded for most of the day and this market stays in an economic disequilibrium as long as the law is in place because demand consistently exceeds supply.


See also

*
Exchange value In political economy and especially Marxian economics, exchange value (German: ''Tauschwert'') refers to one of four major attributes of a commodity#Marxist concept, commodity, i.e., an item or service produced for, and sold on the Market (economics ...
*
Labor theory of value The labor theory of value (LTV) is a theory of value that argues that the economic value In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), produc ...
*
Law of value The law of the value of commodities (German: ''Wertgesetz der Waren''), known simply as the law of value, is a central concept in Karl Marx's critique of political economy first expounded in his polemic '' The Poverty of Philosophy'' (1847) agains ...
*
Prices of production Prices of production (or "production prices"; in German ''Produktionspreise'') is a concept in Karl Marx Karl Heinrich Marx (; 5 May 1818 – 14 March 1883) was a German philosopher, economist, historian, sociologist, political theorist, jour ...
*
Real prices and ideal pricesThe distinction between real prices and ideal prices is a distinction between ''actual prices paid'' for products, services, assets and labour (the net amount of money that actually changes hands), and ''computed'' prices which are not actually charg ...
* Asset pricing#General Equilibrium Asset Pricing


References


External links


Equilibrium and Explanation
chapter 2 o

by
Huw Dixon Huw David Dixon (/hju: devəd dɪksən/), born 1958, is a United Kingdom, British economist. He has been a professor at Cardiff Business School since 2006, having previously been Head of Economics at the University of York (2003–2006) after bein ...

Huw Dixon
{{DEFAULTSORT:Economic Equilibrium Market (economics) Market structure Mathematical and quantitative methods (economics)