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In economics, economic equilibrium often refers to an equilibrium in a market that "clears": this is the case where a market for a product has attained the price where the amount supplied of a certain product equals the quantity demanded. In most markets, this supply and demand balance is an economic equilibrium. The concept of equilibrium is also applied to describe and understand other sub-systems of the economy that do not follow the logic of supply and demand, for example, population growth. (If economic growth encourages population growth, and vice-versa, we might see this two-way relationship attaining balance or equilibrium.) This entry concerns only issues of supply and demand.
In most simple microeconomic stories of supply and demand in a market, we see a static equilibrium in a market; however, economic equilibrium can exist in non-market relationships and be dynamic. This example is also partial equilibrium , while equilibrium may be multi-market or general.
As in most usage (say, that of chemistry), in economics equilibrium means "balance," here between supply forces and demand forces: 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 shift in supply or demand (such as changes in technology or tastes). That is, there are no endogenous forces leading to the price or the quantity.
Not all economic equilibria are stable. For an equilbrium to be stable, a small deviation from equilibrium leads to economic forces that returns an economic sub-system toward the original equilibrium. For example, if a movement out of supply/demand equilibrium leads to an excess supply (glut) that induces price declines which return the market to a situation where the quantity demanded equals the quantity supplied. If supply and demand curves intersect more than once, then both stable and unstable equilibria are found.
There is nothing inherently good or bad about equilibrium, so that it is mistake to attach normative meaning to this concept. That is, food markets may be in equilibrium at the same time that people are starving (because they cannot afford tp pay the high equilibrium price).
In most interpretations, classical economists such as Adam Smith maintained that the free market would tend towards economic equilibrium through the price mechanism . That is, any excess supply (market surplus or glut) will 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). This automatically abolishes the glut. Similarly, in an unfettered market, any excess demand (or shortage) will lead to price increases, which lead to cuts in the quantity demanded (as customers are priced out of the market) and increases 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 market non-clearing situations distinguishes markets from central planning schemes, which often have a difficult time getting prices right and suffer from persistent shortages of goods and services.
This view came under attack from at least two viewpoints. Modern mainstream economics points to cases where equilibrium does not correspond to market clearing (but instead to unemployment), as with the efficiency wage hypothesis in labor economics. In some ways parallel is the phenomenon of credit rationing , in which banks hold interest rates low in order to create an excess demand for loans, so that they can pick and choose whom to lend to. Further, economic equilibrium can correspond with monopoly, where the monopolistic firm maintains an artificial shortage in order to prop up prices and to maximize profits. Finally, Keynesian macroeconomics points to underemployment equilibrium, where a surplus of labor (i.e., cyclical unemployment) co-exists for a long time with a shortage of aggregate demand.
On the other hand, the Austrian School and Joseph Schumpeter maintained that in the short term equilibrium is never attained as everyone was always trying to take advantage of the pricing system and so there was always some dynamism in the system. The free market's strength was not creating a static or a general equilibrium but instead in organising resources to meet individual desires and discovering the best methods to carry the economy forward.
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