Equilibrium

The condition at which two comparable economic variables are in complete balance

What is Equilibrium?

Equilibrium, in its most basic sense, means stability, a state of rest, or a state of balance. It takes the same foundational concept in microeconomics.

 

Equilibrium

 

In microeconomics, equilibrium is defined as the condition at which two comparable economic variables are in complete balance, i.e., both variables are equal. More specifically, economic equilibrium in microeconomics is achieved where price meets quantity, i.e., where supply is equal to demand.

 

Summary

  • In microeconomics, equilibrium is defined as the condition at which two comparable economic variables are in complete balance, i.e., both variables are equal.
  • More specifically, economic equilibrium in microeconomics is achieved where price meets quantity, i.e., where supply is equal to demand.
  • One thing about free markets is that they constantly strive to achieve equilibrium. It means that when there is an excess supply of goods in the market, prices will go down, leading to an increase in demand in the market.

 

Equilibrium in Markets

One thing about free markets is that they constantly strive to achieve equilibrium. It means that when there is an excess supply of goods in the market, prices will go down, which will lead to an increase in demand in the market. And, in such a way, owing to the movement of price and quantity demanded and/or quantity supplied, they are constantly moving to balance each other out, i.e., to achieve equilibrium in the economy.

It stems from the fact that:

  • Price (P) and quantity demanded (QD) share an inverse relationship – i.e., when the price of a good increases, the quantity demanded decreases, and when the price of a good decreases, the quantity demanded increases. It, in economics, is defined as the law of demand.
  • Conversely, price (P) and quantity supplied (QS) share a direct relationship – i.e., when the price of a good increases, the quantity supplied also increases, and when the price of a good decreases, the quantity supplied also decreases. It, in economics, is defined as the law of supply.

 

Hence, the above economic variables are constantly moving in accordance with each other, in the sense that, if a good is in high demand, i.e., its quantity demanded is strong, its price will go up. If the price goes up, the variable quantity supplied reacts to the change, and it thereby increases to meet the increased demand. In such a manner, the economic variables are constantly reacting to each other’s movements and the market; henceforth, they constantly strive to achieve a state of equilibrium.

 

There are three existing properties to achieving equilibrium. When the economic variables satisfy all three properties, the economy is said to have achieved equilibrium. They were developed by a Keynesian economist named Huw Dixon.

The three properties required to achieve a state of equilibrium are as follows:

  • The two economic variables involved no longer have any incentives to change their behavior;
  • The behavior of the two economic variables involved is consistent, and stability is maintained; and
  • Equilibrium is achieved as an outcome of some dynamic process in the economy/in the market.

 

Graphical Representation

Graphically, economic equilibrium is represented by an intersection of the supply and demand curves. It means that when the supply and demand curves meet, or intersect each other, at that point of intersection, the market is in a state of equilibrium. The price at that point of intersection is the equilibrium price, and the quantity at that point of intersection is the equilibrium quantity.

 

Economic Equilibrium

 

What is Disequilibrium?

Disequilibrium is the state where the market is not in a state of rest or state of balance. As mentioned above, when the markets are constantly striving to achieve a state of equilibrium, the economic variables are constantly reacting to each other’s movements.

When the supply and demand in the market are not equal, and when such economic variables are constantly changing in reaction to each other’s movements, the market is said to be in a state of disequilibrium.

 

Additional Resources

CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Aggregate Supply and Demand
  • Demand Curve
  • Market Economy
  • Short-Run Supply

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