Economic Equilibrium

What Is Economic Equilibrium?

Economic equilibrium is a condition or state in which economic forces are balanced. In effect, economic variables remain unchanged from their equilibrium values in the absence of external influences. Economic equilibrium is also referred to as market equilibrium.

Economic equilibrium is the combination of economic variables (usually price and quantity) toward which normal economic processes, such as supply and demand, drive the economy. The term economic equilibrium can also be applied to any number of variables such as interest rates or aggregate consumption spending. The point of equilibrium represents a theoretical state of rest where all economic transactions that “should” occur, given the initial state of all relevant economic variables, have taken place.

Understanding Economic Equilibrium

Equilibrium is a concept borrowed from the physical sciences, by economists who conceive of economic processes as analogous to physical phenomena such as velocity, friction, heat, or fluid pressure. When physical forces are balanced in a system, no further change occurs.

For example, consider a balloon. To inflate a balloon, you blow air into it, increasing the air pressure in the balloon by forcing air in. The air pressure in the balloon rises above the air pressure outside the balloon; the pressures are not balanced. As a result the balloon expands, lowering the internal pressure until it equals the air pressure outside. Once the balloon expands enough so that the air pressure inside and out are in balance, it stops expanding; it has reached equilibrium.

In economics we can think about something similar with regard to market prices, supply, and demand. If the price in a given market is too low, then the quantity that buyers demand will be more than the quantity that sellers are willing to offer. Like the air pressures in and around the balloon, supply and demand will not be in balance. consequently a condition of oversupply in the market, a state of market disequilibrium.

So something has to give; buyers will have to offer higher prices to induce sellers to part with their goods. As they do, the market price will rise toward the level where the quantity demanded equals the quantity supplied, just as a balloon will expand until the pressures equalize. Eventually it may reach a balance where quantity demanded just equals quantity supplied, and we can call this the market equilibrium. 

Types of Economic Equilibrium

In microeconomics, economic equilibrium may also be defined as the price at which supply equals demand for a product, in other words where the hypothetical supply and demand curves intersect. If this refers to a market for a single good, service, or factor of production it can also be referred to as partial equilibrium, as opposed to general equilibrium, which refers to a state where all final good, service, and factor markets are in equilibrium themselves and with each other simultaneously. Equilibrium can also refer to a similar state in macroeconomics, where aggregate supply and aggregate demand are in balance.

Economic Equilibrium in the Real World

Equilibrium is a fundamentally theoretical construct that may never actually occur in an economy, because the conditions underlying supply and demand are often dynamic and uncertain. The state of all relevant economic variables changes constantly. Actually reaching economic equilibrium is something like a monkey hitting a dartboard by throwing a dart of random and unpredictably changing size and shape at a dartboard, with both the dartboard and the thrower careening around independently on a roller rink. The economy chases after equilibrium with out every actually reaching it.

With enough practice, the monkey can get pretty close though. Entrepreneurs compete throughout the economy, using their judgment to make educated guesses as to the best combinations of goods, prices, and quantities to buy and sell. Because a market economy rewards those who guess better, through the mechanism of profits, entrepreneurs are in effect rewarded for moving the economy toward equilibrium.

The business and financial media, price circulars and advertising, consumer and market researchers, and the advancement of information technology all make information about the relevant economic conditions of supply and demand more available to entrepreneurs over time. This combination of market incentives that select for better guesses about economic conditions and the increasing availability of better economic information to educate those guesses accelerates the economy toward the “correct” equilibrium values of prices and quantities for all the various goods and services that are produced, bought, and sold.