Economic Equilibrium Definition
Economic equilibrium refers to a situation wherein specific market forces remain in balance, resulting in optimal market conditions in a market-based economy. The term is often used to describe the balance between supply and demand or, in other words, the perfect relationship between buyers and sellers.
Market price plays a significant role in establishing economic equilibrium and results when supply meets the demand. When an economy is said to be in equilibrium, there should be no surplus or shortage of goods or services. Since the market is always functional, the possibility of it achieving equilibrium seems a bookish concept.
- Economic market equilibrium occurs when the levels of supply and demand align, creating ideal market conditions for both buyers and sellers.
- The types of economic equilibrium include microeconomic and macroeconomic. In microeconomic, supply and demand between buyers and sellers are balanced. With macroeconomics, an economy achieves a balance of aggregate demand and aggregate supply.
- Competitive prices are an integral part of the theory. However, the evolving market condition makes economic equilibrium a far-fetched scenario.
- The equilibrium can be static, meaning the inputs are constant. Or, it can be dynamic where the factors are constantly changing.
How Does Economic Equilibrium Work?
When it comes to a market-based economy, there are two groups of individuals:
- And sellers
Buyers keep looking to purchase goods, and in turn, create demand, or the willingness and ability to buy goods at a reasonable price. When there is a demand for products or services, buyers will need someone capable of providing those goods at a reasonable price. It is where sellers come in. Sellers create supply for produced goods that are capable of being sold at a specific price.
The price of these goods and services can profoundly affect buyers and sellers in a given market. Economists have coined two terms for the price relationship between buyers and sellers. These include:
- Law of demand, and
- Law of supply
The law of demandLaw Of DemandThe Law of Demand is an economic concept that states that the prices of goods or services and the quantity demanded are inversely related when all other factors remain constant. In other words, when the price of a product rises, its demand falls, and when its price falls, its demand rises in the market. implies that when prices increase, sellers will demand less. And the opposite is also true when prices decrease. The law of supply states that as demand rises, buyers must increase output to benefit. These two basic economic laws help keep prices in check and fair for both buyers and sellers.
Naturally, because of this, prices gravitate towards a balanced mean or look to be in a state of equilibrium. It happens when the quantity supplied equals the quantity demanded, or in other words, the prices are ideal for both buyers and sellers.
Finding Economic Equilibrium
Using algebra, one can determine the exact point at which the supply and demand curves will intersect on a given graph and achieve equilibrium.
First, one will have to determine the equations for the demand and supply curves. Let us assume to find the economic equilibrium price of movie tickets. The supply and demand curve equations for movie tickets are as follow:
- Supply curveSupply CurveSupply curve represents the relationship between quantity and price of a product which the supplier is willing to supply at a given point of time. It is an upward sloping curve where the price of the product is represented along the y-axis and quantity on the x-axis. (quantity supplied) = Qs = 30 – 3P
- Demand curveDemand CurveDemand Curve is a graphical representation of the relationship between the prices of goods and demand quantity and is usually inversely proportionate. That means higher the price, lower the demand. It determines the law of demand i.e. as the price increases, demand decreases keeping all other things equal. (quantity demanded) = Qd = 5 + 2P
Next, to find Qs = Qd, we will combine the equations.
- Qs = Qd
- 30-3P = 5 + 2P
- – 3P – 2P = 5 – 30
- – 5P = – 25
- 5P = 25
- P = 5
In this case, the equilibrium for movie tickets is equal to $5 for buyers and sellers to agree on the price and quantity.
Technology is an excellent economic equilibrium example. Companies must compensate to achieve market equilibrium in economics and maximize profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance. due to constant supply and demand changes. Apple, the maker of iPhones, has significant demand for their technology.
According to information from Statista, however, there is a clear trend indicating that demand for iPhones varies throughout the year. During the first quarter of each year, the sales are iPhones are much higher than the rest of the year. It is because of holiday sales contributing to the first quarter financial results that Apple releases each quarter.
With that said, Apple must compensate for the increase in demand and match the supply necessary to achieve maximum profitability. If they fail to do so, they will be missing out on revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions..
When the demand starts to decrease as the holidays are over, Apple will cut back on supply and adjust the price to meet the demand for the year’s remainder. As Apple has developed and matured over the years, they have learned the most efficient methods of achieving this. Thus, it has become the first U.S company to be valued at over $2 trillion.
Types of Economic Equilibrium
There are a few different types of economic equilibrium, including:
MicroeconomicsMicroeconomicsMicroeconomics is a study in economics that involves everyday life, including what we see and experience. It studies individual behavioural patterns, households and corporates and their policies. It deals with supply and demand behaviours in different markets, consumer behaviour, spending patterns, wage-price behaviour, corporate policies. is concerned with individuals’ and businesses’ activities and how they interact to achieve maximum results. Here, economic equilibrium occurs when the price of a good is equal to satisfying the needs of supply and demand.
When supply and demand intersect, this is considered the point of economic equilibrium, and the price is determined accordingly. The Apple example from above can be seen as a case of microeconomic equilibrium.
MacroeconomicsMacroeconomicsMacroeconomics aims at studying aspects and phenomena important to the national economy and world economy at large like GDP, inflation, fiscal policies, monetary policies, unemployment rates. looks at the economy from a wider lens. It involves studying economic factors like gross domestic productGross Domestic ProductGDP or gross domestic product refers to the sum of the total monetary value of all finished goods and services produced within the border limits of any country. GDP determines the economic health of a nation. GDP = C + I + G + NX (GDP), interest rates, and fiscal spending. Economic equilibrium is achieved in macroeconomics by balancing the inputs and outputs, such as aggregate demandAggregate DemandAggregate Demand is the overall demand for all the goods and the services in a country and is expressed as the total amount of money which is exchanged for such goods and services. It is a relationship between all the things which are bought within the country with their prices. and aggregate supplyAggregate SupplyAggregate Supply is the projected supply that a business calculates based on the existing market conditions. Various factors such as changing economic trend are considered before calculating the aggregate supply..
When an economy can match the nation’s aggregate supply and aggregate demand, it is said to be in economic equilibrium. If the economy has more supply than demand, it is wasting resources. However, if they have more demand than supply, they are missing out on profits.
Static vs Dynamic
The economic equilibrium in micro and macroeconomics can be further divided into static and dynamic categories.
Static = In static equilibrium, the factors or inputs will not change. For example, demand and supply will remain constant. All parties involved are achieving maximum gratification.
Dynamic = In dynamic equilibrium, the factors or inputs are constantly varying. Examples can include prices, rates, and ever-changing income levels.
This has been a guide to Economic Equilibrium and its definition. Here we discuss how to find it, how does it work along with an example, and its types. You can learn more about accounting from the following articles –