Equilibrium

Published Mar 7, 2023

Definition of Equilibrium

Equilibrium is a state of balance or stability in an economic market in which the demand for a product or service meets the supply. This state of balance is reached when the quantity demanded and supplied is the same at a particular price level. In free-market economics, this ideal state is self-regulating, meaning that it is achieved naturally without any external intervention.

Example

To illustrate this, consider the market for smartphones. Assume that the equilibrium price for a smartphone is USD 600, and the equilibrium quantity is 50 million. At this price level, the quantity demanded by consumers is equal to the quantity supplied by the manufacturers, resulting in no excess supply or demand.

However, if the price of smartphones were to increase to USD 800 per unit, the quantity demanded by consumers may decrease to 40 million, while the quantity supplied by manufacturers may increase to 60 million. This would result in excess supply, causing inventories to pile up, and manufacturers may be forced to lower prices to clear their stock.

Alternatively, if the price were to fall to USD 500 per unit, the quantity demanded by consumers may increase to 60 million, while the quantity supplied may fall to 40 million, resulting in excess demand, causing consumers to compete for a limited supply of smartphones and driving up the price.

Why Equilibrium Matters

Equilibrium is a crucial concept in economics because it helps determine the market price and quantity of goods and services at which the market clears. It can also provide helpful information to policymakers and businesses when making decisions regarding price-setting, production, and distribution.

Additionally, understanding equilibrium can help in identifying market inefficiencies, such as monopolies, that can distort market forces and prevent the market from clearing. Ultimately, the equilibrium is important because it represents the most efficient utilization of resources in the economy.