Economic equilibrium facts for kids
In economics, imagine a market as a giant seesaw. Economic equilibrium is when this seesaw is perfectly balanced. It means that the forces of supply and demand are equal. When this happens, prices and quantities of goods usually stop changing.
Market equilibrium is a special kind of balance. It's when the price of something is just right. At this price, the amount of goods or services that buyers want is exactly the same as the amount that sellers are making. This special price is often called the competitive price. It tends to stay the same unless something big changes with what people want or what sellers can offer.
Contents
What is Economic Balance?
An economic balance is like a game where no player wants to change their move. Everyone is happy with their current situation. This idea comes from science, where physical forces can be balanced. In economics, it means things won't change further on their own.
Key Ideas of Market Balance
Economist Huw Dixon suggested three main ideas about balance in economics:
- Idea 1: Everyone agrees. The actions of buyers and sellers fit together perfectly.
- Idea 2: No one wants to change. No buyer or seller feels they could do better by changing their actions.
- Idea 3: The market finds its way. The market naturally moves towards this balance point.
How Markets Find Balance: Competitive Equilibrium
In a competitive equilibrium, the amount of goods supplied equals the amount demanded. Idea 1 is met because buyers and sellers agree on the quantity. Idea 2 is also met. Buyers are happy with the price and quantity they get. Sellers are happy with the price and quantity they sell. No one wants to change their mind.
What about Idea 3? Imagine the price is too high. Sellers have too much product, and buyers don't want to buy it all. This is called excess supply. To sell their goods, sellers will lower the price. This brings the price back down to the balance point. If the price is too low, buyers want more than sellers have. This is a shortage. Sellers will then raise the price. This brings the price back up to the balance point. This shows how the market naturally adjusts.
Sometimes, a balance point might not be stable. If the market doesn't naturally move back to it, it's like balancing a pencil on its tip. It's balanced, but a tiny nudge will make it fall. Most markets, however, tend to find a stable balance.
When One Seller Controls the Market: Monopolies
A monopoly is when there's only one main seller of a product or service. In this case, the seller decides the price and quantity to make the most profit.
For a monopoly, Idea 1 (everyone agrees) might not be fully met. Buyers might want more at a lower price. However, Idea 2 is met for the seller. The monopolist is making the most profit they can. They have no reason to change their price. Buyers, though, might wish for a different price.
Idea 3 (the market finds its way) still applies. If the monopolist sets the price too high, they might have too much product. They will then lower the price to sell more and make more profit. If the price is too low, they might not be making as much money as they could. They will raise the price to reach their best profit point.
When Businesses Play Strategy: Nash Equilibrium
The Nash equilibrium is used when businesses make decisions based on what their competitors are doing. It's like a game where each player chooses their best move, knowing what the other players might do.
For example, imagine two companies selling the same product. Each company decides how much to produce. Their profit depends on how much both companies produce. A Nash equilibrium happens when both companies are producing the amount that gives them the most profit, given what the other company is producing. Neither company wants to change its production level because it's already doing its best.
In this situation, Idea 2 (no one wants to change) is met. Each company is happy with its choice. Idea 1 (everyone agrees) is also met because the market price fits with the total amount produced. The idea of stability (Idea 3) is a bit more complex here. It means that if companies adjust their production based on what the other did last, they will eventually reach this balance point.
Fair Prices and Real-World Examples
Most economists warn that an equilibrium price isn't always a "fair" price. It just means supply and demand are balanced. For example, food markets can be in balance even if some people can't afford to buy food.
This happened during the Great Famine in Ireland between 1845 and 1852. Even though many people were starving, food was still being sent out of Ireland. This was because sellers could make more money by selling to buyers in England. The market price for food in the Irish-British market was too high for many Irish farmers and families to afford. This shows that a market can be in balance, but the outcome might not be good for everyone.
Finding the Balance Point: How Prices are Set
To find the equilibrium price, economists often look at how much people want to buy (demand) and how much sellers want to sell (supply) at different prices.
Look at the diagram. The point where the supply and demand lines cross is the balance point. At this price, the amount people want to buy is the same as the amount sellers want to sell.
If the price is above this point, sellers have too much product. If the price is below this point, buyers want more than there is. When demand and supply are not balanced, it creates shortages or oversupply. Changes in what people want or what sellers can offer will shift these lines. This then changes the balance price and quantity.
Here's an example using a table:
| Price ($) | Demand | Supply |
|---|---|---|
| 8.00 | 6,000 | 18,000 |
| 7.00 | 8,000 | 16,000 |
| 6.00 | 10,000 | 14,000 |
| 5.00 | 12,000 | 12,000 |
| 4.00 | 14,000 | 10,000 |
| 3.00 | 16,000 | 8,000 |
| 2.00 | 18,000 | 6,000 |
| 1.00 | 20,000 | 4,000 |
- The balance price in this market is $5.00. At this price, 12,000 units are demanded and supplied.
- If the price was $3.00, people would want 16,000 units, but only 8,000 would be supplied. This is a shortage of 8,000 units.
- If the price was $8.00, people would want 6,000 units, but 18,000 would be supplied. This is an oversupply of 12,000 units.
When there's a shortage, the price will go up to $5.00. This makes people want less and sellers offer more, bringing things back to balance. When there's an oversupply, sellers will lower the price. This makes people want more, getting rid of the extra goods and bringing the market back to balance.
What Makes Prices Change?
The balance price can change if either demand or supply changes. For example, if people have more money to spend (called disposable income), they might want to buy more goods.
Look at this new table:
| Price ($) | Demand | Supply |
|---|---|---|
| 8.00 | 10,000 | 18,000 |
| 7.00 | 12,000 | 16,000 |
| 6.00 | 14,000 | 14,000 |
| 5.00 | 16,000 | 12,000 |
| 4.00 | 18,000 | 10,000 |
| 3.00 | 20,000 | 8,000 |
| 2.00 | 22,000 | 6,000 |
| 1.00 | 24,000 | 4,000 |
Here, an increase in money to spend means people want 2,000 more units at every price. This shifts the demand curve to the right. Now, the new balance price is $6.00. If people had less money, the opposite would happen, and the price would fall.
Prices also change when supply changes. New technology or lower business costs can make sellers offer more goods at each price. This would lower the balance price. If technology gets worse or costs go up, sellers offer less, and the balance price would increase.
Comparing two different balance points, like we just did, is called comparative statics. It helps us see how changes affect the market.
Balance Over Time: Dynamic Equilibrium
Sometimes, things are in balance even when they are constantly growing. This is called a dynamic equilibrium. For example, in a growing economy, the number of people working might increase. In a dynamic balance, the total amount of goods produced and the amount of equipment (like factories) might also grow at the same rate. This means that the amount produced per worker stays the same.
Similarly, in times of inflation (when prices generally go up), a dynamic balance would mean that prices, wages, and the money supply are all growing at the same steady rate. But the real value of things (what you can actually buy) stays the same.
Comparing two different dynamic balance points is called comparative dynamics.
When Things Are Out of Balance: Disequilibrium
Disequilibrium is when a market is not in balance. This can happen for a very short time or for a long time. For example, if a store orders too many video games, they have an oversupply. They might lower the price to sell them. If they don't order enough, they have a shortage.
Some economists believe that labor markets (where people look for jobs) can be out of balance for long periods. This might mean there are more people looking for jobs than there are jobs available. For most goods, prices usually adjust over time to bring the market back into balance.
More to Explore
- Exchange value
- Law of value
- General equilibrium theory
- Prices of production
