No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Five: Supply & Demand: Markets at Work 115 price does not adjust, consumers will continue to use gasoline at a higher rate than they should, and producers will not begin the necessary actions to increase supply. The end result (as we will outline later in this chapter) is that we will have shortages if (1) the price is never allowed to adjust, or (2) there is a much higher price adjustment once prices are allowed to change. MARKET PRICE DETERMINATION: EQUILIBRIUM We’re now ready to explore the most useful model in economics: the intersection of supply and demand. This is a simple model, but it’s not simplistic; the interaction between these two curves helps us understand the market process and the prices that we see in markets. Consider Figure 5.4 . The intersection of supply and demand will determine the market price. We will follow conventional economic practice in this text by identifying the market price as an equilibrium condition, despite its incompleteness as a descriptor of the market process. Figure 5.4, Market Equilibrium Price (P*) and Quantity (Q*). The intersection of supply and demand will determine the market price that will tend to prevail. P ($) Q (#) Q * P* S D Equilibrium: a market price where all buyers that want to sell and all buyers that wish to purchase can do so—a state of economic balance where individual plans (and the expectations which guide those plans) are mutually compatible in the sense that all plans can be accomplished. EQUILIBRIUM: ALWAYS OR NEVER? One online dictionary defines equilibrium as “a stable situation in which forces cancel one another.” Many economic analyses implicitly use this definition, yet we will see that it is woefully insufficient. Even worse, it leads to a view in economics that confuses what happens in the market. Another specialty definition (for geography) gets much closer to economic reality; “An ideal condition towards which a channel is ever tending to develop.” By noting this is an ideal, as a positive statement (what is) it acknowledges that equilibrium is not a reality, but something that a market has a tendency to move towards. The problem with this use of the term ideal is that some think of “ideal” in the normative sense (what should be) and they therefore see prices that are not at some “equilibrium” as something that is almost morally wrong and that needs government to fix. In reality, the market is a process , and the really important economic phenomenon of interest relates to the process of reaching any so-called market equilibrium. The equilibrium that most economists focus on is really of little value in understanding behaviors. The market is constantly adapting to the changing behaviors, tastes, productive techniques, etc., and therefore any equilibrium is at best only at the moment we call “now.” So are we always in equilibrium, or are we never able to achieve it?