Exploring Imbalance: Root Causes, Economic Consequences, and Real-life Illustrations
In the world of economics, markets strive for a state of balance where the quantity supplied matches the quantity demanded. However, this equilibrium is not always achieved, and disequilibrium can occur.
A market is in disequilibrium when internal or external forces disrupt the balance between supply and demand, leading to mismatched quantities that can result in surpluses or shortages. This concept was first introduced by the renowned economist John Maynard Keynes.
One example of disequilibrium is a shortage market, where the quantity demanded exceeds the quantity supplied. In such a scenario, prices tend to rise, reducing demand as consumers seek to pay less. Conversely, an oversupply lowers prices, boosting demand and eventually leading to a balanced market.
Disequilibrium can also occur due to government intervention, such as setting a floor or ceiling for goods or services. For instance, a labor market disequilibrium can occur when the government sets a minimum wage, causing an excess supply of labor in the economy.
Another factor that contributes to disequilibrium is a balance of payments imbalance. This happens when there is an imbalance between domestic savings and domestic investments. If domestic investments are higher than domestic savings, the excess investments will be financed with capital from foreign sources, leading to a current account deficit.
The first prominent flash crash occurred on May 6, 2010, when the Dow Jones Industrial Average fell more than 1,000 points in just under 10 minutes. The cause was primarily a large sell order executed by a mutual fund using an automated algorithm, which triggered a rapid, severe drop in the U.S. stock market. High-frequency trading algorithms reacting to the rapid price changes exacerbated the event, leading to extreme volatility.
However, it's important to note that market forces tend to restore disequilibrium states back to their equilibrium. Arbitrageurs, who profit from price differences in related assets, play a crucial role in pushing supply and demand back into balance.
Removing market frictions, trade barriers, certain regulations, and improving market efficiency and information dissemination can help maintain equilibrium. Innovations in manufacturing, supply chain, or technology can also help address imbalances between supply and demand within a market.
Changes in an exchange rate when a country's currency is revalued or devalued can cause disequilibrium. A current account deficit or surplus means a country's balance of payments is in disequilibrium.
In the case of a labor market shortage, policy proposals that address unemployed workers or investment in training workers to make them fit for new jobs can help correct the excess labor supply situation.
Many economists use 'general disequilibrium' to describe the frequent state of markets today. It's a reminder that while markets strive for equilibrium, they are not always in balance, and understanding disequilibrium is crucial for making informed economic decisions.
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