Disequilibrium

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Disequilibrium Meaning

Disequilibrium is a state of the economy in which the quantity demanded of a product or service is not equal to its quantity supplied. It causes the price of a product to either rise above or fall below the equilibrium price. The purpose of studying disequilibrium is to analyze the variation in market price and equilibrium price.

Unlike disequilibrium, when the prices are in equilibrium, the quantity demanded equals the quantity supplied. Apart from impacting prices, disequilibrium may also exist as a surplus (receipts are more than payments) or deficit (payments are more than receipts) in the balance of payments (BOP) of a country.

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  • Disequilibrium is the lack of equality in the quantity demanded and quantity supplied of a product or service. The state of disequilibrium is present in almost every market.
  • The disequilibrium state may be created due to factors internal or external to the firm.
  • The internal causes of disequilibrium include fixing the prices of certain products or services by the firm. The external causes include the onset of a pandemic, war or a natural calamity.
  • The laissez-faire and Keynesian approaches can help resolve the state of disequilibrium.

Disequilibrium Meaning Explained

Disequilibrium

Disequilibrium is the natural state of an economy, while equilibrium is an unreal one. The concept of disequilibrium originated in the book, The General Theory of Employment, Interest, and Money. This book, written by John Maynard Keynes, was published in 1936.

The price disequilibrium of economics is characterized by a shortage or a surplus. These are explained as follows:

  • Shortage: When the quantity demanded is more than the quantity supplied, there is a shortage in the economy. A shortage causes the prices to rise, thereby increasing the quantity supplied and reducing the quantity demanded. The prices increase till an equilibrium level is reached.
  • Surplus: When the quantity demanded is less than the quantity supplied, there is a surplus in the economy. A surplus causes firms to reduce the prices, thereby reducing the quantity supplied and increasing the quantity demanded. The prices reduce till an equilibrium level is reached.

Disequilibrium often forms the basis of the creation of a new equilibrium. This is because the market forces push the prices towards a new equilibrium.

In the following image, notice that the equilibrium price is $30. At this price, the quantity demanded and supplied is 3000 units. Any price above $30 (like $40) marks a surplus. Likewise, any price below $30 (like $20) marks a shortage. The blue horizontal lines show an excess (or surplus), while the black horizontal lines show a shortfall (or shortage).

Disequilibrium Price

Causes

The disequilibrium state may be created due to reasons within or outside a firm. These reasons are listed as follows:

  • Fixed prices of goods and services: The manufacturer may decide to keep the prices of products or services fixed through a given time period. In such cases, the prices are not changed irrespective of an increase or decrease in the quantity demanded. This creates price disequilibrium in the economy.
  • Government regulations: The government may fix the maximum or the minimum prices on certain products and services. It may also impose tariffs (taxes) on the sale of certain commodities. Consequently, such government regulations may impact the demand and supply, thus pushing an economy into disequilibrium. For instance, the government may fix a minimum wage rate for laborers. If this minimum wage rate is more than the equilibrium price for laborers, the quantity of labor supplied increases. This is referred to as the disequilibrium of the labor market.
  • Deficit or surplus of the current account: A deficit or surplus is created in the current account when the imports of a nation do not match its exports. For instance, in a boom, consumer spending increases causing an increase in imports. This leads to a deficit. On the other hand, in a recession, consumer spending reduces causing a decrease in imports. This leads to a surplus. The disequilibrium of the current account (deficit or surplus) creates disequilibrium in the balance of payments of a country.
  • Other reasons: Political instability, variations in the foreign exchange rate, inflation, deflation, and so on can also create a state of disequilibrium.

Examples

Let us go through some examples to understand the disequilibrium of economics.

Example #1

A mobile manufacturer, XYZ experiences a high demand in the country due to the unique features of its product. However, with the onset of the pandemic (Covid-19) in 2020, the supply chain of the mobile is negatively impacted. The consequences are stated as follows:

  • The transportation of raw materials and finished products is impacted significantly.
  • The quantity supplied reduces though the quantity demanded stays at a high level. This creates a shortage of this mobile in the economy.

Example #2

In 2016, Mervyn King (former governor of the Bank of England), warned that the world economy may soon experience a state of disequilibrium. The reason is the reduced interest rate by central banks of certain nations. The consequences are stated as follows:

  • Low interest rates have created price inflations. These price inflations have reduced the purchasing power of the consumer and made the stock markets more volatile.
  • The change in the purchasing power of consumers will impact the market forces of demand and supply. This may, in turn, create disequilibrium in the world economy.

How to Resolve Disequilibrium?

The disequilibrium state can be resolved by following the listed policies:

  • Laissez-faire policy: The supporters of this policy believe that there should be minimum or no government intervention in the economy. If this is followed, there would be no regulations on market prices leading to an equilibrium state of the economy. It is believed that the economy will reach equilibrium if left alone.
  • Keynesian approach: The supporters of this theory believe that the government should focus on economic expansion, specifically at the time of recession. This implies lowering taxes and increasing government spending on certain products and services. Such constructive intervention would reduce the impact of the recession and restore the growth of the economy.

Frequently Asked Questions

1. What does disequilibrium mean?


It means the shift of the market price either above the equilibrium price or below it. When the market price is more than the equilibrium price, there is an excess of quantity supplied in the economy.

Conversely, when the market price is less than the equilibrium price, there is a shortage of quantity demanded in the economy. Further, a surplus encourages sellers to reduce the price, while a shortage encourages buyers to pay a higher price for the given product or service.

2. When does disequilibrium take place?


It occurs when the quantity demanded is either greater or lesser than the quantity supplied. In other words, the market price of a product or service does not match its equilibrium price.

The disequilibrium state is characterized by a shortage or surplus depending on whether the quantity demanded is more than the quantity supplied or vice versa.

3. What causes disequilibrium?


It is caused by a surplus or deficit of the current account, change in government policies, change in foreign exchange rates, change in the pricing policies of a firm, natural calamity, and so on.