Market Disequilibrium

Difference between market equilibrium and disequilibrium

When the price shifts in either direction away from the equilibrium and prevents the market from clearing, disequilibrium occurs. Thus, the difference between market equilibrium and disequilibrium is that unlike the former, disequilibrium takes place when quantity demanded does not equate to the quantity supplied, thus leaving either a shortage (lack of product or service to satisfy demand) or a surplus (excess of product or service).

Disequilibrium definition economics

If the price falls below the equilibrium price, it would cause the quantity demanded to be greater than the quantity supplied, which would result in a shortage. Inversely, if the price rises above the equilibrium, the quantity supplied outweighs the quantity demanded and results in a surplus. Both are cases of disequilibrium, and can occur due to factors such as sticky prices, government controls, and producers' decisions that fail to maximize profit.

Market disequilibrium graph - shortages and surpluses

If, for any reason, quantity demanded exceeds quantity supplied, there will be a shortage, meaning there is not enough product or service supplied to fulfill the existing demand. Alternatively, if the quantity supplied exceeds quantity demanded, there will be a surplus, meaning there is not enough demand to consume the quantity of the good or service placed on the market.

Market disequilibrium graph - shortage

A market shortage takes place when quantity demanded is greater than quantity supplied. In most cases, such excess demand occurs due to the market price being below the equilibrium. The Law of Demand states that the lower the price, the higher the quantity consumers will seek. However, at the point where price is lower than the equilibrium, supply will be unable to suffice the quantity demanded, meaning that consumers will be unable to obtain as much of a product or service as they seek.

Take a look at Figure 1 below for an example of a market disequilibrium graph with a shortage illustrated on a graph. P₁ represents the price corresponding to the market equilibrium, where the quantity demanded equals quantity supplied (Q₂). However, when price shifts to P₂, quantity demanded at Q₃ is now greater than quantity supplied at Q₁, thus creating a shortage of Q₃-Q₁.

Figure 1. Market disequilibrium resulting in a shortage, StudySmarter Originals

In response to the demand of the consumers, producers will raise both the price of their product and the quantity they are willing to supply. The increase in price will be too much for some consumers and they will no longer demand the product. Meanwhile, the increased quantity of available products will satisfy other consumers. Eventually, equilibrium will be reached. In this situation, excess demand has exerted upward pressure on the price of the product.

Market disequilibrium graph - surplus

If quantity supplied exceeds quantity demanded, the result is a surplus. This can occur due to the market price rising above the equilibrium price. As per the Law of Supply states that quantity supplied increases as price increases, and producers will provide higher quantities of their product or service due to the higher price. However, at this point, the price will be too high for consumers to clear the market, thus leaving a surplus.

Refer to Figure 2 for an example of a market disequilibrium graph with a surplus occurring in the market. At price P₁, which corresponds to the equilibrium, quantity supplied equals quantity demanded at Q₂. But when price rises to P₂, quantity supplied shifts to Q₃ while quantity demanded at this higher price is lower, at Q₁, thus creating a surplus of Q₃-Q₁.

Figure 2: Market disequilibrium resulting in a surplus, StudySmarter Originals

This will induce firms to lower their price to make their product more appealing. In order to stay competitive, many firms will lower their prices, thus lowering the market price for the product. In response to the lower price, consumers will increase their quantity demanded, moving the market toward the equilibrium price and quantity. In this situation, excess supply has exerted downward pressure on the price of the product.

Causes of market disequilibrium

While there are many factors that can cause disequilibrium in a market, consider the ones outlined below:

Market Disequilibrium: Sticky prices

Price stickiness refers to the resistance of the market price of a product or service to change in response to changes and conditions in the market that direct the price to an optimal point. Prices may be “sticky” due to suppliers being resistant or unwilling to quickly change prices despite the changes in market conditions (for example, changes in consumer behavior, production costs) pointing them to do so.

Market Disequilibrium: Government controls

Governmental authorities may intervene in markets by setting price floors or price ceilings for certain products or services. Price floors are price minimums enforced by the government, meaning the price of an affected product or service cannot go lower than the set price floor. Price ceilings are set at maximum prices, hence preventing the price of a product or service at hand to increase past the price ceiling.

Price floors may lead to surpluses if the set price is significantly greater than the equilibrium, thus causing the quantity supplied to be greater than the quantity demanded, with no way to adjust for the imbalance due to the government enforcement. Inversely, price ceilings may cause shortages if the set price is below the equilibrium, thus leading to quantity demanded exceeding quantity supplied.

Market Disequilibrium: Producers' decisions

Based on various circumstances and the influence of outside factors, producers may not always make decisions that are aimed to maximize utility, which would otherwise allow the market to balance out. Suppliers may manipulate prices and quantities supplied in a different direction from what the market suggests. In turn, such decisions may lead to quantities supplied being greater or less than the quantity demanded, thus causing surpluses or shortages.

Market Disequilibrium: Changes in consumer behavior

Shortages and surpluses may occur due to other abnormalities in consumer behavior influenced by a variety of social factors. Consumers may suddenly change their purchasing behaviors based on recent events, news, developments in research, and other factors that may impact how consumers make their purchasing decisions. As a result of such sudden changes, shortages or surpluses may occur for certain goods and services.

Market disequilibrium example

Consider a hypothetical situation provided below for a market disequilibrium example, where the change in consumer behavior leads to disequilibrium.